Monday, December 10, 2018

Three Keys To Trading Performance

In the latest Forbes article, I share three important trading lessons that I have learned from Victor Niederhoffer.  These are not the usual trading psychology homilies; they reflect real-world experience with making sense of market behavior.

The truth is, I could have offered a dozen more lessons I've learned from Vic--all of which are highly relevant to trading.  Here are a few keys to trading performance inspired by his example and reinforced over the years:

1)  It's all about the reps - Vic became a squash champion with fanatical practice, drilling and mastering shots.  In preparing for more active trading this coming year, I am using each trading day as a review, tracking the "trades of the day" and the ways in which they have set up, the ways of best entering them, the ways of best managing positions after entry, etc.  Every day becomes a textbook lesson in good trading.  As markets change, the trades of the day also shift--and the reps are helpful in adapting to the new market conditions.

2)  Think outside the box - I am convinced, based on years of experience working with successful traders, that there is no edge in being consensus.  If you are part of the herd looking at the same charts, regurgitating the same narratives, there is no way to achieve distinctive returns.  My own trading has undergone a renaissance as the result of making cycles the most basic unit of analysis.  Identifying dominant market cycles within stable market periods allows the trader to know when markets are likely to exhibit momentum and when they are likely to reverse.  This has freed me from bullish or bearish biases--there are always ups and downs to be exploited in markets.

3)  Collect people - Vic is a consummate collector.  He has collections of art, collections of books, collections of historical artifacts.  His house is a veritable museum.  But where Vic has been most successful is in collecting people.  He seeks out accomplished people in various fields and brings them together, whether online, in meetings, or in parties.  I don't know any successful traders who don't have well-curated professional networks.  Quite simply, people who are excellent in their domains bring out our own excellence.  We internalize what we experience; that is why we should always surround ourselves with excellence.

Life is too short to settle for mediocrity.  What are you doing in your practice, in your thought processes, and in your social life that elevates you toward excellence?  Such reflections are an excellent way to begin planning for a new trading year.

Further Reading:


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Thursday, December 06, 2018

Finding A Mentor, Not A Guru

One of the best things a developing trader can do is find mentors.

One of the worst things a developing trader can do is follow gurus.

Gurus are not mentors.

Gurus offer answers; mentors teach you how to arrive at answers.

Gurus promote the right way to do things; mentors teach you to find the right ways for you.

The recent Forbes article highlights the sobering fact that 95% of people are imitators; only 5% are initiators and innovators.  Isn't it interesting that those odds are similar to the odds of independent traders becoming consistently profitable?  Imitation is not a winning strategy.  It is a sure path for being part of a herd.

When I spoke with traders at the recent meetup for My Investing Club, I emphasized the importance of learning from your own trading experience:  what works for us and makes sense to us often reveals our underlying strengths.  A mentor can help you learn from your experience; not follow their advice and experience.  

The MIC home page begins with the phrase, "Mentorship is the shortcut to success."  That calls to mind a story recalled in a Jewish book called Tanya.  A Rabbi was trying to find his way to the city and asked a child for directions.  The child explained that there was a "short and long way" and a "long and short way".  The Rabbi took the short and long way and found his path obstructed.  He then returned and asked the child why he had said the path was short.  The child said, "Didn't I also tell you it was long?"

The path of the guru is the short but long way.  It promises quick answers, but these don't work in practice, because they do not draw upon *your* strengths and *your* ability to adapt to shifting markets.  When you follow the guru, you become obstructed--and that makes it a long way.

The long but short way is mentoring.  It takes time to learn from experience and internalize those lessons, just as it takes time to become a golf champion or an Olympic winner.  Mentoring can accelerate the development process by helping you learn from both successes and mistakes--and by giving you *many* models of success that you can integrate to make your own.  That makes mentoring the long but short way--the real shortcut, as MIC notes.

The Forbes article points out how easy it is for us to become influenced by others.  I have never met a consistently profitable trader who has not demonstrated a high degree of intellectual independence.  At SMB, for example, developing traders are part of a team and receive mentoring from senior, successful traders.  They are expected, however, to develop their own "playbooks" and cultivate their own understandings of markets, stocks, and opportunities.

One of the most common errors we make in thinking about trading success is that mentoring is limited to the early years of development.  If markets always traded the same way and followed the same patterns, this would be the case.  It is the ever-changing nature of markets that ensures we not only learn, but continually relearn and update our learning.  That means it is helpful to have mentors throughout one's trading career: colleagues we can learn from.  In dynamic fields, such as medicine and technology, education is not enough.  Success requires continuing education.  And that means ongoing mentoring.  

Further Reading:


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Monday, December 03, 2018

When Your Past Overwhelms The Present

Margie and I are currently fostering a lovely young cat who spent the first year of life in a relatively confined space.  He was wary upon first meeting us, but warmed up and began to play and purr.  This morning, I set up his cat bed in a larger room so that he could become accustomed to new space.  When he saw me carrying the bed, he had a complete meltdown.  He panicked, hurled himself against the window to escape, and shook and growled.  When I put the bed down and spoke to him softly, he calmed down and was eventually able to resume play--but only after returning to his safe bedroom space.

