Wednesday, September 30, 2020

BRETT STEENBARGER'S TRADING PSYCHOLOGY RESOURCE CENTER


Contact For Trading Firms and Media:  steenbab at aol dot com

My Twitter Feed:  @steenbab

RADICAL RENEWAL - Free blog book on trading, psychology, spirituality, and leading a fulfilling life

---

The Three Minute Trading Coach Videos

---

Forbes Articles:


My coaching work applies evidence-based psychological techniques (see my background and my book on the topic) to the improvement of productivity, quality of life, teamwork, leadership, hiring best practices, and creativity/idea generation.  Trading firms, teams, and portfolio managers interested in performance coaching and help with hiring processes can email me at steenbab at aol dot com.  Please note that my work is limited to trading and investment firms, so I cannot provide online advice or coaching services to individual, independent traders


FURTHER RESOURCES




I wish you the best of luck in your development as a trader and in your personal evolution.  In the end, those are one and the same:  paths to becoming who we already are when we are at our best.

Brett
.

Why You're Having Trouble Getting To The Next Level Of Trading Success

 
In the last blog post, I described how I think about markets and trade successfully.  When I follow that framework, I generally do well.  When I attempt to view and trade markets in other ways, I rarely succeed.

The most recent Forbes article is important, because it emphasizes the role of self-management in our success.  Each of us is our own manager, whether we embrace that role actively or neglect it.  Many problems in our trading come from mismanaging ourselves.

This is a very, very important concept.

The starting point of any good relationship is acceptance.  How can we be close to someone; how can we be supportive of them; how can we truly understand and appreciate them if we don't accept them?  

There is an important difference between expanding our trading edges and failing to accept ourselves and our strengths as traders.  Expanding your edge means finding new and different ways of doing the things that already make you successful.  That means applying your strengths--what you do distinctively well--in new ways:  new markets, new market conditions, etc.

Many times we tell ourselves that we're expanding our edge when, in reality, we are trying to be someone and something we are not.  When we make large changes in our holding periods or strategies, we often require ourselves to process information in radically different ways and take on very different levels of risk.  We get away from what we do well and that dilutes our results.  It does not expand us in the least.

We have trouble getting to the next level of trading success because we haven't taken the time to fully identify, appreciate, and embrace our trading strengths.  Perfectionism can be deadly:  it tells us we're not good enough as we are.  An important theme in the Forbes article is that the quality of our performance depends upon the quality of the relationship we have with ourselves.  If we're not good enough as we are, will we ever be able to make the most of what we have?  Can we manage ourselves and our trading well if our relationship with ourselves lacks acceptance?

.

Sunday, September 27, 2020

What Settings Do You Use For Your Technical Indicators?

 
This was a question recently asked of me during a webinar.  It reminded me of an observation of a trading software vendor who provided expert support for his product.  He said that, whenever he spoke with traders needing support and discussed how they were using the software, in 90+% of the cases, they were using the standard, default values for the indicators.  Very few traders explored or adjusted parameters; they stayed with the familiar.

I have found this to be true among users of very specialized software as well.  Many times, there are very powerful tools that can be found on the platforms, but those go unnoticed by a great majority of users.  The enemy of trading success is not emotion; it's mediocrity.

I do look at some technical indicators, particularly oscillators, but not really in a predictive way.  As one wise observer noted, technical indicators are like weather vanes:  they tell you which way the wind is blowing; they don't provide weather forecasts.

The reason I use oscillators and indicators such as those in my recent posts is that I am trying to gauge the presence of cycles within market trends.  If I can identify a trending market with tools that assess buying and selling pressure, then I want to use cycles within the trend to provide entry and exit points with good risk/reward.

So back to the question:  what settings do I use to identify potential cycles in the market?

Quite simply, I look at the settings that were most effective in tracking cycles for the previous day or two and use those settings as long as the current day's relative volume is not unusually high or low.  Since early 2018, the correlation between today's volume and yesterday's volume in SPY is approximately +.86.  The correlation between today's true range and yesterday's range in SPY is about +.77.  In other words, a solid early estimate of today's market participation is yesterday's participation.  I then track relative volume in real time to see if movement and volume are meaningfully diverging from yesterday's values.

If today is tracking yesterday pretty well, I conclude that, over the short time horizon, we have a relatively stable time series and the presence of cycles yesterday should provide information about cycles we expect to see today.  So that means that the technical indicator settings that were most useful in tracking yesterday's cycles aren't a bad starting point for estimating today's ups and downs.  Of course, this logic applies to multiple time frames and is important when considering the interaction of time frames.

For the active trader, there are few considerations more important than *who* is in the market.  That tells us a lot about how markets will move.  The failure to adapt to changes in the market's movement lies behind many trading failures.  The best trading opportunities don't occur in strong, weak, busy, or slow markets.  The best opportunities occur in relatively stable markets: those moving similarly to the recent past.  That provides a unique insight into "edge" and an important criterion for when to not trade.  

.

Monday, September 21, 2020

How To Identify Market Strength And Weakness In Real Time

 

I recently posted on the topics of training for trading success and the factors that lead to success among developing traders.  Here is an example from my own trading.  

