Monday, October 16, 2017

Are You A "Strong" Trader Or A "Weak" One?

There are two types of traders:  

One looks for patterns and relationships that will occur universally and trades those consistently over time.

The other looks for stable periods in markets and trades the patterns and relationships that typify those regimes.

For the first trader, trading psychology is all about consistency and maintaining a consistent mindset.

For the second trader, trading psychology is all about flexibility, creativity, and adapting to changing conditions.

One is a stiff tree; the other is bamboo and willow.

The stiff tree has a hard trunk and looks strong.  It breaks when the wind blows hard.

Bamboo and willow have no trunk and look frail.  They bend with the wind and don't break.

There is a distinct regime in the current market.  There are patterns and relationships playing themselves out with regularity. 

How is your P/L?  Are you the "strong" and stiff tree, or the "weak" and flexible reed?

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Saturday, October 14, 2017

The Great Mistake Traders Are Making

So here is a chart of two trending markets.  What are they?

The blue line is pretty familiar:  it's SPY since the start of 2016.  That's a pretty high Sharpe trend.

The red line is not so familiar:  it's a 100-day moving average of the average daily true range of SPY.  In other words, the red line represents average daily movement (realized volatility) of SPY.

Note that we're getting roughly one-third the movement each day that we saw early in 2016.  And it's not getting better:  the past five trading sessions have averaged a daily true range of .33%.  That is closer to one-fifth the movement we saw early in 2016.

No wonder active traders have been challenged lately.  It's difficult being a directional trader when there is little movement in the instruments you're trading.

The one refrain I've heard from those active traders over the past two years is:  this is going to turn around.  Stocks are too expensive.  Rates are too low.  Volatility is too cheap.  Everyone wants to catch the turn and profit from the break.  So stocks dip, VIX bounces, put/call ratios go to the moon, and the trends continue.  Moderate growth with modest inflation and low interest rates that make stocks a desirable carry instrument mean that SPY has ground higher and vol has ground lower.

Traders' forecasts for reversals in stocks and vol have had more of a psychological grounding than a logical one.  Hope is not a business plan and it's not an edge in markets.  What has been more successful have been strategies that have targeted small cap and higher volume momo stocks that provide greater average daily movement.  Also successful has been migration to asset classes providing greater volatility, from commodities to cryptocurrencies.  And what has been successful has been true trend-following:  investing (not actively trading) equity and vol products.

The point here is that markets go through regimes and those regimes can last longer than traditionalists can stay solvent.  The momo boom of the late 1990s killed short-sellers accustomed to price action from the 1980s.  The collapse of momentum and bear markets of 2000 and 2008 wiped out many who had benefited from the prior bull market.  Now we're seeing a regime in which there is a major bear market in volatility, quite the change from 2007-2009.

This too shall change.  As I've noted earlier, volatility bottomed in late 1993 and late 1995, only to see the bull market really roar on higher volatility into 2000.  It's not inconceivable those dynamics could repeat themselves, with debt and low interest rates and fiscal stimulus stoking an already growing economy with low official unemployment.  A rise in vol does not necessarily entail a bear market in stocks.

But that is tomorrow.  Our job as active traders is to profit today.  We trade what we see, not what we crystal ball.  Adapting to the current regime requires a rethink about what we trade and how we trade it.  There *is* opportunity out there.  One active trader I work with had career high P/L this past week--just as VIX was languishing in single digits.  It can be done.  But not by merely hoping.

Further Reading:  The Market Is NOT Broken
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Tuesday, October 10, 2017

Focus: What Distinguishes Trading Professionals From Amateurs

Fascinating research by Andrew Lo and Dmitry Repin at MIT hooked traders up to physiological monitors to assess their emotional responses to markets in real time.  They found that all traders exhibit emotional processing.  The least experienced traders exhibited the most extreme emotional reactivity.  The authors speculate that an important difference between experienced and inexperienced traders is that the experienced ones focus on their emotional experience to access intuitive insights.  The least experienced traders become overwhelmed by their emotional experience in a fight or flight fashion.  This could help explain why high levels of emotional experience were associated in their research with poorer trading returns in their subsequent research: moderate emotional arousal became a stimulus for focus for the pros, whereas high arousal becomes a distraction for the newbies.

This points to an essential difference between a pro trader and an amateur.  When the pro faces market challenges, he or she increases focus.  When the amateur faces challenges, focus is overwhelmed.  In the face of large market opportunity or threat, does a trader gain or lose focus?  That distinguishes successful traders from less successful ones.

In a recent post, I compared the successful trader with a sniper.  The sniper actually lowers heart rate and body arousal as the target comes into focus.  It would be an amateur who would become excited over the appearance of the target, allowing physiological arousal to interfere with aim.

I knew I had become a professional psychologist when a client opened a meeting by expressing serious suicidal feelings and impulses.  I immediately became very calm and focused and gave that person my fullest attention.  There was no way I could have done that when I was first learning in school.  It was repeated experience--and confidence gained from that experience--that enabled me to view crisis as opportunity, not threat.

Every day of trading can be practice in developing focus.  We can either exercise our concentration and attention or we can reinforce poor habits of distraction.  The successful trader does not *control* emotions.  The successful trader is sufficiently focused to learn from emotional experience.

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Saturday, October 07, 2017

The Trader As A Sniper

For many years, as I was learning trading, a military poster of a sniper hiding in the brush hung on the wall of my office.  In so many ways, the sniper embodies the strengths of the successful trader:

*  Significant learning and practice precede going into the field and developing expertise.  The sniper shoots at many targets under realistic conditions before ever going into actual battle.

*  The sniper must adjust to conditions in the field.  Hiding is different in the desert than in the forest.  Shooting is different in the wind and rain.  

*  The sniper maintains supreme self-control.  The excited, high-fiving sniper doesn't last long.  It's the sniper who can stay motionless for extended periods of time, controlling breathing, and maintaining steadiness who can make the shot and hit the target.

*  The sniper retreats after the kill.  There is no operating on tilt, no taking of impulsive shots, no overconfidence once the target drops.  The priority becomes moving and remaining undetected.

*  The sniper weaponizes math. Many calculations precede the good shot.  The sniper adjusts for distance, gravity, and the movement of the target.  The sniper adjusts for wind speed and changes in the wind.  The slightest miscalibration sends the bullet astray.

*  The sniper follows an integrated processArmy Manual FM23-10 describes the sniper as following an "integrated act of firing", with a preparation phase (complete maintenance and check of equipment); a before-firing phase (maintaining position and checking aim); a firing phase (controlling breathing and body movement, steady squeeze of the trigger); and an after-firing phase (noting the kill or determining errors that led to an errant shot).   

Perhaps most important of all, the sniper--like all true performance professionals--spends much more time preparing for the kill (practicing, hiding, observing) than actually shooting.  From athletics to Broadway productions, the performance professional practices and reviews performance for much more time than he or she spends on the field or stage.  It is the hours of motionless waiting and continual maintenance of the rifle and regular practice under different conditions that prepares the sniper for one good shot.

If you're trading with a sense of excitement; if you're spending more time trading than preparing for trading and learning from past trading; if you find yourself firing away without following an integrated process, think about what would happen to the sniper under similar conditions.  Snipers operate in an environment of opportunity--and risk.  Financial markets offer a very similar landscape.

Further Reading:  Trading Like a Sniper
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Friday, September 29, 2017

Growing Your Trading Success

Growing as a trader means getting deeper in the river, one foot at a time.  Deeper means building new strategies and finding new sources of edge in markets.  Deeper means expanding risk taking with existing, proven sources of profitability.  As a trader, you want to grow, and you want to do it the right way.

Kudos to Mike at SMB, who wrote this post on a trader who was tested in trading a fast moving opportunity and who passed the test.  What was key was that this trader did not go on tilt when losing money and did not lose focus.  Recognizing this, his risk manager gave him a green light and a day that started as quite a loser became quite a winner.  He took a big step in the river, but never got over his head.

Growth as a trader typically comes in two phases.  The first is achieving a high degree of consistency.  The developing trader develops rules and processes and becomes increasingly consistent in decision making.  While achieving this consistency, the smart trader trades small so that all the mistakes made out of inconsistency won't cost too much capital.

In the second phase, the trader has to monetize his or her consistent trading by expanding risk taking.  This must be done in a way where the risk taking finds increasing depth, but where the risk taking is never jumping in with both feet.  Often the problem is that, during the phase of consistency, the trader has acclimated to small risk taking.  Having traded small for many months, the trader internalizes the sense of being a small trader.  No one has achieved great things with small vision.

It's a tricky combination:  revising one's trading self-concept--learning to think big after having managed small risk--while still retaining the rules, processes, and consistency.  Perhaps the greatest impact of a trader passing the test is the impact that success has on the other traders on the floor.  "If they can do it, why can't I?" is the natural response.  That's the best encouragement of all to get a little deeper in the river.