Trauma occurs when life incidents become such threats that they overwhelm our coping.  Not all trauma is full-blown PTSD.  Many events in our lives leave scars that can be reopened at various times in our lives.  A person who was mistreated as a child may function quite well as an adult, but suddenly "overreact" when treated unfairly at work or in a romantic relationship.  Not so different from the cat.

All of us bring our personal histories to trading.  When unresolved issues of self-worth, anger, or anxiety are triggered by the challenges of markets, we can be a bit like the cat.  We can "overreact".  But, of course, what looks like an overreaction in the present is really nothing by a reaction to our emotional past.

Not all of us are acting out our past in our current trading.  But if you find yourself "overreacting" to life events outside of markets--at work, in relationships--there is a high probability you'll bring those issues to your trading.  That's when a professional counseling relationship can be useful to resolve those issues.  No amount of playing with indicators or listening to trading coaches will put your past into perspective.  Investing in the right kind of help could be the best thing for your trading.

Further Reading:


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Friday, November 30, 2018

Rigorously Reviewing Your Trading

One thing I'll be talking about in Saturday afternoon's NYC meetup for My Investing Club will be an enhanced review process I've initiated for my own trading.  My general observation is that the frequency and intensity of review processes is associated with learning and performance improvement.  What I'm testing with the enhanced process is whether making the review structured and concrete also contributes to the learning and development curve.

So what I did was write out all my trading rules in a two-page Word document.  The rules are broken down to explain in detail:

a) What I need to see to enter a position (This includes criteria on multiple time frames);
b) What I need to see to tell me the position is incorrect;
c)  How I need to size the position;
d) What I need to see to take initial profits and the portion of the position to take off;
e)  What I see as a subsequent target and where to take the rest of the position off;
f)  When to not trade; when to trade more actively; when to trade more selectively.

This trading document/plan serves two important purposes:

1)  Review before trading starts to ensure that the rules are being followed in generating ideas, with special emphasis on the rules relevant to the prior day's trading;

2)  Review at the end of trading to assess whether rules were followed and especially to look at how a following of the rules could have improved the day's trading;

3)  Targeting one or more rules to focus on for the coming session to improve trading.

The idea is that every day is a practice situation in implementing the trading framework.  Over time, we become more grounded in our best practices, and we also better as rule-governed traders.  This is the value of having a true playbook for each market and strategy that we trade, as Mike Bellafiore has illustrated.

What I can tell you from my experience is that just the act of putting your trading into a very tight, clearly defined rules framework highlights the factors of what we most need to focus upon to improve our performance.  If we cannot convey our best practices on paper in a way that others can understand, how can we expect to be grounded in them in real time?

Further Reading:


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Sunday, November 25, 2018

How To Invest In Your Trading

I'm looking forward to a NYC meetup with My Investing Club members on Saturday.  On the surface, the group is misnamed.  Almost everyone in MIC is a trader, not an investor!  That misses an important point, however.  Becoming part of a trading group is all about investing in your trading.  Too many traders treat their trading like trades:  they try one approach, then another; work on one thing, then another.  In and out, in and out.  The successful traders invest in their trading:  they devote ongoing effort to growing themselves and their trading processes.

A great example of this is the idea recently put forward by Modern Rock:  finding a Trading Accountability Buddy (TAB).  The key word here is accountability.  A TAB is a co-investor in your trading business:  someone who learns with you, learns from you, and teaches you.  Think of it this way:  if you learn one valuable trading lesson each day and turn it into an improvement the next day, you'll achieve a tremendous compounding of learning over the course of a year.  But if you *and* a TAB share your learned lessons and improvements, you've now doubled that compounding.  You succeed simply because you're on a much more rapid learning curve than others.

What a great investment in your trading.

As Alex points out, one of the great advantages of an investing group is the opportunity to get together in person in a setting like a Hawaii beach (or a NYC pub!) with multiple potential accountability buddies.  Everyone shares experiences; everyone answers questions; everyone becomes a resource for others.  Investing in trading becomes a group process, not just something you do in isolation.

I'm in the middle of writing my fifth book on trading psychology--one that will be very different from the others.  The topic is the relationship between spirituality and trading:  how it's not enough to develop ourselves--we have to develop our selves.  So many of problems that impact trading--from overtrading to greed and fear of losing--are *not* the result of psychological disorders.  They are the result of letting our egos get in the way of our trading.  The techniques and perspectives taught by the world's great spiritual traditions really are ways of moving beyond ego.  As I illustrate in the book:  Great trading comes from the soul, not the ego.

I look forward to talking about soul-full investing at the New York meeting--and in coming blog posts!

Further Reading:


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Wednesday, November 21, 2018

Oversold In An Oversold Market: What Happens Next?

I've been interested to see a number of bearish stories about the stock market in recent days.  Somehow these stories were missing when we were trading close to the highs.  But the assumption seems to be that because we've seen weakness in stocks, oil, high yield bonds, etc., we are in danger of an outright bear market.

Maybe.  

Sometimes that happens.  

But is that truly a trade-worthy idea?

Yesterday, we saw fewer than 10% of all stocks in the SPX average trading above their three-day moving averages.  The market is broadly weak in the short run.  Interestingly, when we look at how the SPX stocks are trading relative to their 5, 10, 20, 50, 100, and 200-day moving averages, well fewer than 50% are trading above those benchmarks.  So we're very oversold on a short-term basis in a market that is also oversold on a medium and longer-term basis.  (Data from the excellent Index Indicators site).  

It turns out that this configuration has occurred 46 times since 2010.  Ten days later, the SPX has been up 33 times and down 13 times for an average gain of over +1.63%.  Many of the losing instances clustered in the 2011 period when we had some prolonged weakness.  Similarly, when we take the data back to 2006, losing instances clustered in 2008/2009, so that there was a positive return over the next day or two from 2006-2009, but actually a negative average return over the following ten days.

There is a subtle but important lesson here.  The human tendency is to make an assumption about whether we are in a bull or bear market and then extrapolate expectations on that basis.  A better use of the data is to recognize that the kind of pullback we've seen is historically a very good buying opportunity in all but significant bearish periods.  If we do not see a sustained bounce as we walk forward day over day, we can update our thinking to increase the odds that perhaps we're in the throes of a bear.  Conversely, if we see sustained buying, we can question the bear thesis as we walk forward.

Rational traders and investors operate in a Bayesian manner.  They start with a researched base case founded on experience and then keep an open mind, modifying the odds of their base case as new data emerge.  For them, conviction is a process, not something we have or don't have.

Further Reading:


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Sunday, November 18, 2018

The Best Way To Trade Better Is To Trade Better Ideas

Margie and I visited the Aros art museum in Aarhus, Denmark earlier today, where we circled the Rainbow Panorama and viewed the town landscape through a variety of colored glass walls.  The idea is to be inside a rainbow and see what the world looks like.  Indeed, the same scene gives a different appearance when viewed through colors of orange, blue, and yellow.  The colors turn ordinary experience into a work of art.

In the recent Forbes article, I describe three techniques for generating creative insights.  The key point of the post is that trading psychology does not just help us trade our ideas better; psychology can also help us find better ideas to trade.  My experience, with hedge fund managers, day traders, and longer-term investors, is that the single most important thing we can do to improve performance is improve our idea generation.

A powerful way of accomplishing that is by viewing markets through fresh lenses, just as we did in viewing the skyline from the art museum.

Here are a few ways I've seen traders use creative processes and insights to view markets through fresh lenses:

1)  A very successful trader charts and analyzes patterns in the relationship between markets, not the markets themselves.  For example, he looks at spread relationships in commodities, relative value relationships in rates, and relative strength data for individual stocks.  The relative strength data that he examines shows clearer and cleaner patterns of momentum and reversal than the usual data traders look at, setting up successful trades.

2)  In my recent trading, I have viewed market data through the lens of volume bars (a fresh bar draws after a certain amount of volume that is traded).  The volume bars even out market activity over different parts of the day, yielding clearer patterns of market cycles.  These cycles provide a powerful way of making money when there are not clear trends.

3)  Market Delta breaks each transaction in futures markets into "buying" transactions (those transacted at the market offer price) and "selling" transactions (those transacted at the market bid price).  The ongoing flow of trades at bid versus offer effectively captures shifts in dominance between big buyers and sellers, helping individual traders identify potential turning points.

4)  An enterprising fund utilized satellite data to identify traffic patterns in shopping malls and estimate consumer activity.  These data provided advance information of both company earnings and overall economic activity. 

What is the common thread here?  In each case, the creative trader is not just interpreting the same data in different ways, but actually viewing different data.  This creates fresh perception and the identification of patterns that others cannot see.  The blunt reality is that, if we look at the same information as everyone else, we'll pretty much see the same things as everyone else.

Great ideas begin with creative insight and creative insight begins with fresh perception.  When you have new data, you can see new things--and suddenly markets and ideas become less crowded.

Further Reading:  


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Tuesday, November 13, 2018

How Overconfidence Derails Our Trading

Here's an observation I've made of both traders and investors--those with little experience and those who have been doing this all their lives:

They are at their best when they treat their ideas as hypotheses and continually update their hypotheses as price action, news, and fundamental data emerge.  Their focus is on what they would need to see to disconfirm their hypotheses.  That allows them to exit quickly and limit risk in adverse conditions.  It also enables them to take the opposite side of a trade should they observe a meaningful disconfirmation of their ideas.