TraderFeed readers are familiar with the NYSE TICK measure that identifies how many stocks in the NYSE universe are trading on upticks versus downticks at any given moment.  It's a great real time measure of market strength and weakness.  How price responds to the upticks/downticks is just as important as the absolute value of TICK.

On the top chart (from Sierra Chart, Friday's market), you'll notice a TICK measure specific to the NASDAQ 100 Index.  On the bottom chart, is a TICK measure for the Russell 2000 Index.  I've drawn yellow arrows to show the divergence between the TICK readings for the two indexes around 10:16 AM.  There was also a divergence between the TICK readings for the Dow 30 Index and the Standard and Poor's 500 Index.  By looking at TICK measures specific to each index, we can identify strength and weakness in real time.

I review these patterns each day and find ones associated with trading opportunities.  The continual review--and the focus on unique, informative measures--has greatly helped the consistency of my trading.  For a while, my trading performance was lagging.  It was when I doubled down on one of my strengths--pattern recognition--that I was able to identify and exploit new opportunity.  

.

Friday, September 18, 2020

One Tough Question To Ask About Your Development As A Trader

 

Imagine that you are an aspiring athlete.  You want to make the cut to join a championship team.  Here is the question:

If you trained as hard for your sport as you currently train to improve your trading, what would be your odds of making the team?

Reviewing markets, reading about markets, talking to people about markets: all those might be helpful, but they are not training to improve your trading.  What are you doing to actually train for improved performance?

As the most recent three-minute trading coach video suggests, we become what we do daily.  That is how we reach our trading psychology and trading goals.

Perhaps traders run into problems in their trading simply because they are out of shape.  Without the training that pushes us to use it, we tend to lose it.

The Three Minute Trading Coach

Tuesday, September 15, 2020

Relative Volume: How Much Opportunity Is In The Market Today?

 
For short-term directional traders, opportunity often boils down to movement.  It's tough to take a lot out of a market that is moving in a narrow range.  This is why a common topic I hear among the traders I work with at SMB is whether they should be focusing on trading the market vs. trading individual stocks that are moving.  In lower volatility market environments, it's often promising to shift the trading focus to those "stocks in play".

That is why I carefully track the relative volume in the overall market on an intraday basis.  Above we can see the last two trading days in SPY (top), with five-minute bars going into the market close.  The bottom panel consists of color coded relative volume bars.  Relative volume tells us, at each time period, whether the volume we are currently seeing in the market is above average (green), average (blue), or below average (red) compared to the last five trading sessions.

Let's think about what that means.  If we see unusually low relative volume, it means that large, directional participants are not active in the market.  In relative terms, market makers and short-term traders are dominating the price action.  The players we need to see in the market who can create sustained momentum and trends are not a force to be reckoned with in the market.  To some degree, in today's market, that is a function of institutional participants sitting out of the market ahead of tomorrow's Fed meeting.  You can see from the yellow arrow and the sequence of declining red bars that, as the day proceeded, volume was low and became even more relatively restrained.

That was important to the day's trade because we had gapped up with decent initial breadth.  A trader seeing that might wonder if we would see upside momentum through the day and a possible vigorous trend day.  Noting relative volume, the trader would have questioned this hypothesis, which turned out to be a good decision.

Relative volume also provides important information relevant to how much we can take out of each trade.  Early in the morning, I bought a pullback in the market and, noticing the low volume, sold it for a quick four-point gain in ES.  Had the strength attracted greater participation, I might have sought a more distant profit target.  Low volume means, not only less movement per day, but less movement per bar.

Many problems in trading occur when traders don't properly identify and adapt to the opportunity environment.  They play for momentum when the participants who create momentum are not present.  They add to positions that initially go their way only to see the market reverse amidst lower volume.  It isn't enough to focus on trading "setups".  We need to know how the market is likely to move when conditions set up.  It's yet another example of how having the right tools can help us master the craft of trading.

.    

Monday, September 14, 2020

Free Group Coaching and Mentoring at Traders Summit

 
Traders Summit is a large online event, free of charge, that will feature a number of well-known presenters, many from the Forex trading world.  You can check it out here.  On Saturday, September 26th at 8:45 AM Eastern Time, Joe Perry of Forex Analytix and I will be hosting a large coaching and mentoring event, where we answer any questions you have about trading, markets, trading strategies, and trading psychology.  The entire session will be Q&A and discussion, so that we can learn from each other's questions and integrate mentoring and learning with coaching.

Do you have questions you'd like to see Joe and I address in the session?  I'll be happy to put the questions from readers at the front of the queue.  All you have to do is send your question to the email address I use for the blog site (steenbab at aol dot com) and we will tee it up for the Summit session!

Thanks for your interest.  I look forward to seeing you bright and early a week from Saturday!!

.

Sunday, September 13, 2020

What Is The Psychology Of Other Traders In The Market?

 
In recent posts, I have illustrated some of the market information I track to gain an edge in my trading.  This post took a look at one of my favorite indicators and how I use it to identify market trends.  This post and this post examined how I find longer-term edges in the market that are related to momentum/trend and value/reversal.  This post took a unique look at market breadth and concerns it posed for the market.  Now we'll take a look at information that can help us identify the psychology of the traders who are active in the market.  That's like taking a look around the poker table and gathering the "tells" that give you some idea of who might be holding strong and weak hands.

