Monday, January 23, 2017

Three Warning Signs of Trading Failure

There are three warning signs of failure among traders I've observed:

1)  Letting Political Preferences Color Investment and Trading Views:  Barry Ritholtz makes an excellent point in his recent article.  You may love the new President; you may dislike him; you may have doubts and concerns about his administration; you may have hopes and aspirations for his term in office.  Politics is a poor predictor of market performance, as Barry illustrates.  

2)  Becoming Fixed in a Bullish or Bearish Stance:  There are reasons to take a directional view at various times, but chronically taking one stance or another is a sign of imposing one's views on markets, rather than following the flows of supply and demand.  I've worked in places where analogies to such market crashes as 1987 and 2008 are regularly trotted out and used to justify bearish stances.  Invariably, those have been after times of weakness, preceding market rises.

3)  Becoming Locked Onto a Single Time Frame:  Traders often have favorite indicators or statistics.  They latch onto those and view markets solely through those prisms.  What looks like an overbought market in one time frame may be the start of a rise in a longer one.  What appears to be a range bound market at one time period might be a pause in a longer-term trend.  As in much of life, we are most likely to overreact to events when we fail to place them in context.

These three warning signs are problematic, because they suggest that the trader is not truly evidence-based.  An evidence-based trader approaches markets the way a juror ideally approaches a trial:  with an open mind, weighing each piece of evidence, and arriving at a judgment based upon the evidence.  The competent juror looks for facts and only makes their mind up when the facts line up.  It's not a bad model for traders.


Sunday, January 22, 2017

Is This Market Headed Higher or Lower?

If you check out the recent market review from Jeff Miller, you'll notice something interesting:  U.S. economic data are quite strong.  The Philly Fed index of business conditions, for example, has been rising strongly, exceeding expectations.  Jobless claims are at unusually low levels, the opposite of what we'd expect if we were on the verge of recession.  

Interestingly, my model of stock market sentiment has been on the bearish side over the past week.  That model looks at the ratio of put option activity to call option activity for all listed stocks (not indexes) and exchanges.  The regression model takes out the overall impact of implied volatility for the market overall and recent price change, so that we can see--for a given level of $VIX and recent price change--whether market participants lean bullishly or bearishly.  When they are relatively bullish (model below zero), the next ten days in SPY, going back to 2014, have averaged a loss of -.15%.  When traders are relatively bearish (model above zero), the next ten days in SPY have averaged a gain of +.69%.

The stock market has been correcting in recent weeks, which can be seen in the above graphic that tracks intermediate-term market strength.  This measure is derived from the number of SPX 500 shares that make fresh 5, 20, and 100-day new highs versus lows.  (Raw data from Index Indicators).  What we've been seeing is a diminishing number of shares making new highs.  On an intermediate-term basis, we've also seen some expansion in the number of stocks making new lows.  For example, across all exchanges, fresh one-month new lows have outnumbered new highs for the past four trading sessions.  

With respect to the major averages, it's been a relatively flat correction to this point, with more sector rotation than outright weakness.  We're trading at about the same level in SPY as we were in mid December.  My ensemble model, which combines individual models related to such factors as buying/selling pressure; volatility; sentiment; and breadth, has been leaning bearish for the past week.  That leaves me open to the possibility of further correction, as the model anticipates price change two weeks forward.  The rotational nature of this correction, the strength in economic data, and the strength of the post-election rise (which saw a meaningful expansion in the number of stocks participating on the upside) all lead me to believe that any such weakness will indeed be part of a correction and not an outright bear market.

Should rates continue to rise as part of a gradual normalization of Fed policy in response to a firmer economy and rising inflation, we could see a movement out of fixed income and into the stock market.  That would especially be the case if the tailwinds of coming economic stimulus look to outweigh headwinds that could come from restrictive trade policies.  If we, indeed, were to get further correction in stocks and even more bearishness from sentiment data (as anticipated by the trading model), the investor in me would be looking to scoop up some values.

Further Reading:  The Trading Model

Saturday, January 21, 2017

Living Life as an Origin, Not as a Pawn

In his book Personal Causation, Richard De Charms outlined the difference between people who experience themselves as origins versus pawns.  Origins are those that can initiate chosen action; they have impact on the world.  Pawns are those to whom things happen.  They are relatively powerless and passive.  A similar distinction in psychology is internal versus external locus of control:  the degree to which we perceive life outcomes as within or outside of our control.

All of us experience bad things in life.  Some of us experience really bad things.  We either move on as survivors or victims.  Survivors live their lives as origins; victims as pawns.  Survivors wrest control of their futures; victims experience life as outside their control.