The traders are at their worst when they treat their ideas as conclusions and dig in their heels in these views in the name of "conviction".  This leads them to interpret market information with confirmation bias, looking at data that support their views and minimizing information that might not support their ideas.  Such an approach leads to a loss of flexibility and a situation where the only effective stop level is pain.

One way we turn confidence into overconfidence is by crystallizing our observations into narratives.  Among portfolio managers trading global markets and strategies, this is sometimes pejoratively referred to as "macro story telling."  The trader observes information--perhaps fundamental, perhaps monetary, perhaps intermarket, perhaps price-action based--and turns these observations into a narrative.  "Stocks are going higher because economic conditions are improving and sentiment is bearish."  That could be a simple narrative.  It is not a tested set of relationships, and it is not treated as a hypothesis.  It is a conclusion drawn from limited pieces of information.

It's surprising how often traders with bullish or bearish biases can find information to weave into bullish or bearish narratives!  

Once the narrative has crystallized, it organizes our perception.  We see the world through the lenses of our narratives.  That makes us less sensitive to other, possibly more relevant lenses and information.  Seeing the world through our story-telling--and then justifying that in the name of confidence--is the height of overconfidence.  What we want instead are multiple hypotheses, each with shifting odds as information comes out.  At some point, the odds shift sufficiently that we can put on a trade.  But we are always updating those odds, and we are always aware of what would lead us to reverse that trade.

A great exercise is tracking your self-talk during the course of a trade.  Is your internal dialogue information-based, or are you grounded in a single narrative?  Are you flexibly assessing odds and possibilities, or are you looking for information to support your fixed view?  Or are you so self-focused and P/L focused during the trade that you never get the chance to update your thinking?  That often occurs when our "conviction" views suddenly prove vulnerable.

This is one of the great ironies of trading:  It takes unusual confidence to believe that we can outperform the world's most experienced money managers.  Taken too far, however, that confidence can ensure our failure.

Further Reading:  


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Sunday, November 11, 2018

The Role Of Creative Insight In Trading Success

In the Trading Psychology 2.0 book, I outline several new frontiers for improving trading performance.  One of the most interesting and promising is the enhancement of creativity.  Simply put, the success of traders and investors rests on their ability to perceive unique, distinctive market opportunities that are not apparent to others.  For the faster, shorter-term trader, this means detecting patterns in price action that reflect shifts in supply and demand.  For the slower, deeper-thinking investor, it means piecing together information about companies and economies and arriving at original theses that ultimately will drive the behavior of other market participants.

Having worked with very successful market participants who operate in both the faster and slower modes, I can attest to the role of creative insight in the trading process.  This not only pertains to the generation of ideas, but also their management.  During the life of a trade there are many decisions to add to positions, take them off, or hold them.  For the discretionary trader, all of these decisions are more or less informed by creative insight. 

Here are a few ideas relevant to the role of creative insight in trading success:

1)  Few trading processes--from market preparation to research/idea generation to risk management--are designed to maximize the creativity of the trader.  Indeed, common trading behaviors, such as discussions on trading floors and ongoing following of price action on our screens, actively interfere with creative outcomes.  When traders talk about "process", they often mean the repetition of helpful practices.  This is valuable, but the following of routines via habit patterns, will not in itself maximize the creativity of a trader's thought process and, indeed, may work against it.

2)  Maximizing creative thought requires an unusual degree of flexibility.  What we know about creativity suggests that multiple brain centers are at work in processing information, reflecting multiple cognitive processes.  Processing multiple, different sources of meaningful information and processing all that in different cognitive modes (analytical, reflective, etc.) aids the insight process.  Sitting in one place and staying in one dominant mode of analysis/thought is a great way to stifle creativity.

3)  Creativity is never maximized in our normal, routine states of consciousness.  Research into creativity suggests that a variety of moods and levels of cognitive focus/awareness impact creative thought.  There is a very strong case to be made that many of the commonly noted psychological problems experienced by traders--from performance anxiety and overtrading to frustration and lack of discipline--stem from states that actively inhibit creative thought. 

In short, a major problem with trading performance is that traders focus on what they perceive to be their "edge" in markets when in fact "edge" is the result of a process, not a static set of market relationships.  Where there is no creativity, there can be no edge.  Reducing "edge" to a rote series of patterns virtually ensures that the trader will fail when market regimes change.  It is the ongoing creative process that fuels our adaptation to evolving market conditions. 

The implications of this perspective are profound.  The most useful self-coaching traders can do is reverse-engineering their best trades and especially the processes that led to the relevant decisions.  A solution-focused perspective suggests that all experienced, reasonably successful traders already are tapping into creativity at various points in the trading process.  The key is distilling *your* ingredients of creative insight and turning those into robust routines that can provide you with an actual, ongoing edge.