(By the way, I share this information as a way of giving back to the trading world that has been good to me, but also as a way of connecting with other traders doing and sharing unique things in the market.  Who we are determines who we will attract, and I want to attract and surround myself with talent.  There is no better way of attracting rational, inquisitive, and creative minds than to make those qualities visible to others.  Over time, that has enabled me to build a rich and rewarding network.)

OK, so click on the chart above that is taken from my Sierra Chart platform.  The top panel shows the December ES futures on a five minute basis, looking at Friday's morning session.  The red and green MESA adaptive moving averages are based on the work of John Ehlers and are constructed to minimize false signals from whipsaws.  We get a buy signal when the red line crosses above the green and vice versa.  The slope of the green moving average gives an idea of trend.  We get a crossover signal to the upside at 10:45 AM, but note that we're not in a trending mode.

The next panel shows the volume traded in each five-minute period, color coded green or red depending upon whether that period was up or down.  Note some expansion of volume on the selling at 9:55 AM and some contraction of volume at the top at 11:05 and 11:10 AM.  That is worthwhile information.

The third panel is a 3-period moving average of the amount of volume that is transacted at the market offer price minus the amount of volume transacted at the market's bid price.  This tells us the psychology of other market participants:  how many are aggressive in buying (lifting offers) and how many are aggressive in selling (hitting bids).  The moving average acts as a nice short-term overbought/oversold measure.  Note how we make a short-term oversold level at a higher price low at 10:55 AM.

The bottom panel is a table with two values.  The top values represent the volume traded at the offer minus the volume traded at the bid price during each five-minute bar.  The bottom values are a cumulative running total of volume traded at offer vs. bid, similar to an advance-decline line, but now providing a running measure of the psychology of other traders in the market.  

Note the yellow arrows and the values underlined in yellow.  Notice how we're actually showing more volume at bid than offer over the course of the morning going into the market's high at 11:10 AM.  Yes, we had a moving average crossover and, yes, we had an oversold signal at a higher price low.  But as we moved higher, the sellers were actually dominant.  The cumulative numbers are getting weaker, not stronger, as we move higher.  It's a great example of a false breakout, and notice how we reversed after 11:10 AM on significantly increased selling pressure.

What goes into a perfect trading psychology is intellectual independence and the willingness to look at information that others neglect; dedicated focus and the willingness to analyze the market bar by bar every day to identify patterns and become better at recognizing them in real time; and open sharing and the willingness to give back in order to connect with the right people and learn from them and with them.

You will never be a champion playing someone else's game.

.

Friday, September 11, 2020

Tools To Improve Market Timing From John Ehlers

 
I understand John Ehlers will be retiring in the not too distant future and is holding a comprehensive four-day workshop from October 19-23rd that will cover the scope of much of his work.  For those unfamiliar or uncomfortable with the math behind his methods, the workshop could provide a user-friendly, hands-on introduction.  For those willing and able to wrestle with new indicators and ways of processing market data, John's books are excellent resources.  And, on top of it all, there is his MESA software that implements his research.  I'm going out of my way to write this blog post about John and his work because I have always found him to be rigorous, evidence-based, and free of hype.  He publishes the real time track record of his stock picks on the Stock Spotter site and makes himself available to answer questions and help traders.  

Two key insights behind John's work are:  1) by creating better filters for market data, we can create superior technical indicators; and 2) by preprocessing market data (including detrending), we can identify market cycles more robustly.  As I have emphasized many times in this blog, all market time series consist of linear (directional/trending) components and cyclical components.  It is the interplay of the directional and cyclical elements that creates momentum and value patterns that can be traded.  One powerful strategy for trading is to go with market trends and make use of shorter-term cycles within those for timing.  John's work borrows tools from engineering to more readily identify these trends and cycles.

If you click on the chart above, you'll see a 60-minute chart of the September ES futures contract.  Notice in the top panel the red and green lines going through the chart.  Those are shorter- and longer-term MESA adaptive moving averages derived from John's research.  (This particular chart was drawn in Sierra Chart).  The yellow arrows show crossover points.  The MESA averages, because of their construction and filtering, provide crossover signals that are more free of whipsaws and thus more reliable than the standard version.        

Show me a master craftsperson, whether in trades or the arts, and I'll show you someone with superior tools.  No credible subspecialty surgeon uses off the rack, generic instruments and materials.  Similarly, high performing traders cannot expect exemplary results from preset levels of generic indicators.  Our psychology and mindset can be just fine, but they cannot in themselves elevate our craft.  

--
 Added 9/12/2020:
Here's a screenshot from my tradestation viewing Friday's trade in ES.  The bottom panel is a five-period detrended oscillator that makes it easier to identify short-term cycles in market data by taking trend out of the calculation.  My experience is that market time series are made more stationary (stable) when looking at volume-based bars rather than time-based ones.  In the chart, each bar represents 12,000 contracts traded so that we can see how the day session unfolded.  Note (bottom panel, blue arrows) that we make short-term cycle lows at equal or higher price lows and that the MESA Adaptive Moving Average crosses over between the two cycles (yellow arrow) to shift to a buying mode.  I love buying cycle lows at higher price lows in an early rising market where prior shorts are likely to be trapped.  Note also how the volume transacted at the bid vs. offer price shifted as the market made its low during this period, showing how buyers were becoming more aggressive (lifting offers) ahead of the market turn.  Again, the right tools make all the difference if you're going to master your craft.
.

