The Trader Coach Project: Changing Behavior Patterns

In the last post in this series, I outlined how Trader C and I redefined the concerns that brought him to coaching. We targeted three specific positive trading behaviors that he wanted to implement with consistency--his trade size, stops, and profit targets--and reduced the size of his longer-term positions to reduce the pressure from the intraday risk management (loss limits) at his firm. We also set up a structure by which he could grade himself each trading day on these three dimensions of improvement.

A good coach leverages the existing strengths of a trader. It turns out that Trader C has experience with meditation and utilizes it with some regularity. This provided us with an opportunity to adapt his meditation to our three goals. What I suggested is that he engage in his meditation routine--breathing deeply and slowly, keeping his mind focused--but that he *vividly* imagine himself trading and doing the things he needs to do to achieve an "A" grade in regulating his size, placing/honoring stops, and setting/following profit targets. Each day for 15-20 minutes prior to the trading session, Trader C's homework was to stay focused on different market scenarios--winning trades, losing ones--and visualize how he would handle each of these in order to give himself that "A" grade.

Such visualization, combined with relaxation and increased focus, provides repeated experience for the trader to cement the positive patterns. By mentally rehearsing his desired trading behaviors, he accelerates the building of positive habits through repetition. Moreover, by vividly imagining a variety of market scenarios for mental rehearsal, he facilitates the generalization of his positive behaviors to almost any situation he's likely to face.

A key aspect of this generalization is that I asked Trader C, during the trading day and prior to making any trading decisions, to consciously take just a couple of deep breaths before acting. The idea behind this is that he will be building an associative link between the focused, relaxed state and his rehearsed, positive trading. (See my Psychology of Trading book for a more detailed discussion of the role of state shifts in behavior change. The Enhancing Trader Performance book includes two chapters devoted to the how-to's to cognitive and behavioral change methods). By taking a moment to get himself calm and focused prior to making a trading decision, Trader C can improve his access to the "A" grade trading practices.

During the past week, Trader C largely earned "B" grades and better. Interestingly, it was a very good week for his trading and his annual equity curve hit a new high. The goal of our work is to turn his best trading into habit: to make it automatic. There's no need for "motivation" and "discipline" when positive behaviors are internalized and made routine.

In my next post, we'll follow up on Trader C's progress--including challenges he continues to face--and how we address those.

RELEVANT POST:

Accelerating Behavior Change With Imagery
.

When Markets Gap Down, What Happens Next?

If the markets stay true to their overnight course, we should have a weak opening. This creates a large downside gap relative to yesterday's close. I decided to go back to the start of 2004 (N = 888 trading days) and investigate what happens after the S&P 500 Index (SPY) opens lower by more than .40% (about 6+ full ES points in the current market).

We've had 45 instances of such weak opens. From the open to that same day's close, SPY averaged a loss of -.19% (19 up, 26 down). That compares to an average open-to-close change of .02% (463 up, 380 down) for the remainder of the sample. Thus there has been some tendency toward downside follow through after a weak open.

I then looked at those occasions in which the weak open was below the lowest low price of the prior three trading sessions (N = 14). On an open-to-close basis, SPY averaged a loss of -.32% (5 up, 9 down). Once again, we see no positive edge following a weak open. Indeed, there seems to be short-term follow through to the downside on a majority of occasions. Out of the 45 downside opens, 31 traded lower by at least -.30% during the subsequent day session.

=========

I've already received positive feedback re: the Twitter Trader feature now on the blog. It enables me to post brief comments about the market that ordinarily wouldn't merit an entire blog post. The last five comments are displayed on the blog. To see all the prior comments for the day, check out my Twitter page.
.

Behind the Market's Weak Money Flows

My recent discussion in the Trading Psychology Weblog and my last posting on money flows among the Dow 30 stocks found that the recent rally has differed from previous market strength. The pink line in the chart above represents what I call the Relative Dollar Volume flows for the Dow stocks. This compares the 10-day dollar flow for the 30 stocks to the average dollar flow over the prior 200 trading sessions. When the number is negative, it means that today's flow is below the 200-day average; when it's positive, it means that we have above average flows into stocks.

The chart shows clearly that the recent bull market has been built on the back of above average money flows into the large caps.

During the most recent rise, however, money flows have headed straight south. For nine consecutive trading sessions, we've had below average dollar volume flows. Indeed, we've barely had more money flowing into stocks as flowing out. And that has been during a period of record Dow highs.