Further Reading:  Trading and Risk Intelligence
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Wednesday, September 27, 2017

What Is The Value Of Technical Analysis?

A recent post from the excellent Mathematical Investor blog questions whether the use of chart patterns and technical analysis truly offers value in financial markets.  The authors point out how easy it is to manipulate information to look significant (commonly encountered when an "analog" to the current time period is found in a previous historical period).  Indeed, it's possible to find historical analogs to any market behavior simply because the search space over the course of financial history is so large.  This is classic overfitting: the similarities of today and the past are likely to be chance artifacts.

As one astute market participant noted to me, one has to be suspicious that other disciplines do not make use of chart patterns and indicators of historical time series.  If, for example, a weather forecaster were to note that today's warm temperature is a breakout from the recent range of temperatures and therefore we should see temperatures trending higher through the week, this would not be a credible forecast.  Nor would we take seriously a weather forecast that looked for configurations of cloud patterns.

Although the validity of technical patterns is often questionable (How often do we see valid backtests of assertions made on technical grounds?), it is their poor reliability that I find particularly problematic.  It is not unusual to find two technicians look at the same chart and arrive at radically different conclusions based upon the lookback period considered and the definition of the pattern.  One might see one wave count in a given market; another will arrive at a different count.  Both will entertain "alternate counts" that lead to radically different conclusions.  Can you imagine radiologists arriving at wildly different interpretations of imaging scans?  The lack of reliability would make it difficult to develop any kind of valid surgical intervention.

All that being said, I do see empirical work out there that links past returns to future ones.  Very often, these studies find value and momentum effects (circumstances in which past returns lead to reversals or continuation) that are tested for economic as well as statistical significance.  I have also seen traders firmly define patterns that "set up" in intraday markets and test them out for skews in forward returns, creating successful "playbooks" that guide their trading.  This study of market intraday momentum recently came to my attention as an example of more rigorous implementation of price patterns as potential predictors.  I also observed a daytrader this past week rigorously test a pattern of behavior in the VWAP of stocks that led to short-term momentum.  

Does technical analysis have merit?  I would argue yes, but more as a source of hypotheses than as a source of conclusions.  We can frame market behavior in terms of patterns, but it is important that these patterns be defined objectively and tested properly before they merit the investment of hard-earned dollars.

Sunday, September 24, 2017

Finding Energy and Purpose in Your Daily Life

You are working hard, but are you working on the right things?

You are climbing the ladder, but is it leaning against the right wall?

You are busy, but are you productive?

Are your daily efforts energizing you or draining you?

Is most of your time spent coping with challenges or implementing a life vision?

You are leading your life, but are you truly leading your life?

Too many people I meet with are working hard and doing the best they can do to cope with daily challenges. They are striving but not thriving. This latest post addresses how we can bring visionary leadership to the leading of our lives.  It might be the most important thing I've written.
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Saturday, September 23, 2017

The Most Important Reason Traders Can't Size Up Their Positions

It's really true:  confidence doesn't come from success alone, but rather from facing failure and moving beyond it.  When you've been tested and tested and tested again, you begin to recognize that the tests are what make you stronger.  They provide the opportunity of learning, not merely the threat of loss.

But many traders fail to look fear in the face.  They chronically undersize positions in an effort to prevent major losses.  When their ideas work out, however, their undersizing also prevents major gains.  Over time, those traders are nagged by the sense that they have skill, learning, and an edge in markets, but are not taking proper advantage of their strengths.

So they come to me and ask for help in risk-taking.  They want to size up positions, but can't bring themselves to do it.  It's too scary to look fear in the face, so they settle on quick glances.

Why is this?  Why are some very talented traders unable to take optimal advantage of their talents?

I recently met with a group of traders and reviewed their journals.  Most of the journal entries were very detailed, suggesting hard work and desire to improve.  The entries went through the trades they put on, how those trades went, and what they could have done better to manage the positions. Sometimes the journal entries also spoke of missed opportunities and positions sized too large or taken in the absence of a clear signal.

My first reaction was that these journals are a waste of time.  They outline problems, but don't contain any detailed plans for correcting those problems.

But I was wrong.  The journals were worse than a waste of time.  They were killing the traders.

Look at it this way:  Suppose I kept a detailed journal of your life and wrote down everything you did wrong, as well as the things you could have done better.  Better yet, imagine approaching a young son or daughter in this manner.  What would be the result?

Damaged self-confidence.