Wednesday, September 09, 2020

What Goes Into A Perfect Trading Psychology?

 
What ingredients go into an ideal trading psychology?  Here are a few that stand out in my experience:

1)  Planning - Think of an elite boxer going into the ring with a plan; a football or basketball team that plans for an opponent; a surgeon that plans the procedure; a military unit with a battle plan.  Wherever we see high level performance, we see evidence of extensive, detailed planning.  The ideal mindset for the trader, like for the entrepreneur, is focused on a plan and its execution.

2)  Focus - Without a plan, there is nothing to focus upon that is within our control.  It's not enough to have a plan; we also have to be laser-focused on that plan so that we can implement it automatically, as the result of considerable repetition.  The analogy I often use is that of the military sniper.  All focus is directed to the target and the execution of the plan.

3)  Calm - An excited mindset is a distracted one.  No sniper, no surgeon, no chess grandmaster emotes during a performance.  The intense focus on the plan creates a flow state, a sense of being in the zone:  total absorption in the task at hand.  It is in this flow state that we are best able to discern what markets are doing and respond.

4)  Purpose - Before the performance there is a sense of challenge, opportunity, and enthusiasm.  The focus is on doing something special, something meaningful, something important.  After the performance, there is a sense of accomplishment, appreciation, fulfillment.  The elite performer is motivated by purpose and that drives an energized mindset that motivates the calm, focused planning.

Think of the Broadway actor or actress before going on stage.  There is anticipation and enthusiasm and the desire to connect with the audience and provide an amazing experience for all.  And that drives a complete absorption in the role and on everything that has been rehearsed.  It's all about calm focus and being that person you've rehearsed so often in practice.  Preparation for trading and going live each day in markets is not so different.

Resources for Trading Psychology

.        

Sunday, September 06, 2020

What Predicts Success Among Developing Traders?

 
I've spent many years working with developing traders and have learned a good amount about what makes some successful and others not.  Below is a summary of what I've learned:

1)  Motivation and passion for trading and succeeding are not predictive of success - Not all who profess motivation are hard workers and not all hard workers work the right ways.  Starting out with a drive to make money is, if anything, associated with greater odds of failure and emotional upheaval.  There *is* an association between dedicated effort and success (see #2 below), but it's the ability to channel motivation into constructive effort that is key to success.  The louder the trader professes passion and motivation, the more I dig to look for substance.  I generally come away with very little.

2)  The learning that goes on before a trader puts money at risk and the effort that goes into learning when markets are not open are predictive of success - The consistency and intensity of the learning process distinguish those who succeed.  The amount of detail in their journals/reviews and the ways in which the reviews build upon one another over time are big predictors of success.  Unsuccessful traders take away isolated, fragmented bits of learning from each day and week.  Successful traders have a curriculum in mind:  they learn in a cumulative, coordinated fashion.  True deliberate practice is a significant predictor of success.

3)  Innovation is predictive of success - I consistently see successful traders develop multiple ways to profit in markets.  They don't look at the same things as everyone else, and they don't think about markets the same way.  I recently spoke with a trader who utilizes options structures to trade patterns associated with macroeconomic data releases.  Sometimes his trades capture patterns of volatility, sometimes directional patterns, sometimes patterns of relative value.  He is playing on a multidimensional chess board, and that provides him with multiple ways of winning.

As Mike Bellafiore and I emphasized in our recent podcast with Tradeciety, success in markets comes in stages:  first with learning concepts; then by observing patterns in markets; then by practicing trading and developing consistency in performance; then by sizing up risk and cultivating new sources of edge.  A very common source of failure among traders is the temptation to short-circuit this process.  

Now here's a key takeaway:  It's the quality of the learning process that shapes the positivity of a trader's mindset.  A positive psychology does not create success.  A positive psychology is the result of focused learning and the exercise of creative problem solving.  No amount of self-help exercises will substitute for skill development and the capacity to uncover fresh sources of opportunity.  There is a surprising overlap between the qualities of successful traders and the qualities of successful entrepreneurs.  Innovation + focus + detailed effort turns dreams into realities.

The Three Minute Trading Coach Video Series

.

Friday, September 04, 2020

How To Ride Trending Moves In The Market

 
A common issue I hear from traders is that, if they miss an initial move in the market or in a stock, they have trouble participating in a potential trend.  Indeed, sometimes out of the frustration of missing the initial move, they will find themselves fading it and turning a missed opportunity into an actual loss.  Here is one tool I use to trade potential trending (directional) moves in the market and how I use it.

If you click on the chart above, you will see a one-minute chart of the SPX futures (ES; bottom panel) for yesterday's morning session.  Plotted above is the NYSE TICK readings, with the zero line highlighted in yellow and a green line providing a five-minute zero-lag moving average.  (Chart from Sierra Chart).  

What we can see very early in the session is net buying interest (upticking), with the moving average of TICK above the yellow line.  Notice, however, that the buying interest is modest and does not result in a higher early move in ES.  Then we begin making lower lows in the TICK and lower highs, with the overall distribution of the TICK values falling mostly below the yellow zero line.  As that occurs, we can see ES price moving lower.  Indeed the bounces in the TICK, representing efforts at market buying, simply cannot be sustained and result in greater selling pressure and now a directional move down in ES.

The key identification is that buying pressure in stocks is waning and, when it occurs, can only move the index to lower price highs.  Those modest bounces in TICK are great short-term entries to the downside, allowing us to ride the emerging trending move.

Notice how this approach fits very well with the idea of trading cycles within a trending market:  when we get lower price highs with each bounce, those become opportunities to ride the direction downward.  The cycles provide us with good risk/reward entries and can be used as opportunistic exits if we're trading around a core position.

Finding the right tools and conceptual frameworks for your trading will not guarantee you a great trading psychology, but it's hard to maintain a constructive mindset without those tools and understandings!


Added 9/4/2020:

For the past year, I have been studying buy and sell signals from common technical trading systems.  What I find is:

1)  A key is identifying technical indicators that are not highly correlated to each other;

2)  A key is tabulating buy and sell signals for all stocks in a universe as your primary measure, not the technical reading for an overall index.  This captures the breadth strength referenced in recent posts;

3)  When calculated in this way, buy signals and sell signals for each system are not highly correlated at all.  This suggests that strength and weakness are independent variables and should not be combined into composite indicators;

4)  The edges associated with strength and weakness for different indicators are quite different.  Modeling multiple edges without overfitting is a promising source for quant signals.

5)  Ultimately our edge comes from looking at things others don't think of and doing a level of work others are not willing/able to undertake.

6)  When you've done the hard research and see the edges clearly, that provides a level of confidence that cannot be derived from mere self-help techniques.

Video:  Is Trading Your Path To Greatness?

.

Monday, August 31, 2020

More Ways Of Finding Edges With Momentum And Value

 
In the recent post, we took at look at short-term breadth strength and how that can help us identify opportunities associated with momentum and value.  Now let's extend that view by exploring breadth strength at longer time horizons.

Using the same database with SPX, what we find is that when the percentage of stocks closing above their 20-day moving averages is in the highest quartile of the sample, the next five days average a gain of +.51%.  When the percentage of stocks closing above their 20-day moving averages is in the lowest quartile of the sample, the next five days average a gain of +.33%.  All other occasions actually average a loss of -.17%.  In other words, in the rising market since 2014, essentially all short-term gains were achieved when the market was broadly strong and broadly weak.  If we look at next 20-day returns, we find out that when stocks were most broadly strong, returns averaged +1.76%.  When stocks were most broadly weak, returns averaged +.98%.  All other occasions averaged a gain of only +.17%.  

Now let's zoom out to the percentage of stocks closing above their 100-day moving averages.  When we have had the greatest longer-term breadth strength, the next 20 days have averaged a whopping gain of +2.36%.  When we have had the lowest level of breadth strength, the market has actually averaged a loss of -.33%.  In other words, breadth strength at the longer time frame has brought considerable momentum, but low breadth strength has also shown a level of downside momentum--not value!

We're starting to see that edges are complex:  the result of interplays among short, medium, and longer timeframes.  That cannot be captured by a single chart pattern or indicator reading.

But let's take another look:  We will divide the sample into quartiles based upon VIX readings.  When VIX has been in its highest quartile, the next 20 days in SPX have averaged a large gain of +2.40%.  The remainder of the sample has averaged a gain of only +.28%.  So here we see a large value effect (weak and volatile markets leading to reversals) and relatively modest evidence of momentum.  When we look at edges in the market, breadth strength matters but may show very different forward returns in low and high volatility regimes.

What I have found is that it's when short-term patterns of supply and demand, such as the ones described here and here and here, line up with the multi-day patterns of breadth strength and volatility that the best trading opportunities occur.  There is a huge edge in clearly knowing where your edge lies.

Added 9/1/20:

Notice how we closed 8/31 with fewer than 50% of SPX stocks above their 3- and 5-day moving averages, according to the Index Indicators site.  That triggered the breadth signal from this post.  We can see from the chart below that we were getting a good amount of volume hitting bids in the ES futures, taking us to a short-term oversold point at a higher price low.  That is how price and volume behavior can confirm a signal from breadth.  Note how we have since bounced in premarket trading.


Trading psychology cannot substitute for understanding the psychology of the market you're trading.  Per Ms. Parker, when you hear someone say that your mindset is your edge, don't toss their advice aside lightly.  Hurl it with great force.  

.

Friday, August 28, 2020

Actively Trading Momentum and Value In The Stock Market

 
This post will begin a short series on finding edges in the broad stock market related to momentum (directional persistence) and value (directional reversal).  A good place to start would be to review the recent post on how to trade a trending market.  Notice how the signal described in that post captured the most recent upside opportunity quite well.  Not all movement in the market is meaningful and it's easy to get so caught up in short-term ups and downs that we end up trading randomness.  If we can backtest patterns of momentum and value, we can begin to ground our trading is what is meaningful.