Perhaps it is not coincidental that this period of very weak money flows also corresponds to a period of unusually negative NYSE TICK readings. Money flow, after all, is tracking the dollar volume in the market as a function of whether it is occurring at the market bid (selling pressure) or market offer (buying interest). This is the same way that the TICK is calculated, albeit without the volume component.

A number of commentators have suggested that these statistics have become skewed due to the recent abolition of the uptick rule, which had prevented traders from shorting stocks until they traded on an uptick. Without the uptick rule, sellers are free to hit bids just as buyers lift offers. The net effect may be to create a greater (and more accurate) representation of selling pressure, turning the distribution of such measures as TICK and money flow downward.

Still, I'm not convinced that all the weakness in these measures is mere artifact. The fact remains that, as we've moved higher, fewer stocks have been making fresh 20-day highs (my preferred measure of strength) and fewer have been closing above the volatility envelopes surrounding their short-term moving averages (my favorite measure of momentum). Divergences continue to abound among market sectors, as noted in the Weblog.

At an intraday level, as my Twitter comments indicate, I found selling programs greeting the market all day today as we approached Monday highs in the S&P futures. This has continued in spades in after hours trading as I write.

Clearly some of the indicators will need reconfiguration as a result of the change to the uptick rule. One rule that won't be repealed, however, is that rising markets that are losing strength tend to reverse and return toward their longer-term value area (the region in which the greatest amount of volume has been transacted). We saw that dynamic at work during today's trade, and we may be in the process of seeing a longer-term return to value in the extension of the day's weakness.

RELATED POST:

False Breakout or Fresh Bull Market Leg?
.

Implications of the Change to the Uptick Rule

As noted by the Daily Options Report, Jason Goepfert of SentimenTrader attributes the recent shift in the distribution of the NYSE TICK (fewer readings of +1000 and greater) to the impact of the elimination of the uptick rule for shorting. As a result, we have traders shorting by hitting bids, not waiting for upticks. That potentially skews the TICK in a more negative direction. As Rennie Yang of MarketTells recently observed, this has created a mean in the TICK closer to zero (whereas it had been +200 and higher in the recent past). Using that zero point as a reference (to see if the distribution of TICK values was dominantly above or below that point) worked well in this morning's trade.

If the uptick rule is indeed responsible for the shift in the NYSE TICK, then we should see a similar shift in the Dow TICK ($TIKI). It does appear that this is the case. Going back to March 1st and looking at one-minute data, the average one-minute high value for $TIKI has been 11. Over the past week, the average has been 9. Interestingly, however, the recent average low for $TIKI (-10) is similar to the average low since March (-11). It's the strong uptick readings--for both $TICK and $TIKI--that appear to be truncated.

Meanwhile, here's another implication of the elimination of the uptick rule. That makes it easier to short stocks by hitting bids and should give us better sentiment readings in Market Delta. (Above I've illustrated this morning's chart in AAPL). In other words, the balance of volume at bid vs. offer should tell us more about what institutional traders are doing in each stock now that they don't have to short on upticks.

RELEVANT POSTS:

Tracking the Adjusted TICK

Trading With the Adjusted TICK
.

Twitter Trader - Dr. Brett's New Real-Time Blog Feature

If you look carefully at the sidebar for this blog, you'll notice a new feature called "Twitter Trader". I've installed the Twitter widget into the blog, which enables me to enter brief (about 2 sentences) text messages onto the blog from my cell phone, IM, or desktop (with the Twitteroo application).

If you're not familiar with Twitter, it's used as a messaging/micro-blogging application that helps people stay in touch with their social networks. You can add friends to your networks and subscribe to the networks of others, so that everyone can see what people are up to. By adding the widget to, say, your personal website, people can stay up to date with you whenever they view your site. Moreover, you can stay in touch with others by having their updates forwarded to your phone or desktop.

For TraderFeed, the application of Twitter is somewhat different. By adding the Twitter Trader section to the blog, I've essentially created a microblog within a blog. This will enable me to enter brief messages about the market as the market is trading. For instance, I might see a move in currencies that is likely to impact stocks and send that message to the Twitter Trader section of the blog.

The blog will display the five most recent Twitter entries. Refreshing the blog page will ensure that the latest entries are displayed. To see all Twitter entries, you can go to my personal page on Twitter. Clicking the "follow me on Twitter" link at the bottom of Twitter Trader will get you to my Twitter page. Refreshing that page will also ensure that the latest entries are displayed.

I'll be feeling my way around the Twitter Trader feature. My aim is not to post continuously through the day, but rather to focus on important market observations. Please note that I do not trade actively all day--most my trading occurs in the morning--and I do not trade every day (because of being on the road and working with traders). I don't anticipate making Twitter entries when I'm away from the markets.