Further Reading:


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Thursday, November 08, 2018

Strategies For Overcoming The Big Losing Days

It's not uncommon to find traders who make money more often than they lose it, only to wind up with negative P/L due to the presence of a relatively small percentage of big losing trades.  Bella of SMB recently wrote a post on five ideas of how to minimize the damage on your worst trading days.  These same principles apply to longer time frame managers, who can see many portfolio gains erased by a single outsized loss in one position.  Let's see if we can build upon Bella's insights and figure out ways of overcoming large losing days.

1)  Risk Management - I'm convinced that one of the great advantages of trading at a hedge fund, prop firm, etc. is the presence of external risk management.  A good risk manager will not only hold you to loss limits, but can catch you in the process of losing too much.  Even better, a risk manager can play a proactive role by letting you know when you might be vulnerable, perhaps by holding multiple correlated positions or by holding a large position going into a major news event.  As I've mentioned in the past, no baseball pitcher is expected to take himself off the mound.  That is the job of the pitching coach.  Sometimes it's not your day, but that can be tough to recognize in the heat of battle.  The risk manager is your pitching coach.

So what do you do if you don't have a dedicated risk manager?

Substituting for the risk manager, as Bella notes, are hard and fast rules for how much you can lose in a single position; how much you can lose in a day/week/month; how much you can lose across positions.  It is important to make these rules explicit--written down and in front of you--and it is important to size all positions so that, if they are stopped out, they will not exceed the limits you set.

For portfolio managers, that means knowing your risk per position and acceptable risk across the portfolio.  For day traders, it means knowing your risk per trade as well as your risk per day.  For active day traders, I like the idea of having separate risk limits for the morning trade and then again for the afternoon, effectively breaking the day into two trading days.  For active portfolio managers, I like having risk limits for each month or quarter.  

The idea is to never lose so much in one period that you can't come back in the next one.

2)  Psychological Management - The big losing days are typically the result of snowballing.  One loss leads to another leads to frustration leads to imprudent trading.  Or, overconfidence and directional bias leads to oversizing trades, which leads to vulnerability and frustration.  At such points, the problem is not just the shift of mindset, but the lack of awareness of this shift.

Look, we expect competitive people to not like losing, to have periods of frustration.  And, for all of us, the ego can sometimes get in the way of doing the right things.  We are fallible; that we can't control.  What we can do is become better and better at *recognizing* our fallibility.  This is why preparation before we begin trading is so important, allowing us to identify in advance what would tell us our positions are the wrong ones.  On my trading screens, overlaid on charts are various indicators, including short-term RSI, moving averages, regression lines, etc.  Do I think those are predictive?  Not really.  They are there because, if I'm trading directionally, those weather vanes should be pointed in my direction.  If we dip below a key moving average while I'm long, I want to mentally rehearse my stop scenario.  The idea is to anticipate loss and cement in your mind what you'll do about that loss.

Why is that effective?  It is difficult to become frustrated about an outcome you've rehearsed many times.  It's difficult to go on tilt and trade poorly if you've clearly laid out your plans for a losing position.  This is why, when a position is on, I want to rehearse my exits in detail.  I want to know where to take profits, where to get out.  That becomes a kind of mantra while the trade is unfolding.

I generally find that, if I start the day flexible and open-minded, rehearsing a variety of trading scenarios, I don't get too caught up in any one idea.  Excitement is just as much of a risk factor as pessimism and negativity.  I recently went in for routine surgery.  The surgeon was all business, clearly planning out the procedure with the team.  Do I want a surgeon who is excited about the procedure?  Do I want a surgeon who is full of "conviction" over his plan for the procedure?  Hell no.  As it turns out, the surgery discovered a couple of unexpected growths--fortunately nothing dangerous--that needed to be removed.  That's why they call it exploratory surgery.  All trading should be exploratory trading.

If you have firm risk limits and a process that keeps you aware of your thought processes and the unfolding of your trades, you'll have plenty of losses--but none that have to be debilitating to you or your account!

Further Reading:


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Sunday, November 04, 2018

Becoming a Baby Bear: How We Can Do A Better Job Of Reaching Our Goals

As this video of a baby bear from @ziyatong graphically depicts, there is a lot to be said for motivation as a path toward our goals.  When the situation is urgent and the endpoint remains in front of us, we can summon great drive to achieve the seemingly impossible, just like that baby bear.

The problem is that situations are not always *so* urgent and goals are not always so clearly visible.  We make resolutions and goals in one state of mind only to find that urgency waning when our attention is taken elsewhere.  That is why motivation is necessary to reach challenging goals, but not sufficient.  

In the latest Forbes article, I outline two key factors that help us reach our goals.  In that article, I link excellent research resources that highlight ways in which we can move from the daily leading of our lives to becoming actual leaders of our lives.

A key, per Zig Ziglar's quote above, is turning motivation into a habit.  That is, we create routines--processes--for tapping into the values and visions that animate our lives.  This is why a religious person will start their day with prayer.  The morning prayer, at one level, is a habit.  At another level, it is a way of connecting with what is meaningful and motivating.

When we have habits that tap into motivation, suddenly our goals become urgent and visible--and we can be like that baby bear.  It's not enough to wake up our bodies in the morning; we also have to awaken spirit.  Without the habit of motivation, goals become little more than wishes...entries in our trading journals that show good intentions, but little more.

What is *your* process for becoming a baby bear?

Further Reading:


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Friday, November 02, 2018

Finding Resources That Make Your Trading Better

An insightful market old-timer explained to me early in my trading career that technical indicators were more like weather vanes than weather forecasts.  In other words, they tell us how the wind is blowing; they don't necessarily tell us what the weather will be.  That doesn't diminish the value of a weather vane.  If we're flying a kite or sailing a boat, the weather vane is quite relevant!

As with sailing, traders make an implicit assumption:  the environment that has characterized the recent past will continue into the immediate future.  This is true whether we are anticipating trend continuation or the continuation of cycles/reversals.  Tools that provide unique information regarding recent regimes are useful weather vanes for guiding trades going forward.

At the recent Trade Ideas conference in San Diego, I was impressed with the VWAP tools introduced by Brian Shannon of Alphatrends.  Volume-weighted average price (VWAP) is a way of tracking the behavior a market or stock by placing the greatest weight on the prices that transact the greatest volume.  It's a true weather vane, telling us if we are staying consistently above or below VWAP or if we are cycling around an average price.  It also tells us if that average price is rising or falling--and if the rate of rising/falling (slope) is changing.  

Brian makes creative use of VWAP in two ways:

*  By anchoring the calculation of VWAP to key price levels, such as points of breakout or points of earnings releases (see here).  

*  By looking at VWAP at multiple time frames, to identify degree of convergence and divergence among the VWAP values (see here). 

If we think of it, the convergence of VWAPs across time frames is a nice way of visualizing the volatility of a market and anticipating possible breakouts.  The anchoring of VWAP tells us if a key level is truly acting as a key level:  for example, if a gap higher is truly leading to a trend.

The larger idea here is to continually grow your trading resources.  Physicians engage in continuing education; they keep up with new ideas and techniques.  Similarly, it's not enough for us to learn as beginning traders: we must continually learn and relearn to adapt to an ever-changing market landscape.

Further Reading:


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Saturday, October 27, 2018

Reading the Psychology of the Market

Just as important as the psychology of the trader is the psychology of *other* traders!  The market itself has a psychology, defined by the moment-to-moment shifts in sentiment and behavior of participants.  There are three questions we need to ask about any market:

*  Who is in the market? - This is defined by volume and relative volume.  More market participation means more institutional participation and greater volatility of price movement.

*  What are they doing? - Are market participants leaning to the buy or sell side?  Is that leaning shifting over time?  As we shall see, the distribution of stocks trading on upticks versus trading on downticks is helpful in reading participant behavior.

*  Where are they doing it?  - We hear traders talk about "key levels" all the time.  Sometimes these are based on support/resistance; sometimes based on ratios and inferences from prior moves.  Whatever.  When we see significant shifts in "who is in the market" and "what they are doing", the price levels at which these shifts occur are meaningful.  If we break to the downside on significantly elevated volume and stocks trading on downticks, we should not revisit the level at which the break occurred if this is, indeed, the start of a market downleg.

Now let's add a fourth question to our ongoing monitoring of the market:

*  How well are they getting it done? - How much price movement are we seeing as a function of a given level of buying or selling?  Are buyers or sellers moving price meaningfully higher or lower, or are they having difficulty breaking to new highs or lows.  Very often, before the bulls take over from the bears or vice versa, we see one side failing to move price significantly.  That side becomes trapped when the other side takes over and needs to cover, contributing to a move in the other direction.

Above we see a chart of a two-hour moving average of the NYSE TICK (red line) versus SPY (blue line) from the start of September to present.  Note how, during the run up to highs in September, the distribution of NYSE TICK values was not meaningfully positive.  The amount of time spent below the zero line was as great as the amount spent above--and actually a bit greater as we moved closer to the highs.  This was one of the yellow caution lights that had me concerned about the quality of the market highs we were seeing.  

Notice how, at the start of the downtrend, we broke to significant new lows in the $TICK measure.  That shift in distribution told us that sellers had taken control of the market.  Note that this occurred relatively early in the decline, when SPY was about 289.  Stocks persistently traded on downticks.

In recent sessions, we have seen buyers come into the market, as we can see by the two-hour measure going into positive territory, but note that they are not "getting it done".  The buying bursts, mostly short-covering, are able to retrace only a relatively modest fraction of the prior price decline.  At some point--and I'm prepared for it to come soon--the selling pressure will have trouble making new lows and buyers will step in more aggressively, with higher $TICK readings.  That is how bottoming processes begin.  

Conversely, if we start the week lower on expanded volume and very negative $TICK readings, then we know we have not yet hit a downside equilibrium.  We can read market psychology by continually updating our assessment of volume, distribution of upticks and downticks, and the ability of both of those to move price.  This is not so much a matter of "predicting" what the market will do as identifying in real time what is actually occurring.