So let's begin simply.  We're interested in the percentage of stocks in the SPX universe that close each day above their respective five-day moving averages.  (Data can be found via the Index Indicators site).  That provides an indication of what I call breadth strength:  the degree to which there is broad strength or weakness in the market.

My database goes back to August of 2014, so let's see what happens in the market after five days of broad strength and weakness.  To accomplish that, I first divide the dataset into quartiles and examine average forward returns.  When we have seen the broadest strength in the market (top quartile of readings above five-day moving averages), the next twenty days in the market have averaged a gain of +1.31%.  When we have seen the weakest readings on our indicator, the market has averaged a 20-day gain of +.97%.  All other occasions in the market have averaged a 20-day return of only +.48%.  

In other words, we have achieved superior returns by buying the market when we've had unusually strong breadth and when we've had unusually weak breadth.  The unusually strong breadth has provided upside momentum; the unusually weak breadth has provided value.  During the overall upward market from 2014 to present, that has been a way of capturing a good chunk of returns in the market trend, as the recent post observed.  This simple indicator has done a pretty good job of tracking the psychology of the market.

Are there ways of improving on this indicator and refining our ability to trade value and momentum?  That is what we'll explore in the next post.

Using Breadth, Strength, and Momentum to Capture Market Cycles

Wednesday, August 26, 2020

What Does A Professional Trader Work On In His Trading?

 

I jumped at the opportunity to participate in the upcoming Festival of Learning hosted by RealVision.  (Here is where you can sign up for the sessions that run from September 2nd - 4th).  My eagerness came from the chance to speak with Mark Ritchie, Jr., an experienced trader and fund manager.  I wanted to hear his take on trading psychology and the challenges he faces running his own fund.

So what was one of the very first things that Mark discussed in our pre-recorded session?  Was it managing his losses or staying in emotional control of his trading?  No.  It was letting his profits run.  He wisely pointed out that a trader can be great at limiting losses and getting stopped out, but still not make the most of his or her trades.

Mark questioned the wisdom of the old saying that you can't go broke taking a profit.  Because much of a trader's total return comes from a handful of top opportunities, taking profits prematurely can cap success.  This is why, in my work with traders at SMB, we focus on monthly statistics and pay particular attention to whether the average size of winning trades is greater than the average size of losers.  Many times that ratio needs improvement, not because the trader is letting losing positions go or adding to them, but because they stop out of winners before the positions have hit their targets.

Here's a big psychological point:

The traits and strengths that we need to limit our losses are different from the ones we need to maximize our gains.  We need to consider these as separate skill sets and work on them independently.

Limiting our losses is all about prudence and conscientiousness:  the ability to be careful.

Maximizing our gains is all about willpower: the ability to sustain a goal in the face of uncertainty. 

Mark's insight was that, for experienced traders, the prudence comes naturally.  If it didn't, they would never get to the point of being experienced!  But tolerating uncertainty is different.  When we watch our positions tick by tick, it's easy to see something concerning and use it as an excuse to bail.

There's an old saying:  failure to plan is tantamount to planning to fail.  If tangible targets for our positions aren't firmly set in our minds and mentally rehearsed, we will have no goals to focus on to get us through the uncertainty of price paths.  The real problem is not just getting out of trades too early.  The problem is failing to set vivid goals for our trades that energize us and feed our willpower.  Come to think of it, that's a problem many of us face in life as well as markets!

.

Sunday, August 23, 2020

A Different Look At The Market's Weak Breadth

 


Above, with big kudos to the excellent Index Indicators site, we can see a chart of the SPX (black line) over the past six months.  Overlaid in the green line is the percentage of SPX stocks trading above their 20-day moving averages.  Note how this percentage has tailed off in recent days, falling slightly below 50%.  It is one further indication of weak breadth in the current stock market.  (Please check out the recent Forbes article for a detailed discussion of current market breadth and what that has meant for stocks over the past 20 years).  Indeed, I went back to my database which starts in 2006 and examined all market occasions in which SPX was up over 5% in a month, but the majority of its stocks were trading below their 20-day moving averages.  Surprisingly, there was only one occasion, on July 25, 2011.  That preceded a double-digit percentage decline in stocks over the next 10, 20, and 50 days.

When I divided the sample of strong monthly returns in quartiles based upon the percentage of SPX stocks trading above their 20-day moving averages, I found that the quartile with the weakest breadth returned an average of -.77% over the next 50 trading sessions.  All other occasions averaged a 50-day return of +3.05%.  The results suggest that, when we have strong upside momentum, the rising tide lifts all boats and forward returns are favorable.  When the tide is not lifting all boats, there is reason for caution.

The current market is interesting because there are differences among stock sectors regarding relative strength, with technology (XLK), consumer discretionary (XLY), and communication services (XLC) sectors quite strong in the relative performance ratings of StockCharts and the energy (XLE), financial (XLF), utilities (XLU), and real estate (XLRE) sectors notably weak.  Even within each of these sectors, there are relatively strong and weak industries.  For example, in the weak energy sector, renewable energy equipment shares are very strong.  In the strong technology sector, telecommunications equipment companies are weak.  

As we move forward, shifts in the market's advance-decline numbers will tell us a great deal as to whether the rally can broaden out and sustain itself or if it falls into a topping mode with continued industry and sector weakness.  I note that, even with the recent market strength, we're seeing subpar performance from banking stocks, real estate REITs, integrated oil and gas shares, airlines, and marine transportation companies.  If the economy is to turn around, these areas should display growing strength.  For that reason, they are among the parts of the market on my radar.

.

Thursday, August 20, 2020

What We Do Shapes How We Feel

 

The Rabbi makes a profound point:  Our joy supports our thinking.  When we are downhearted, can we really focus on opportunity?  When we are joyful, will we really become wrapped up in short-term P/L and missed trades?  We tend to think that trading well will make us happy.  But what if happiness helps us trade well?

A fascinating study finds that even just simulating the act of smiling leads us to feel happier.  What our muscles do, our minds process.  "When your muscles say you're happy, you're more likely to see the world around you in a positive way," the study author reports.  There are houses of worship where prayer is interwoven with dancing, singing, and clapping of hands.  We see the same thing during weddings.  Could it be that the physical acts of celebration help us internalize a celebratory frame of mind?

We know from psychological research that positive emotional experience helps us process information more broadly and more effectively.  Research also finds that positive experience also helps us be more productive and is associated with enhanced physical health.  What if active expressions of joy, fulfillment, love, and energy actually contribute to our positivity?

This has important implications for trading psychology.  What we express with our bodies may shape the quality of our mindsets and experience.  Think of what you're expressing during your trading, during your meetings with peers, and during your reviews.  Perhaps you're not expressing very much at all in your body language, your tone of voice, etc.  How might such a lack of expression impact your experience?  Perhaps it's not a coincidence that the interns I see learning so well at SMB are so physically expressive in their enthusiasm.

What our bodies do may shape what we experience--and that can either strengthen our common sense or disrupt it.  Cognitive psychology emphasizes that our viewing impacts our doing:  how we process events shapes how we experience and respond to them.  But perhaps it's equally true that our doing shapes our viewing:  what our bodies do shapes our feelings and thoughts.  Could a restricted range of physical activity and expression create limitations in our states of awareness?  

Think about team meetings in most workplaces.  Think about the environment on most trading floors.  Think about how much energy, joy, and satisfaction you give visible expression to during your trading.  Too often, our image of behavior that is "professional" does not permit such expressions.  Could it be, that in our pursuit of the professional, we never find the common sense that is strengthened by joy?

Further Reading:  Radical Renewal
.

Monday, August 17, 2020

How You Learn Shapes How You'll Earn

 


There's a trader I'm working with who I believe will be a star in the not-too-distant future.  He reviews his trading extensively each day and week, keeps a wealth of statistics about his trading, and often sends his reviews to me and others for suggestions. What I find unique about this trader is that his sole focus has been on improving the consistency of his trading, not the P/L.  He is like a Toyota manufacturing plant, closely examining quality in every part of the process and then pouncing on opportunities for quality improvement.  He derives pleasure from getting better and better and that drives increases in his sizing and risk-taking.

I recently did a video on how to avoid trading on tilt.  It's a big question for so many traders: How do we make sure that emotional disruptions don't color our decision-making and hijack our trading?  It was only after making the video that I realized that I had never seen this trader on tilt.  Yes, he had losing days, and in the past he had some slumps.  But I never saw emotional, reactive trading.  That's when it hit me:  The entire way he had set up his learning process has kept him level-headed.  He is always looking for what he could do better, so missing trades and placing losing trades aren't threats or frustrations.  They are simply fuel for quality improvement.  

When we focus on learning and quality of trading, we take P/L out of the equation, which helps us take our egos out of trading.  Some journals I read are like, "I did this and then I did that. I lost money and next time I need to take my time." It's all about them!  The trader I'm working with spends much more time examining how his stocks moved and how he could better recognize that movement.  He's like a diamond cutter looking at his work, finding small flaws, and then working on reducing those.  It's a focused, intentional process, without much drama at all.

Little wonder, then, that his trading has this same quality.  How we learn shapes how we earn.  Our learning processes shape our mindsets and our priorities.  What we do and how we do it becomes what we internalize.  Without a disciplined, focused learning process, can we truly expect to trade in disciplined, focused ways?

.

Friday, August 14, 2020

Trading A Trending Market

 


I had an interesting conversation with a frustrated trader recently.  He lamented that it is impossible, as an active trader, to trade a market that "goes up every day".  Out of this frustration, he had broken rules, placed trades outside his "playbook", and lost money.

It's a great example of how a negative trading psychology can create poor trading, but also follows from poor market understanding.

With a big shoutout to the Index Indicators site, above we see a chart of the SPX 500 (black line) over the past three months.  The green line represents the percentage of stocks in the index that close above their three-day moving averages.

Now here's the important principle:  In any market, there is always a trend component and a cyclic component.  In other words, we can best describe any time series as a linear, directional function plus a dominant cycle.  It is the ways in which the linear (trend) component combines with the cyclical component that creates the charts we see.