If you keep harping on what you do wrong, why would you internalize a sense of opportunity and achievement?  If all you focus on is what you could have done better, eventually you'll believe that all you can do is fall short.  A good sports coach or military leader knows when to praise and when to criticize: when to build up and when to tear down.  Without the building up, all we do is tear down.

So what happens?  We make money but internalize the sense of "could have done better".  What we don't internalize is confidence.  We're never on the front foot when taking risk because we've programmed ourselves to expect shortcoming.

Take a look at your trading reviews and journals.  Do they inspire?  Do they focus on specific learning and achievement, or are they simply ventings of frustration and things that didn't go as well as possible?  Many, many traders are not working on their trading at all.  They are working on tearing themselves down.

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Sunday, September 17, 2017

Turning Our Goals Into Commitments

One of our great vulnerabilities is that our intentions tend to be mood dependent.  When we've just lost money and are in a remorseful state of mind, we vow to correct our errors and stick to our best practices.  Then, the remorse gives way to curiosity and excitement and we forget our resolution.  We allow our new moods to create different intentions--and different action patterns.  True discipline means acting in a consistent manner regardless of mind state.  That requires commitment.  If we are truly committed to losing weight and getting in shape, we get to the gym no matter what time of day it is or what the weather is like.  When we are committed to self-improvement, we don't rest on our laurels when things are going well.  As Mike Bellafiore recently pointed out, we use positive performance the same way we use negative performance:  as a source of learning and development.

Commitment is something we do, not something we have.  The religious person starts each day in prayer; the basketball team meets each day for practice and conditioning; the world-class trader searches for opportunities and re-searches sources of new opportunities.  These are routines sustained by a sense of urgency and importance.  They are not mood-dependent because the sense of urgency transcends the moods of the moment.  I might not feel like going to the gym and eating a healthy meal, but if I know the health of my heart depends on those actions after I've just had a heart attack, my feeling state of the moment becomes irrelevant.  

Traders focus on setting goals to further their development, but goals by themselves lack power unless they are backed by urgency and are fueled by commitment.  If I deeply love my wife and am filled with gratitude for the many things she has brought to my life, I can be in a funk and yet still want to do things for her and with her.  If I urgently desire to win the next game, I'll shrug off my tiredness and push myself and my teammates in practice to take us to the next level.  Show me your daily routine, and I'll show you your commitments.  If it's in your heart, it will be in your calendar; if it's in your calendar, it will become an intrinsic part of you.  Our activities express our character and shape it.

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Saturday, September 09, 2017

Four Important Trading Insights

Here are a few valuable insights I've gathered from my recent work with skilled, successful traders:

1)  What you trade is as important as how you trade:  The successful traders are trading instruments that move in meaningful ways and that capture their best ideas.  That means trading instruments that show the right kind of movement, and it means expressing your ideas through positions that offer the best risk/reward.  The successful traders have many ways to capture ideas:  many time frames, many instruments (stocks, futures, options), many markets.

2)  Balance matters:  When trading gets difficult, it's often the traders most passionate about trading--who devote most of their waking hours to trading--that are most vulnerable.  It's easiest to see markets clearly when trading fits into your life, not when you are frantically fitting your life into trading.  The goal is to have a happy, fulfilling life no matter what markets or P/L are doing.

3)  The best trading ideas come to you:  So much of trading boils down to real time pattern recognition.  You see many things, and you see them line up, and the idea comes to you that the market is making a top or bottom, that the momentum move will continue, etc.  Finding the good trade means shutting down the ego, emptying the mind, and becoming receptive to insight.  If you are actively *trying* to make money and thinking about how much you're making or losing, you fill your mind with outcome-thinking, which crowds out the process focus.

4)  Develop a higher cause:  I hear traders fretting over losing trades, getting frustrated and losing discipline and focus because of missed opportunities.  Chill.  There are people with real problems in the world: their homes flooding, their lives in jeopardy, their futures uncertain--in Houston, in Florida.  I've been impressed with traders who are strongly grounded in their religion.  Of course they don't like making trading mistakes, but they don't let the most recent trades dictate their moods or perspectives.  Perspective is the most powerful psychological tool of all.

When we develop relationships with other dedicated, successful traders, we build role models.  We learn from their experience, accelerate our development, and contribute meaningfully to the growth of others.  Trading goes best when it is yoked to rewards (intellectual fulfillment and challenge; committed teamwork) that are independent of the most recent trading results.

Further Reading:  The Power of Doing Nothing
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