Further Reading:


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Wednesday, October 24, 2018

The Role of Spirituality in Trading

I have been pleasantly surprised by the initial interest traders have expressed in the book I am writing on spirituality and trading.  

The key idea is that many trading problems spring from our failure to transcend the ego.  We identify with winning/losing, with overall P/L numbers, with being right or wrong in our ideas, and all of these identifications lead us to overreact to markets.

The world's great spiritual disciplines are tool kits for moving beyond our egos by connecting with larger realities.  The purpose of the book I'm writing is to acquaint traders with these tool kits and their potential for improving not only trading, but all of life.

One spiritual perspective is that all of our problems recur until we learn from them.  Life is a classroom and the problems we face repeatedly are the lessons we're meant to learn.  

What are your trading problems, and what are they trying to teach you?

Your problems are your curriculum.  Only when we embrace our problems do we learn from them and become more than we are.

Further Reading:


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Saturday, October 20, 2018

How Our Physical Health Impacts Our Trading Psychology

Let's take a look at how the state of our bodies impacts our health and well-being and ultimately the mindsets we bring to trading.

Recent research suggests that a sedentary lifestyle--one without exercise--is more harmful to our health than smoking, diabetes, or high blood pressure.  The lack of aerobic fitness is a larger risk factor for mortality than having many medical conditions that we regard as necessary to treat.

*  Poor posture, such as sitting hunched over a screen for many hours per day, has been implicated in low blood oxygen levels.  Low blood oxygen levels are associated with higher stress levels and greater fatigue, both of which can negatively impact our executive brain functions and ultimately our performance.

Fascinating studies placing people in high altitudes (and thereby reducing their blood oxygen levels) find that low blood oxygen is responsible for declines in mood and worse cognitive performance.  Poor aerobic fitness interferes with our optimal processing of information.

Research finds that increased exercise is associated with lower rates of depression and greater levels of happiness.  Exercise also improves our sleep quality, which in turn is associated with higher levels of well-being and focus/concentration.

There is yet another way in which physical exercise can help our trading.  By training ourselves to tackle challenges, day after day, we build a mindset that encourages the tackling of challenges in other areas of life.  Quite simply, developing ourselves physically can be a powerful pathway toward developing our performance--in markets and in our personal lives.

Further Reading:


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Wednesday, October 17, 2018

The Power Measure: How Is Volume Moving Price?

In the most recent Forbes article, I highlighted the importance of monitoring the amount of movement we get per unit of market volume.  When we look at normal bar charts, we see price as a function of time, with volume on the X-axis.  A large bar tends to be one in which we see increased volume (increased participation at that point in time), moving the market more than usual.

A different way of viewing market behavior is to look at volume bars (price where each bar represents an amount of volume traded) and see if bar size (volatility) is expanding on the upside or downside.  What this is telling us is not just how much volume is coming into the market, but how much each unit of volume is actually moving price.  When we see bigger bars coming in on market upmoves than downmoves, we can actually visualize where the market is finding its greatest ease of movement.

(This is a great example of the importance of creativity in trading.  Looking at price-volume-time through different lenses enables us to see fresh relationships that can illuminate what is actually going on in the market.  Looking at the same charts as everyone else is a great way of seeing the same things as everyone and becoming part of the proverbial herd.)

Above we see the full day's trade in the ES futures for 10/16/2018.  It's a great day to study, given the major turnaround in the overnight session and trend day during NY hours.  The blue line is the ES futures, with each bar representing a small unit of trading volume.  The red line is a running correlation of the size of the bars and the directional movement (open to close) of the bars.  Hence, when we get more upside movement per unit of trading volume, the correlation goes positive and vice versa.  

Shifts in this "power measure" tell us that volume is moving price more easily in one direction than another--a worthwhile heads up, though not a precise timing measure.  Notice, for example, how the correlation shifted positive and stayed positive during the period of the market's big turnaround.  Notice how subsequent moves lower in the correlation occurred at successively higher price lows--a great indication of the underlying strength of the market.

This is a relationship relevant to multiple time frames.  The illustration above, with over 500 bars per day, is clearly relevant to active day traders.  I maintain the measure for bars with much larger volume to examine multiday patterns.  The value of such measures is not as crystal balls, but as multiple lenses through which we can understand the dynamics between buyers and sellers.  There are many other such lenses, such as the shifts in distribution of upticks and downticks across all listed stocks.  Many trading problems occur, not because of emotional disruption, but because of cognitive poverty:  an absence of perspectives that yield fresh, valid insights.

Further Reading:


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Monday, October 15, 2018

How To Prepare For Challenging Trading

If Noah had waited for the storms and floods, it would have been too late to gather the animals and build the ark.  Our role as traders is to prepare for possible adverse outcomes so that we can ensure our survival should one of those materialize.

How can we prepare properly?