The more someone has actually been victimized, the more important it is to not live life as a victim.  I've worked with those who have been raped, sexually assaulted, and physically abused.  They move on successfully as survivors, not as victims.  They overcome by refusing to remain victims.  They find their voices and forge meaningful paths of action.  I once worked with a medical student who had been horribly abused.  She lived every day refusing to succumb to painful memories and instead dedicating herself to healing.  What a beautiful transformation:  her ability to survive was an inspiration to many others.

I can honestly say that I've never met a successful, productive person who fundamentally experienced themselves as a victim.  Successful, productive people originate; victims suffer.  The medical student became a survivor by using her suffering to originate healthy outcomes for others.  The trader who endlessly complains of unfair, rigged, and manipulated markets is a psychological victim.  Such traders cannot originate success as long as they experience themselves as pawns.

The problem with political correctness (see recent perspectives here and here) is not a matter of left- or right-wing politics.  The problem with political correctness is that it enshrines psychological victimhood.  Survivors do battle; they don't seek "safe space" refuge from every perceived "microaggression".  Political correctness, at its worst, is virtue signaling via victimhood:  an attempt to establish one's status--and especially to diminish the status of others--by embracing pawn status.  The goal is not to find one's individual, authentic voice, but to extinguish the voices of others--the precise opposite of diversity.

At companies I've worked for, I've heard quite a few managers criticize political correctness.  Ironically, many of these managers work for businesses in which questioning management decisions is taken as a sign of disloyalty and lack of teamwork ethic.  Quite a few employees have been referred to me over the years because they spoke out.  My job, apparently, was to help those employees build their "positive psychology" and become better "team players".  Political correctness shuts down criticism, whether it originates from one side of the political spectrum or another.  We cannot be origins if we are punished for our voices.  Per Voltaire (and Snog's Ballad), we are ruled by those we can't criticize, whether the punishers are governments, corporate overlords, or politically correct thought police.

No one will respect you as a trader for the number of times you lose money, or the ways you lose money.  They respect you for getting up after getting knocked down, learning from experience, finding your strengths, and growing and persevering.  If you re-read the Market Wizards texts, you'll appreciate how often successful traders experience harrowing losses.  They are in the texts because they moved forward as survivors and originators who transcended defeat, not as victims.  

Life is far too short to be lived in pawnhood.  What in your life--and in your trading--are you originating?

Further Reading:  Trading as Training in Mental Toughness

Friday, January 20, 2017

What are the Trading Lessons You'd Want to Teach Your Younger Self?

A very helpful post from Bella at SMB asks the question of what you would tell your younger trading self.  What lessons have you learned that you would have wanted your beginner self to know about?

One of the important ones Bella discusses is being a sponge.  He makes a great observation: the best traders he works with talk like him.  Not because he has all the answers, but because they've internalized the learning he shares as a mentor.  Great lesson for our younger self:  find a mentor and absorb their teaching.  All performance learning is apprenticeship.

A second important lesson I would impart to my younger trading self is repair it, before you repeat it.  Keep detailed score of your trading process and results and learn, learn, learn from mistakes and successes.  Spend more time repairing and less time staring at screens, fearful of missing the next trade.  Missing your mindset errors will cost you much more in the long run than missing a trade entry.

A third lesson is illustrated by the metal band Judas Priest.  They took a great folk song from Joan Baez and re-interpreted it, giving it an entirely different sound.  Over 20 years later, the band had matured and gave the song yet another voice.  That's what great artists and traders do:  they innovate, and they mature.  I'd want my younger self to be less interested in consensus ideas and approaches and more focused on finding his own voice.  Absorb the lessons of mentors and then use your experience to make those lessons your own.

Absorb learning from those who have blazed a path ahead of you.  Relentlessly work on yourself to improve weak areas and build on strengths.  Then, armed with learning, experience, and self-mastery, don't be afraid to blaze your own path and become one of those mentors that will inspire and educate others.  Expertise is a developmental process...make sure you're continually developing.

Further Reading:  Developing the Right Trading Routines

Thursday, January 19, 2017

The Foundation of Trading Success: Finding Multiple Ways to Win

Successful traders lay very deep foundations.

What does that mean?

It means that they find multiple ways to win and develop experience and expertise in each of those areas.

Think of any successful company:  a soft drink company, an automobile manufacturer, an electronics maker.  All have many products that they sell.  Each one is a potential profit center, and the combination of multiple profit centers creates a deep foundation for the business.  If one year SUVs don't sell, the auto manufacturer can sell fuel-efficient sedans or sports cars.  Multiple ways to win means that you can win even when some of your strategies don't.

The successful money manager creates a portfolio of relatively independent trades, each of which possesses positive expected value.  One idea might be to be long the US dollar because of interest rate trends and central bank policies in the US versus other countries.  Another idea might be to be long mega-cap stocks and short micro caps because of the anticipated impact of fiscal stimulus and tax credits.  Still another idea might be to buy agricultural commodities because of a change in long range weather forecasts from the best meteorologists.  Such a portfolio has multiple ways to win...if one idea doesn't work out, the others can.

Similarly, the active daytrader may trade a reversal pattern with active stocks near the open and then trade a surprise earnings report later in the day with a single stocks and then trade a trending stock into the close. Over the course of the day, the active trader has placed many trades, each with an edge.  It is the serial pursuit of opportunity that creates diversification each day.  One trade can fail and the day can still be profitable.

What that means is that successful traders must be able to innovate at two levels.  First, they must find new ideas and fresh opportunities.  Second, they must cultivate new sources of ideas and opportunity.  The first involves exploiting the edges we already possess; the second involves identifying additional edges.  The successful trader is never static, never dependent on one type of market condition to make a living.  Just as research and development is the lifeblood of technology and pharmaceutical companies, it is the source of long-term success for traders.

When successful traders aren't trading, they are researching, developing, and innovating.  When unsuccessful traders aren't trading, they're staring at screens and forcing trades.  There is nothing better for trading psychology than being at the cutting edge of a growing business.

What makes a trader successful is discipline:  doing the right thing with fidelity.  What keeps a trader successful is innovation:  doing new things and turning them into disciplines.

Wednesday, January 18, 2017

Turning Goals Into Consistent Actions

Here's an idea to add to your keeping of a trading journal:

Instead of simply recounting what you did right and wrong and what you'd like to do going forward, grade yourself on your consistency.  

Your consistency grade requires a list of your best practices.  These are the things you do when you're at your best.  They can be lifestyle choices, such as how you eat or exercise; they can be best trading practices; they can be best practices in terms of your romantic and family relationships.  In other words, the list consists of the things that define you at your best.

Your consistency grade represents a frequency count of the number of days in the past week in which you have enacted that best practice.

When our two youngest children were very young, we created "sticker charts" for them.  Each day they cleaned their room, played well together, and ate well, they received a sticker.  If they received stickers every day of the week, they could cash those in for a toy or fun thing to shop for over the weekend.  The key to the exercise was the requirement that stickers had to be earned every day.  That rewarded not just good behavior, but consistency in good behavior.  It's that consistency that builds positive habit patterns.

Imagine an adult equivalent of the sticker chart:  If you can check the boxes on your best practices list every day, you arrange a reward experience on the weekend.  Perhaps it's a reward experience with someone you love, giving an extra incentive to achieve consistency.  Most traders are achievement oriented.  If they set up this kind of system and make it public (we hung the sticker charts on the refrigerator), they will want to check the boxes.  They will not want to fall short of a goal they commit to.

The hard part in making changes is getting to that place in which desired behaviors become routine behaviors.  It's easy to fall back into old patterns before the new ones take root.  Structuring your work on yourself--and on your trading--as work on consistency helps you make that transition, building those new, positive habits one day at a time.

Further Reading:  Turning Success Into a Habit

Tuesday, January 17, 2017

Making Sense of the Market's Auction Process

Here's an admittedly unusual chart taken from last week's stock market action.  The red lines represent the amount of total upticks in the market on a one-minute basis.  I use this as a measure of buying pressure.  The blue line represents one-minute closing prices in SPY.  The chart is arranged so that the week's high price for SPY is at the left and moves toward the low price at the right.  Time is not a variable here.  We are looking at buying pressure at each price level of SPY during the past week.

What we see is that buyers were quite active as we crossed the 227 level in SPY.  We also see very low levels of buying and in fact net negative buying from approximately 226.75 to 226.87.

It's a way of smoking out where the buyers and sellers are located.  I've found this to be a very useful way of thinking about "support" and "resistance"--and an especially effective way of identifying points where fresh buying or selling are entering the market.  

It's also an example of how looking at market data in new ways can provide fresh perspectives that aid market understanding.  If a price level has held sellers this past week but cannot hold sellers early this week, it's a very useful indication of a shift in supply vs. demand.

I find my most effective trading captures an understanding of who is in the market and what they've been doing.  Too many traders attempt to forecast what prices *will* do before they truly understand what they've been doing.  The market is an auction, and you're watching the behavior of buyers and sellers to determine whether the price of the goods is likely to rise or fall.  It's amazing what we can see when we place market behavior in proper context.

Further Reading:  The Most Powerful Step We Can Take Toward Becoming Solution Focused

Monday, January 16, 2017

Turning Information Into Knowledge: 100 Sources of Potential Insight

Traders are typically inundated with information--from charts and data feeds, chat, financial media, social media--but obtaining knowledge (not to mention wisdom!) requires some active filtering.  The challenge is to be open to new sources of perspective, but not so open that everything becomes a blur.  I would much prefer to deeply ponder five excellent sources of knowledge than skim fifty.  Indeed, it's the proliferation of information--and our desire to assimilate it all--that often prevents us from obtaining true knowledge and wisdom.

A recent feature from Feedspot highlights 100 top blogs and websites associated with the stock market.  These have been ranked as a function of site traffic and social media followings.  TraderFeed is on the list, as are a number of news and trading-related sites.  A great exercise would be to scan the list and find one source of information that can truly provide knowledge for your trading.  While not all 100 will be relevant to every trader and investor, the odds are good that at least one can provide new ideas and perspectives.

Creativity begins with new inputs:  we're most likely to achieve new insights when we look at new things and contemplate old things in new ways.  The challenge is finding the information most likely to provide us with actionable knowledge.  The list of 100 sites is a good place to start.  

Further Reading:  Some of My Favorite Financial Websites for Developing Traders

Sunday, January 15, 2017

Positive Psychology and Trading Psychology: Bloomberg Radio Interview With Brett Steenbarger

I have to say, in the many years in which I've participated in interviews, I've never encountered one as detailed and well-prepared as Barry Ritholtz's recent interview of me on Bloomberg Radio.  He sent me questions in advance, updated those questions before the interview, and then came up with additional questions during the interview that revealed his prior thinking on the topics.  Barry's podcast series, Masters in Business, has become an impressive body of work, including interviews with such authors as Michael Lewis, Daniel Kahneman, and Philip Tetlock.  

One of the major themes of the recent interview was the role and importance of positive psychology for the discipline of trading psychology.  Positive psychology grew out of the early work of Abraham Maslow and the subsequent research of Martin Seligman and others.  It is the study of human strengths and competencies, as opposed to the study of psychological disorders.  An excellent curated list of positive psychology readings can be found here.

In a performance field such as trading and investing in financial markets, it is the leveraging of these positive attributes that distinguishes success.  Solution-focused work turns traditional counseling, therapy, and coaching on its head by intensively studying our successes--and then building upon those.  The Trading Psychology 2.0 that I describe in my recent book is a view of trading performance that highlights such strengths as adaptability, creativity, and the continual evolution of best practices into best processes.  Those topics were barely mentioned in trading books when I first began working with participants in financial markets almost two decades ago. 

If you have goals and a vision for yourself, the best way to reach those is to find the ways in which you are already moving toward those ideals in some ways, at some times.  There are patterns connecting your smaller successes that can become the framework for larger successes.  We are already the people we wish to become, but often only occasionally and inconsistently.  It is our moments of best performance that hold the key to the achievement of our greatest dreams.

Thanks again to Barry and the Bloomberg team for the opportunity to exchange ideas.  The podcast series is an invaluable resource for traders and investors.


Saturday, January 14, 2017

The Power of the Pause

Here's a very simple rule that distinguishes good traders from poor ones:

Good traders trade poorly at times.  When they do, they pause from trading, reassess the market and themselves, and don't return to trading until they're in a different mode.  That different mode could be a different state of understanding; it could be a different emotional, cognitive, and physical mode--often it's all the above.  When good traders trade poorly, they make changes before placing additional capital at risk.  Pausing from trading is an essential part of their success.  It returns them to their best practices.

Poor traders also trade poorly at times.  When they do, they continue trading, and they compound their mistakes.  They never achieve a different mode, because they're so focused on markets that they never observe themselves.  When poor traders trade poorly, they place additional capital at risk before they can make changes.  That further trading is essential to their failure.  It keeps them from implementing best practices.

To determine a trader's skill, watch what they do when they are not trading.  How well do they research and reassess markets?  How deeply do they reflect and observe themselves?  It is in life's pauses that we have an opportunity to change direction.  Without powerful pauses, nothing can change.

Further Reading:  Three Best Practices of Trading