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: