Monday, April 25, 2016

Trading Notes for the Week of April 25, 2016

Friday, April 29th

*  I'll be talking with the Benzinga pre-market prep show at 8:35 AM today.  We'll take a look at the psychology of the current market.

*  I love this post regarding innovating and finding new trade setups from Ivanhoff.

*  Stocks bounced nicely from overnight weakness yesterday but then stalled at prior peak levels and sold off sharply into the close.  Breadth was not especially poor; fresh monthly new highs dropped to 915 and new lows rose a bit to 235.  Technology/NASDAQ shares broke below their earlier April lows; housing stocks (XHB) also took a hit.  That's not the kind of action you'd expect if the market was pricing in economic strength.  Fewer than 50% of SPX shares are trading above their 3, 5, and 10-day moving averages.  Let's see if that can bring in buyers, as prior short-term corrections have been able to do.

*  A few things different about this most recent market drop:  1) higher volatility on the decline, with extreme selling on the NYSE TICK measure; 2) the market's inability to rally during USD weakness and commodity firmness; and 3) continued breakdown of correlations among market sectors.  It's when we see shifts in volatility and correlation that we want to entertain notions of regime change.

*  My intermediate-term measures are still nowhere near oversold levels.  I'm quite open to toppy market action here and an intermediate-term correction within the bull cycle.  I'm not expecting a sudden reversal to bear market mode.  Note the sharp rise in VIX.  My Pure VIX model has turned neutral; not yet in "fearful" territory.





Thursday, April 28th

A look at the recent move to higher interest rates, which has affected the trading of higher yielding stocks and stock sectors.

*  Stocks have fallen back after the Bank of Japan disappointment last night.  We're now near the lower end of the recent trading range.  I haven't noticed particular breadth weakness.  Indeed, smaller cap indexes moved to new highs yesterday, as did a number of large cap sectors.  Much of the index weakness has come from technology shares and the higher yielding sectors.  New monthly highs rose to 1112; new lows rose a bit to 209.  My intermediate-term cycle measures are stretched to the upside, however, so I would not be surprised to see further consolidation.



*  Most of the corrective activity we've seen in stocks since the February low has consisted of sector rotation; hence no meaningful deterioration in the breadth numbers.  Below we can see a chart of stocks across all US exchanges making fresh 3-month highs versus 3-month lows.  It has stayed healthy throughout the recent move.  One of the things I'm tracking going forward is the degree to which we see across the board weakness on pullbacks versus rotational movement. 




Wednesday, April 27th

*  Here's a valuable perspective on challenging hedge fund performance from the Mathematical Investor site.

*  My measure of breadth volatility has reached low levels last reached in late November, 2015 before the market drop.  Volume in stocks has also been lagging, which has been associated with subnormal forward returns.  That being said, breadth improved yesterday, with 876 fresh monthly new highs and 189 new lows.

*  Note the divergent sector performance in the past week, with higher yielding shares underperforming and commodity-related shares outperforming.  (Graphic from FinViz).  Rates have been rising ahead of the Fed; I'm keeping a close eye on this.  Note also how technology has been lagging.  Rising rates?  Higher commodities?  Low growth?  Can't imagine a stagflation scenario would be a great one...



Tuesday, April 26th

Excellent research links from Abnormal Returns.  A great aggregation of quant research comes from Quantocracy.  Lots of new ideas in these sources and lots of good blogs to follow.

*  So far my trading experiment has been interesting.  I've been placing far fewer trades, only trading when the market lines up on three time frames and a short-term signal is triggered.  The signal comes from volatility bands drawn around event bars, so the bands reflect what I've been calling pure volatility (volatility per unit of market volume).  The target is also based upon a movement in pure volatility units.  The very structured nature of the risk taking has led to zero overtrading and a higher hit rate on trades.  I'm placing only a tenth of the trades I was placing before, overall profitability in dollar terms has not been hurt, and of course risk-adjusted profitability has increased greatly.  It is not clear to me that much of the trading we do adds value.  By structuring rules around our best trades, we can create significant free time for research and life outside of markets.