In a market with a strong trend, the linear component will dominate and corrections (from the overlying cycles) will be short-lived.  In a range market, the cyclical component will dominate and there will be only a small directional aspect to movement.  If we can estimate cycle frequency by locating trends and ranges within longer time-frame cycles (cycle amplitude is in part a function of volatility), then we can use cycle extremes to more actively trade directional movement.  

The chart above illustrates this concept.  We have had good buying opportunities when the percentage of stocks trading above their three-day moving averages has dipped below 50.  In an uptrend, such pull backs occur at successively higher price lows.  By waiting for the cycle trough, we can participate in the trend with good risk/reward.

So, for instance, buying those 11 occasions in the past three months when fewer than 50% of SPX stocks were above their respective short-term moving averages led to a a 91% win rate with an average holding time of a little more than two days.  Such an active trading strategy did not capture all the gains of buy-and-hold, but the active trader participated in half of those gains while keeping the maximum downside to under half a percent.

The important point here is that many trading psychology problems come from fighting trends.  If we perceive a trend, a promising strategy for active traders is to buy dips at successively higher lows (or sell bounces at successively lower highs).  Trending markets are impossible to trade only if you have no tools for identifying the cycles within trends.

Tuesday, August 11, 2020

Avoiding Burnout: Every Goal Needs A Vision

 


One mistake traders make is reviewing their trading and stating an intention to do things better next time, but then never actually turning that review into specific goals and plans that would guide the improvement process.  This is very common when traders begin keeping a journal.  

A second mistake traders make is setting very specific goals--and often multiple goals--but never connecting those goals to a broader vision that provides energy and inspiration.  Without the vision, work on goals easily becomes drudgery:  an endless task list.  Perhaps that is why I'm hearing from so many burned out traders during this COVID period.  Goals can push and guide our efforts, but it's the pull that comes from vision that truly moves us forward.

In the previous blog post, we looked at handling adversity as a key element in trading success.  It is when we are supremely challenged that we dig deep and access fresh sources of energy.  Many times, this rising to a challenge occurs in a team context, where members of the team draw from each other in a positive role modeling.  When we have an individual or shared vision, we can tap into the meaning and significance of that ideal to forge ahead with our goals even in the face of setback.  

The vision may need to be something larger--more meaningful to you--than P/L alone.  It may be a vision of the kind of person you wish to become; the kind of business you ultimately want to build; the ways in which you want to make use of the returns from your trading.  Perhaps trading is a means to a vision that you pursue in the non-market hours of your life.

In any of these cases, what moves us forward is a purpose that is larger than us.  Yes, it helps to work on our execution, our idea generation, our risk management, etc.  But we will pour ourselves into those efforts if they speak to what is important to us in life.  To use an analogy, no amount of working on problems will restore love and commitment to a troubled relationship.  A fulfilling relationship is so much more than something we work on.  We have a relationship with markets as well.  Working on trading is necessary, but it can't be all that we do.  We also need to nurture the positives to keep the vision alive.

.      

Saturday, August 08, 2020

How Do You Handle Adversity?

 

It is said that adversity doesn't build character; it reveals it.  When the sh*t hits the fan and everything is going against us, we learn a lot about ourselves.  

When power went down in our region and we were left without telephone, internet, or cable service, I wondered how I would work with traders.  Everyone was working from home, which meant that my only ways of connecting with them had been taken away.  A fleeting thought went through my mind that I could cancel all my meetings.  As soon as the thought entered, I rejected it.  I was not going to give up.  I drove my car to various towns in the area until I found a spot with a solid internet connection.  I kept my phone charged with the car battery and downloaded an app that allowed me to do face-to-face meetings with minimal bandwidth demands.  Instead of working from home, I discovered work-from-car!

Similarly, when everything went down in the recent storm, I received encouragement from Margie and together we figured out how to use a portable generator and connect it to major portions of our house.  I have minimal mechanical skills--I actually tested as learning disabled with respect to performance tasks as a child--but I was not going to be a victim of the storm, and I was not going to let Margie down.  

In both cases, adversity brought out a latent strength, a quality I have, but do not always draw upon:  persistence in the face of challenge.  I refuse to let circumstances control me.  That refusal gives energy and leads to creative solutions I would have not pursued otherwise.

Recently, I've noticed significant differences in how traders handle adversity, whether it's a losing trade, a missed opportunity, a drawdown, etc.  The really good traders refuse to let the setback control them.  They view and re-view their trading and they make sure they drill the learning lessons in their head.  They miss an entry, but they don't give up on the idea.  They don't simply place a revenge trade; they become even more focused as a result of the missed trade--and that allows them to find another way to participate.

That's really it:  adversity can disrupt us, or it can focus us.  It can lead us to withdraw and seek comfort, or it can push us to dig deep and draw upon our latent strengths.  The concept of sisu suggests that each of us possesses a second wind of energy that we can access during periods of challenge.  Might it be the case that the winners in life's race are those with the greatest capacity to draw upon that second wind?  Perhaps by continually placing ourselves in challenging circumstances, we can cultivate the sisu--the access to hidden strengths--needed to perform at our best when we most need to perform.

Further Reading:

.