In the recent Forbes article on how to navigate these volatile markets, I make the point that a close examination of similar historical periods can help us anticipate a variety of scenarios: both ones of risk and ones of opportunity.  It's not that the immediate future will replicate any of the past price paths in similar circumstances.  It's that the past price paths can tell us what is possible--and maybe even what is likely--going forward.

So let's take a specific example.  I recently noted that we had made a multi-standard deviation move to the downside--over five standard deviations, to be precise.  In similar situations going back to 1993, we were up 11 times, down 4 over the next five trading sessions.  Of the four down instances, all were lower by more than 2%.  Of the eleven up instances, six were higher by more than 3%.  Volatility was the norm and bounces were common.

Psychologically that alerted me that, even though I thought we could see further downside, I had to be prepared for short squeezes.  In fact, those have been more common in the past than not.  The past instances also alerted me to the likelihood of further volatility, which led me to temper my position size.  When we traded weak in morning hours, I took an initial short position, saw it go my way modestly, and then bounce higher.  The quality of the bounce made me take notice, as it demonstrated a shift in the amount of movement per unit of volume--something I describe in the Forbes post.  I quickly covered my short position for a small loss and avoided a larger drawdown.

Knowledge of the past prepared me for possible future outcomes.  It helped me stay open minded--and that helped me manage risk.  In trading as in sports, preparation primes us for action and that builds our mindset.

Further Reading:


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Friday, October 12, 2018

Lessons We Can Take Away From Broadly Oversold Markets

And the trick, of course, is getting cut the right way.  An uncut diamond isn't worth much, and a diamond cut the wrong way is too flawed to be worth anything.  When we take losses the right way and learn from those, that's when we develop the facets that give us value as traders.

One of the bad cuts I see people taking in the recent equity markets is failing to adapt to new, volatile market conditions.  Buy the dip at VIX of 12 is quite different from the same strategy at VIX of 24.  When a market becomes more volatile, we trade more volume per unit of time.  Moves that might have unfolded in hours now occur in a few minutes.  That has relevance for how you size positions and how much heat you can take on ideas that ultimately work out.

I looked at the overbought/oversold statistics from Index Indicators and found something outstanding.  Fewer than 5% of stocks in the SPX are trading above their 3, 5, 10, and 20-day moving averages.  In other words, not only are we quite oversold; we are very broadly oversold.  Essentially everything has gone down.

So what has happened historically after such broadly oversold occasions?

Since 2006, when I began my database, we have only had 15 other such days.  That means that broadly oversold markets only occur less than half a percent of the time.  As we saw in the last post, this means that the current market conditions are historically rare.  Below we can see the dates of occurrence in chronological order:


9/29/2008
10/7/2008
10/9/2008
11/20/2008
5/6/2010
5/7/2010
5/20/2010
8/2/2011
8/4/2011
8/8/2011
10/3/2011
11/23/2011
8/24/2015
8/25/2015
2/8/2018

We can see right away two things:


1)  These rare occasions can "clump".  When we see one, it's not unusual for others to follow.  This is also something we saw in the last post.  A very oversold market can stay oversold for a period and indeed become more weak.

2)  These occasions have occurred during markets we have recognized as meaningful corrective periods or as bear markets.  These occasions have also been accompanied by significant volatility.  The median VIX for the 15 occurrences has been almost 41.  The median VIX for the rest of the sample is a little over 16.

And what have been the forward paths for these broadly oversold markets?

Bounces have been the norm, but it's not always a one-way path.  The next day has been 9 up, 6 down.  Two days later has been 12 up, 3 down.  Five days later has been 12 up, 3 down.  That being said, ten trading days later we see 8 up, 7 down.  Ten of the 15 occasions have posted a lower daily close within a ten trading day period.  Two-sided markets over the next two weeks are not unusual.

Forward volatility is expectable.  Thirteen of the 15 occasions moved more than 2% from close to close over the next two trading sessions.  Nine of the occasions moved more than 4% up or down over a next five-day period.  Very large moves are not uncommon.  During 2008, we saw near-term closes up 9% or more and down 9% or more.  After the 2011 occurrences, we saw moves up and down exceeding 5%.

There has been opportunity longer-term.  The longer-term investor recognizes that broadly oversold markets are taking down high quality, growth companies along with less stellar firms.  This can create unusual value for individual stocks and also for the market. With the exception of the 2008 occurrences--a protracted bear market--we were meaningfully higher in SPX one year after the broad selling periods.  If we believe this to not be a recessionary period with major economic dislocations, the drop can be a great opportunity to buy stocks for longer-term holding periods.  

So it's back to the theme of getting cut the right ways.  When market participants puke, it's common to see favorable forward returns, but not without volatility and retracements.  Shorter-term traders can take each day as it comes, knowing there will be meaningful movement to capture.  Longer-term investors can identify stocks worth snapping up at bargains, but also create market hedges (and size appropriately) to weather the forward volatility.

Knowing historical patterns is a great way to prepare oneself for forward price paths.

Further Reading:


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