*  We saw increased selling pressure in yesterday's trade, but price held relatively well and has bounced a bit in overnight trade.  New monthly highs dropped to 586 and monthly lows also dipped to 208.  I'm still not seeing significant weakness across sectors; the central bank focus the rest of the week will dominate trade.  

*  We can see the market's strength in the cycle measure below.  My long-term cycle research suggests that we made an important cycle low in February (the prior cycle low was October, 2014) and have been in a momentum phase of the new cycle.  I ultimately expect the current cycle to take us to new highs, driven as much by dovish central banks and the need for yield as growth per se.



Monday, April 25th

There is a psychological process that underlies self-confidence--and more specifically a cognitive process.  Key is the recognition is that confidence is an expression of optimism--and optimism comes from finding structural similarities between present challenges and past ones that have been mastered.  This is very relevant to the capacity to stick with one's ideas and weather drawdowns.

*  I'm currently working on a project that tracks long-term cycles in the stock market.  These cycles extend for months, not minutes or days.  It is at this horizon that momentum effects most clearly emerge.  For example, if we go back to 2006 and track the percentage of SPX shares that close above their 100-day moving averages, we find that the top half of readings (those in which there has been strongest breadth) result in an average next 50-day gain of +2.15%.  The bottom half of readings average a next 50-day gain of only +.33%.  The lion's share of the performance differential occurs after a 20-day holding period.  Think about what that means for traders who develop longer-term ideas but have to trade them on short time frames and what that means for short-term traders.  Also think about the implications for the current market.

*  Stocks have pulled back in overnight trading, continuing to consolidate recent gains.  None of my breadth measures suggest that we're yet at an oversold level, as can be seen below.  This measure tracks SPX shares trading above their 3, 5, 10, and 20-day moving averages.  (Raw data from Index Indicators).


Sunday, April 24, 2016

How to Become a More Confident Trader

One of the most common questions I hear from traders is how they can trade more confidently.  Nothing is quite as frustrating as developing good ideas and then not having the confidence to properly act on those ideas.

Where does confidence come from?  In this recent article, I address this question and why it's important.  Once we view confidence as a way of processing self-relevant information, we can literally learn to be more confident in our trading, our personal lives, and in our careers.

I've found three important contributors to lack of trading confidence:

1)  Not putting in the work - When we try to borrow ideas from others, we never really deeply understand those ideas.  The process of independently generating an idea ensures that the idea makes sense to us.  That gives us staying power during temporary periods of adverse price action;

2)  Negative self-talk - When we focus on everything we could have done better and everything we did wrong, we create mini failure experiences for ourselves over time.  Our self-talk reflects our relationship with ourselves.  How can we feel confident in who we are and in what we do if we're constantly tearing ourselves down?

3)  Not playing to our strengths -  Many traders attempt trading styles that don't match their personality and cognitive strengths.  Over time that generates frustration and erodes confidence.  Trading frequently when we function best as big picture idea generators inevitably exposes us to noise and randomness.

Imagine each day and each week beginning with challenging, meaningful, and doable goals.  Over time, you build a library of success experiences and internalize the sense of being successful.  True confidence is earned, but it's also learned.  It's the expression of optimism, as applied to our selves.  Confidence, like its absence, is ultimately the conversation we choose to have with our selves.

Further Reading:  How to Act on Our Convictions
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Saturday, April 23, 2016

Limiting Your Challenges vs. Challenging Your Limits

A while back I wrote about rock musician John Mellencamp, who decided that his band had gotten into a rut.  As a challenge, he required each member, including himself, to learn a new instrument that would be featured on songs for the next album.  That album explored an entirely new sound for the band and became one of their most popular.  The band talked about what they wanted that album to sound like, departed from their usual music to make it happen, and extended their success.  

A savvy trader recently pointed out to me that the quant fund Two Sigma held a competition for their staff to program a robot to play winning air hockey.  That assignment had nothing to do with trading whatsoever, but it forced the staff to learn new technologies, new programming languages.  That investment in development can eventually help the fund research and develop new opportunities.

At some point, you've grown within your skill sets and it's time to learn new skills and make new music.  Focusing day by day, traders attempt to limit their challenges by sticking ever more closely to what has worked.  In that mode, they never get around to challenging their limits and becoming ever better at what they do.

I recently spoke with a trader who took the time to learn--really learn, as a discipline--mindfulness meditation.  He attended regular classes led by a master and practiced daily.  He found his time in front of markets quieter, moving slower.  He found it easier to step away from screens when nothing was happening and stay more focused when decisions needed to be made.  In learning outside of markets, he has become better within markets.

What are your limits as a trader?  What skills can you learn to challenge and extend those limits?  If you're not growing as a person, will you really grow your trading?

Further Reading:  Maximizing Our Trading Environment
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Monday, April 18, 2016

Trading Notes For The Week Of April 18, 2016

Friday, April 22nd

*  Excellent post from Jesse Felder questioning the wealth effect from recent central bank policy.

*  Stocks pulled back in Thursday's trade, with fewer than 50% of SPX shares closing above their 3 and 5-day moving averages.  Despite the pullback, even my shorter-term measures remain in overbought territory, as seen below:



*  Note how the pullback in bond prices (rise in yield) was accompanied by drops among consumer staples (XLP), utility (XLU), and real estate shares (IYR).  Because these sectors offer enhanced yield and because government bonds offer so little yield, rate views are playing out in these stock sectors.  This is a very relevant dynamic for traders/investors.

*  Retail (XRT) and technology (XLK) shares have been underperformers lately; much of the recent strength has come from commodity related sectors (XLB, XLE, XME).  Strong commodities (DBC) are another macro theme playing out within stock sectors; the relative performance of stock sectors has been important lately...it's not just risk-on, risk-off across all sectors.

China underperforming recently amidst concerns about credit defaults.  On the radar...


Thursday, April 21st

*  Rob Hanna shares historical market patterns on the Quantifiable Edges blog.  Also check out Rob's work with Scott Andrews on the InvestiQuant blog.  Lots of good ideas here.

*  Stocks continued their move higher on continued positive breadth.  Across all exchanges, we had 1205 stocks make fresh monthly highs against 192 lows.  As noted earlier, it's the absence of distinctive weakness in any of the sectors that is noteworthy in the recent market strength.

*  Here's a valuable perspective on supply and demand in the US stock market.  It's a 10-day moving average of upticks versus downticks among all NYSE shares.  Note that, since the February lows, that average has never dipped below zero.  Most recently this strength has been due to the low level of downticks; quite simply, we are not seeing sustained selling from institutions and this has kept stocks aloft.





  *  Here's a look at what's been relatively strong and weak among stock sectors from the FinViz site.  Note the unusual strength among commodity related shares--a complete reversal of the weakness we saw early in the year and through a good chunk of 2015.  Renewed strength among commodities has been the clearest indication that markets are no longer pricing in deflationary forces and that's been good for global stocks.




Wednesday, April 20th

*  Looking for a sketch pad for quantified patterns in stocks and ETFs?  Great screener on Kora Reddy's Paststat site.

*  Stocks moved to new highs for this run, with significantly expanded breadth.  Across all exchanges, stocks making fresh 3 month highs vaulted to a new peak.  (See below).  The general rule is that peaks in breadth/momentum tend to precede price peaks for bull cycles.  While breadth is stretched here--and indeed we've pulled back in overnight trade--we continue to see dips at successively higher price lows, which is what makes for bull moves.


*  A different way of looking at breadth tracks the number of NYSE stocks giving buy versus sell signals across a variety of technical trading systems.  I keep those stats as a cumulative running total, which has also displayed unusual strength in recent sessions.  (See below).  What is equally noteworthy is that few shares are giving sell signals, which is a reflection of the low level of selling pressure evident in the upticks/downticks data.  Bottom line, I'm not seeing signs of deterioration in this market at the present time.


*  Note also the breakout strength among international equity indexes (EFA).  We've seen broadening international strength in stocks as the US dollar has weakened. 



Tuesday, April 19th 

*  Limited notes next few days;  working with traders in London. 

*  Breadth continues strong,  with over 1000 fresh monthly highs and over 80% of SPX stocks closing above their 3, 5, and 10 day moving averages. 

*  The measure of upticks and downticks continues to show unusually low selling pressure. Stocks are unlikely to sustain weakness if institutional participants are not selling. 


Monday, April 18th

One of the greatest life risks we take is playing it safe.  Life is too important to be wasted on inconsequential goals.

*  Recently the hit rate on my trades has gone up.  That's because I'm not *trading*.  I am entering positions like an investor and exiting like a trader.  Waiting for things to line up across different time frames provides the good entry.  Defining a significant move for a given volatility regime and exiting when that is achieved provides the good exit.  Slow to get into trades, quick to get out when the market gives good prices.  Perhaps the edge in such a method lies in making *not trading* the default.  All I can say is that my interest in markets has redoubled ever since I got away from screens.  Frequent trading is like frequent eating: nothing could be worse for the palate, stomach, and appetite!

*  Stocks opened the weekend lower on the heels of the inability of the OPEC meeting to produce an agreement over production cuts.  Since the early trade, oil and stocks have rebounded a bit; I'll be watching the correlation between oil and stocks to see if we re-enter the regime that was bearish for both, as well as for high yield bonds.  A resumption of a strong dollar trade would fuel such a regime; in the absence of the dollar trade, the correlation between oil and stocks may be less certain.

*  Breadth dipped on Friday, with 795 stocks making fresh monthly highs and 137 registering new lows.  My volatility measures have hit low levels that have been associated with market tops, including the "pure volatility" measure that tracks the average volatility per unit of trading volume.  So far, we haven't seen a significant expansion of selling pressure in the uptick/downtick measure or in the new lows data; I'm watching those closely.  My "pure correlation" measure, tracking the correlation among stocks specific to given volatility regimes, also is at (low) levels historically associated with subnormal forward returns over a several week period.

*  My measure of intermediate term strength, assessing new highs versus lows across all SPX shares, has fallen toward neutral levels even as price has moved higher.  While a few measures look toppy, it would surprise me if this bull move were to suddenly morph into a bear.  




Sunday, April 17, 2016

The Dynamics of Stock Market Cycles

Above we can see that the volatility of stocks across market sectors has come down significantly since the February lows.  Since 2012, when realized sector volatility has been in its lowest quartile, the next 20 days in SPY have averaged a loss of -.40%.  When sector volatility has been in its highest quartile, the next 20 days in SPY have averaged a gain of +3.54%.  

During historical investigations, I consistently find that intermediate-term returns are significantly tied to volatility and correlation regimes, particularly when the statistical overlaps among realized volatility, implied volatility, and correlation are eliminated.

The reason for this is that the psychological dynamics of market tops differ from those of market bottoms.  Stocks make tops when values become sufficiently stretched to the upside that buying interest dries up.  In that context, the weakest sectors begin to fall off, breadth wanes, correlations go from lower to higher, and volatility shifts from lower to higher.

Stocks make bottoms when values become sufficiently stretched to the downside that the buying interest of value participants is aroused.  This creates a reversal while volatility and correlation are still high, as breadth rebounds strongly.

This interplay of the dynamics of tops and bottoms is what creates market cycles.  Ultimately it is the interplay of shorter-term, momentum/trend players and longer-term value participants that creates the drying up at tops and sharp rebounds at bottoms.  Tracking volatility and correlation regimes is a way of gauging, in relative terms, where we stand in intermediate-term market cycles.

Further Reading:  Sector Correlations
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Saturday, April 16, 2016

Creativity, Innovation, Research and Development: Building Your Trading Future

Here are a few things I'm currently working on:

*  I'm looking at the Ichimoku Cloud indicator and whether it has any unique value in predicting future price behavior in stocks.  The challenge is in finding unique value, as any indicator is likely correlated with others and with past price change itself.  So inevitably you're looking at the value of the residuals (the indicator minus the overlapping input of other variables), not the relationship of the indicator to market behavior per se.  I've gathered the data for number of all stocks on NYSE each day that are moving into and outside their clouds and found some interesting things.  For instance, if very few shares move into their clouds from levels above and below, returns are much more bullish than if many shares enter their clouds.  Returns are also different when you look at the number of stocks trading above versus below their clouds.  The whole exercise has become a way of thinking about momentum and value factors in near-term returns.

*  I've divided each day's market into thin slices of volume and applied an algorithm to each slice to determine whether the volume transacted over that period was dominated by buyers or sellers.  This is different from looking at upticks versus downticks in the market, as it's designed to track the footprints of sophisticated execution algorithms that seek to buy the bid price and sell the offer.  The money flow figures resulting from this analysis show interesting divergences at turning points in the market.  (Right now it's lagging the recent market strength).

*  I've gone back to 1980 and am manually creating an event time-based time series of price behavior for SPX.  That is difficult, because you can't use volume bars (volume totals are wildly different over that period), so bars have to be created on the basis of price behavior.  Preliminary results suggest that market cycles are much more evident in the stock index when looking over long periods and when looking at bars that are activity-based and not based on chronological time.  The goal is to devise an active investment approach based on these cycles.

Well, you get the idea.  These projects may or may not pan out, but there will always be at least a couple of projects in my hopper at any given period.  Research and development never stops; that ensures that I keep learning and adapting.  

What does your R&D program look like?  How are you exercising creativity?  How are you innovating in your trading practice?  How are you going to be different and better by the end of this year?  These are the kinds of questions true trading entrepreneurs need to be addressing.

Further Reading:  Finding Your Creativity Zone
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Monday, April 11, 2016

Trading Notes For The Week Of April 11, 2016

Friday, April 15th

*  Adam Grimes offers perspectives on mastering trading fears.  It's one reason risk management is so important.  If losses become emotionally debilitating, they inevitably result in future poor trades and missed opportunities.

*  Stocks traded in a slow, narrow range yesterday.  Breadth tailed off a bit, but fresh monthly highs continue to significantly outnumber new lows:  1009 vs. 110.  About 65% of SPX stocks closed above their three-day moving averages, down from over 85% yesterday.  If the recent move to new highs was indeed a breakout move, we should see upside follow through and decent volume on such a move.  Stalling on slow volume gives me pause.  A false breakout would trap a lot of late bulls.

*  We continue to see an increase in shares outstanding for the SPY ETF.  That has led to subnormal near-term returns in SPY on average; it's a useful sentiment gauge.

*  Recent sessions have shown a notable absence of selling pressure from institutions on the upticks/downticks measure.  As long as that's the case, it's difficult to imagine much of a correction in stocks.  Conversely, an expansion of downticks (selling pressure) would be an early sign of potential regime shift.
 

Thursday, April 14th

*  More must reading each week: Why earnings expectations are important and great weekly summaries from Dash of Insight.

*  Stocks moved to new rally highs yesterday with solid breadth.  Across all exchanges we had 1084 monthly new highs against 119 new lows, the strongest reading since late March.  While the new highs aren't quite as strong as readings last month, the relative absence of shares making new lows is telling.  The market generally makes significant reversals from highs when individual sectors break down.  I'm not seeing that breakdown so far.

*  Another perspective can be found in the cumulative number of buy signals versus sell signals among all NYSE stocks across multiple technical indicators (see below).  During 2015, this measure trended lower as groups of stocks failed to participate in market strength.  Now we can see it trends higher.


*  At a more micro level, cumulative upticks versus downticks among NYSE shares also continues quite strong.  This measure often trails off when we see weakness among smaller cap shares.  I'm not seeing that weakness at present.






*  All that being said, a number of my measures are stretched to the upside now (over 90% of SPX shares closed above their 50-day moving averages and over 80% above their 3 and 5-day averages), so it wouldn't be unusual to see some consolidation.  Note that pullbacks in breadth (below) have occurred at successively higher price lows.  





Wednesday, April 13th

*  Every day I'll try to identify a particularly good reading pertaining to markets.  This will also help to highlight people doing good work.  Here's an unusually thought-provoking post on stock market valuation from David Merkel at Aleph Blog.

*  Stocks traded steadily higher yesterday on the heels of positive oil news.  We've since added to those gains in premarket trading and look to test recent highs.  Interestingly, breadth is lagging a bit here.  Across all exchanges, fresh monthly new highs dropped from 598 to 577 and new monthly lows rose from 281 to 332.  Here's how the three-month new highs vs. lows look at this juncture:


*  Buying interest continues to swamp selling pressure on the upticks/downticks measure.  The cumulative ticks have broken to a new high (see chart below) and institutional participation (total upticking and downticking) has been strong. That has led to positive near-term returns on a short-term basis.


*  Since March 21st, we've seen net share creation in the SPY ETF, one of my favorite sentiment measures.  Returns have tended to be best when we've seen net redemptions.


Tuesday, April 12th

Some excellent wisdom in the Abnormal Returns interview with Matt Hall, including making investing and trading fit into your life and not the reverse.

*  Stocks finished with a late selloff after early strength and have since bounced a bit higher in overnight trade.  Bottom line is that we continue in a range trade.  Despite the selloff, advancing stocks outnumbered declining shares.  New monthly highs across all exchanges rose to 598 and monthly lows dipped to 281.  About 50% of SPX shares closed above their 3-day moving averages and 46% above their 20-day averages--the kinds of numbers you might expect in a range market.

*  Year to date, as the graphic from FinViz suggests, we've seen strength among utility and basic material shares (falling rates and the bounce in commodities have helped) and weakness among financial and healthcare shares.  It's been a bull market for some sectors and bearish for others--quite a mixed performance. 


*  US dollar weakness has corresponded to the period of higher commodities and higher prices for overseas stocks as well as US ones.  At some point dollar weakness will become overpositioned to the point where we could see a meaningful unwind; that would be a potential risk-off scenario to be on the lookout for.  We're having trouble sustaining weakness as long as a weak dollar helps global economies.

Monday, April 11th

You're running your trading in a smart way, but are you running it in an emotionally intelligent way?

*  We continue to trade in a range, as stocks on Friday generally closed higher but off their lows.  As of Friday's close, we saw new monthly highs expand from 385 to 476 and fresh monthly lows drop from 517 to 295.  That 517 new monthly lows was the weakest reading we've seen since the uptrend launched in February; I'm watching carefully to see if it holds.  Significantly fewer than 50% of stocks closed on Friday above their 3, 5, and 10-day moving averages.  (Data from Index Indicators).  I would be concerned for the bull trading case if we cannot sustain a bounce from here.

*  Commodity-related shares (XLB, XLE), consumer staples (XLP), and healthcare (XLV) have been relatively strong in recent sessions; retail (XRT) and financial (XLF) shares have been relatively weak.  Note the particular relative weakness of regional banks (KRE) and the continued crushing of yields in the Treasury (TLT) and high quality corporate (LQD) areas.  The banking sector index ($BKX) looks anemic.  If we were to have problems unraveling the bull, my vote goes to the banking group.

Continued concerns about pension shortfalls are in the media.  One person is quoted as saying that 7+% annual returns over the long haul are reasonable for pension fund payout assumptions.  Reminds me of assurances about ongoing 7% growth in China, even as outflows continue.  In a world of crushed yield, it seems to me pension funds cannot achieve targeted returns without enhanced risk-taking.  That is scary.  

*  Across a range of technical systems, we've seen a tailing off of buy signals relative to sells, with the two about even as of Friday's close. 


Sunday, April 10, 2016

Creating Your Trading Future



You are an entrepreneur; you run your trading business.  Here are some questions that might help you focus your efforts:

*  Are you creating a future for the business or are you mostly struggling to get by in the present?  Specifically, how much time are you spending on research and development, building the tools for tomorrow's trading, and how much time are you spending watching markets and placing trades?

Are you running the business in a way that would make you want to work for yourself as an employee?  Leadership is as crucial in a one-person operation as in a large enterprise.  How effective is your leadership of your trading business?

Is your business really growing?  Are you finding more opportunity now than in the past?  Are you trading new markets and/or new strategies or are you stagnating?  Would you choose to be an investor in your own business?

Would you be proud to post your PnL and your trades every day?  Suppose a film crew was filming you and your trading: would you want that film to be released?  What would someone watching that film conclude about you?

Look yourself in the mirror and ask yourself the tough question:  

Do I really want to be spending the next five years of my career doing what I'm doing now?

If you're on the right entrepreneurial path, the answer to that question is a no-brainer.  If you're on the wrong path, the answer is difficult--but it's the first step toward defining your promising future.  That can be very exciting.

Further Reading:  Becoming the Leader You'd Want to Follow
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Saturday, April 09, 2016

The Greatest Mistake Traders Make


Thanks to Bella at SMB for bringing this video on building your inner coach to my attention.  There are quite a few gems in the video, including the idea that your inner voice--how you talk to yourself--needs to become your inner coach.  We build that inner coach by maximizing performance in the present: focusing on what we're doing now and how we can do it better.  It is the process of self-improvement that yields the outcome of success.  Or, as the video emphasizes, winning is not an outcome; it's a process.

The mistake I see traders making is that they spend the lion's share of their effort on coming up with the next trades--not on the process of winning.  They focus on making money, not on getting better.  It would be unthinkable for them to go a full trading day or week without placing a trade, but they think nothing of going a day or week with no concrete work at the self-improvement that is the source of winning.

Imagine an athlete who felt the need to enter competitions every day, not wanting to miss any opportunity to win.  So much time would be spent on the playing field or court that little or no time would be spent in the gym.  Playing time would eclipse practice time.  Conditioning would fall apart; performance would show the effect of the lack of drilling and practice.  The need to win would get in the way of winning.

That is the greatest mistake I see among traders.  They want to be on the field; they want to score.  They are fearful of missing opportunities to win.  So they don't go to the gym; they don't drill and practice; and over time they lose their edge.  Their inner voices reflect the ups and downs of the most recent performance; their inner voices are not inner coaches.  

As the video suggests, suppose your inner voice while trading scrolled across the screens of other traders.  Would you be proud to display your inner voice, or would you be ashamed?  If you wouldn't want your inner voice to go public, why would you want it filling your head?

Further Reading:  The Real Reason We Trade Emotionally
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Monday, April 04, 2016

Trading Notes For The Week Of April 4, 2016

Friday, April 8th

Insightful post on the misery of bull markets from The Reformed Broker.  Many traders are temperamentally long vol; the one prediction you most rarely hear is one for little movement and little price change.

*  Going back to 2010, if you take the number of 5-day new highs minus lows among SPX stocks and compare those to 20-day new highs minus lows, you get an interesting view.  When that time series is divided into quartiles, we find that when 5-day new highs/lows greatly exceed 20-day highs/lows, the next five days in SPY average a gain of only +.04%.  When 20-day new highs/lows greatly exceed 5-day highs/lows, the next five days have averaged a gain of +.39%.  (Raw data from Index Indicators).  Think of the implications for FOMO trading...

*  We reversed Wednesday's strength yesterday, closing with 5-day new highs/lows well below the 20-day level.  Less than 20% of  SPX shares closed above their 5-day moving averages and, for the first time since this rally began, fewer than 50% of stocks closed above their 20-day averages.  My cycle measure is now neutral, as we work off the recent strong readings (see below).


*  VIX has jumped to above 16 with yesterday's drop.  I have built a model that predicts a normal VIX level from two variables:  recent price change and recent realized volatility.  When VIX is more expensive than the model predicts it should be based on historical precedent, returns have been positive; when VIX is more cheap than the model predicts, we have seen subnormal returns.  Thursday of last week through Monday of this week, we hit cheap levels in VIX valuation.  With yesterday's drop, we are back to being expensive in VIX pricing.  To give an idea, going back to 2012, when VIX has been in its most richly priced quartile, the next five days in SPY have averaged a gain of +.76%.  When VIX has been most cheap, the next five days have averaged a gain of only +.03%.  In short, when options participants price in too much vol, we tend to get higher prices--which implies a mean reversion in vol!


Thursday, April 7th

*  What would a startup community of traders look like?  Love this post from Howard Lindzon, mainly for the entrepreneurial zest I see missing among so many traders and trading firms.  Amazing what a difference it makes to be surrounded by innovators who bring vision and optimism to the future.  I see precious little of that in the trading community.

*  Stocks found solid buying yesterday in the wake of oversold readings, but have pulled back in overnight trade.  My intermediate-term strength measure, which looks at new highs versus lows for SPX shares on three different time frames, continues to work off its extended readings.  Many of my cycle-based measures look similar.  We're getting fewer new highs among stocks and new lows have ticked higher the last two sessions.  Yesterday, across all listed stocks, there were 467 new monthly highs and 417 new lows.


*  Using data from the Stock Charts site, I track the number of NYSE stocks giving buy versus sell signals across multiple technical indicators, such as Bollinger Bands, CCI, Parabolic, etc.  Here too we see the waning strength recently.  My measure of breadth volatility (the volatility of breadth readings) has picked up lately from low levels and that generally has been associated with weak returns.


*  Housing (XHB) has been relatively strong.  Not so much commodities (DBC).  Notice the strength of euro and yen versus the US dollar (FXE and FXY).  Hard to believe that is what ECB and BOJ want to be seeing; note the relative weakness of European (VGK) and Japanese stocks (EWJ).

Wednesday, April 6th

*  We can't change our behavior unless we're aware of our behavior patterns.  Here's a great post on self-awareness and trading from Tradeciety.

*  The pullback in stocks continued on Tuesday, giving us the first real negative breadth reading we've had since the rally launched in February.  (See chart below).  Across all exchanges, 270 stocks made fresh monthly highs and 492 registered new monthly lows.  (Data from Barchart).  Only about 10% of SPX shares closed above their 3-day moving averages and about 15% above their 5-day averages (data from Index Indicators), telling us that the pullback has been broad.  VIX has climbed above 15 and we saw greater put buying across individual shares.






*  Yesterday I noted the expansion of buy signals for stocks on the Stock Spotter site; those signals expanded even further after yesterday's weakness.  This has generally been positive for SPX.  Their cyclical model for SPY is also quite bullish, which has backtested well.  While I'm viewing this as a pullback in a bull phase of a cycle and expect a retest of recent highs, I will be watching the vigor of any bounce carefully.  Given the breadth of the recent weakness, it would not surprise me if we were to enter a more prolonged topping/range period.  We should see pronounced breadth divergences on forward strength if that scenario were playing out.

*   Note the considerable strength in high quality corporate bonds (LQD).  As noted a little while back, these are natural candidates for those seeking yield.  On the other hand, high yield bonds (JNK) have been relative underperformers.  This is a defensively minded market, which could also be why US shares have been outperforming overseas ones (EFA). 



Tuesday, April 5th

Excellent post on trading strategy and tactics from The Crosshairs Trader.  Very helpful in developing trading plans.

*  We've seen a pullback in stocks and, with Monday's close, now have fewer than 50% of SPX shares closing above their 3- and 5-day moving averages.  With 831 monthly new highs and 288 new lows, we're still not seeing significant deterioration in the breadth data.  Energy stocks have been the weakest group given the recent oil weakness, but I'm not seeing significant weakness among any of the sectors.  Financials have been relatively flat of late, so I have a close eye on those.

*  The realized volatility of VIX has hit levels that have been consistent with past market peaks.





*  I noticed that, as of yesterday's close, we had an elevated number of buy signals on the StockSpotter site.  I continue to be impressed with their work.  Their forecast model for SPY also is bullish.  When those two factors have been present since late 2013, when I first began tracking their numbers, returns five to ten days out have been bullish.  Specifically, we've been up 19 times, down 8 over the next ten trading sessions for an average gain of +1.17%.  


Monday, April 4th

*  Long-term success, in trading and in life, means sustaining our passions.  Here's how we do that.

*  We're seeing fresh highs this morning and have almost entirely erased the drop from late December.  Friday closed with 767 new monthly highs across all exchanges versus 217 lows.  Still no significant expansion of weakness in the upticks/downticks data, as we closed Friday at fresh highs.  Note that the cumulative upticks/downticks measure has vaulted above 2015 levels.


*  Among SPX shares, new 100-day highs outnumbered new lows by 127 issues (data from Index Indicators).  That is the strongest breadth reading on that measure since the rally began in February.  The last time we had a reading that strong was late in 2014.  Note how we have stayed overbought in the new high/low measure for a considerable period, attesting to the momentum of this rise.


*  Note how oil has been moving lower day after day, even as stocks have rallied to new highs.  The oil drop is noteworthy, coming on the backdrop of a weaker dollar.  High yield corporate debt (JNK) has also failed to make new highs in the last couple of weeks and global stocks have lagged (EFA).  Could it be that weaker makes for stronger?  As long as we're seeing deflationary forces at work, the Fed is likely to maintain a dovish stance.