At this juncture, I won't be adding friends to Twitter for pure social networking. If, however, you're an experienced blogger/trader and add Twitter to your site for market commentary, I would gladly add you as a friend so that we could create a composite commentary for traders. (Traders going to any of our Twitter pages could follow our entries and those of our selected friends.) This would create a valuable Web 2.0 resource for traders--a real time stream of market observations from multiple perspectives. It could easily evolve into a high-level conversation about markets as they trade. Cool.

If you have suggestions or feedback re: Twitter Trader, drop me a line at the email address in the "About Me" section of the blog. I appreciate your interest and hope this real time feature of the blog helps to apply some of the ideas from the posts.

Brett

Australia and New Zealand Conference Appearances This Fall

Just a quick note to let readers know that I'll be appearing at the annual meeting of the Australian Technical Analysts Association (ATAA) in Brisbane. I will be delivering two presentations on Friday, October 5th related to trading psychology, the psychology of the markets, and strategies for self-coaching. If you're from Down Under and might be attending, do drop me a line at the email address in the "About Me" section of the blog home page.

I'm also working on the possibility of offering a seminar in Auckland, NZ for the Society of Technical Analysts of New Zealand (STANZ) prior to the ATAA event, possibly that Monday or Tuesday. If you're in the Auckland area, also drop a line; I'd enjoy meeting.

Monday Market Thoughts

* Been Here Before? I had a funny feeling this AM that I'd seen this movie before: the market makes a momentum peak in April, trades in a range for the next several months, then breaks out to new price highs in July on weak TICK and non-confirming advance-decline numbers. The market? 1998. We can see above that the current advance-decline line is still not confirming the market's recent highs, though it's not nearly as weak as 1998's level at the July price peak.

* Other Advance-Decline Lines Non-Confirming - Stats kept by Decision Point find that we have confirmed price highs in the advance-decline line specific to NASDAQ 100 stocks. AD lines that are not confirming price strength are those specific to the S&P 600 small caps, the S&P 400 midcaps, the NASDAQ Composite, the S&P 500 large caps, and the common stocks only for the NYSE Composite. That's a lot of non-confirmations.

* Big Market Lessons - The Big Picture passes along some excellent perspectives from Mark Hulbert. Abnormal Returns also passes along an interesting article from Hulbert re: "neighbor", herding effects in portfolio selection.

* Interesting Reading - Mike again finds worthy links, including an article on trading and blackjack and an interview with Doug Hirschhorn.

* Buybacks Gone Wild - Companies seem to love their own valuations here; the market is awash in buybacks. Here's a skeptical perspective on the buyback binge.

* Losing Relative Strength? - The Shanghai A Index--the poster child for emerging market strength--is well off its highs of the past few months.
*

Do Traders Prefer Winning Trades or Making Money?

It seems like a strange question to ask: Would traders rather make winning trades, or would they rather make money in the market?

As the Dr. Mezmer blog nicely outlines, people tend to prefer the positive: they preselect samples so that they can make positive predictions about the future and they gravitate toward positive short-term outcomes when given the chance.

Consider the situation in which people face two situations:

1) A majority of their bets win money, but occasional large losing bets cause them to lose money overall;

2) A majority of their bets lose money, but occasional large gains cause them to make money overall.

As the good Dr. Mezmer notes, nearly half of participants in such an experiment choose the first option--even when they know the negative expected returns. When they don't know the odds in advance, a larger proportion of subjects select the first condition. That is, they prefer winning in the short run to making money over the long haul. (See this study for a fascinating discussion of the preference for short-term wins over longer-term success in a card game).

Is it any surprise that traders have difficulty letting profits run and containing losses? The desire for frequent wins causes traders to take profits quickly; the aversion to losing leads to holding losers in hopes of converting them to winners.

The culprit, perhaps, is our preference for good moods. Frequent wins make us feel good momentarily, even though they might not be in our best interest in the long run. (A trend following style of trading--and the difficulties sticking with such a style--is a good case in point). An interesting post from Dr. Richard Peterson supports the Wall St. adage "sell in May and go away" and suggests that seasonal shifts in moods might be responsible for the pattern. Indeed, he cites research that finds greater evidence of seasonal patterns in higher latitude markets (such as Scandinavia)--and that finds opposite patterns in southern hemisphere markets (where seasons are reversed).

Does it make sense that returns could actually be superior when people are risk-averse and in bad moods (as the "sell in May" pattern would suggest)? Peterson quantified negative and positive words in the transcripts for the Nightly Business Report and found a significant correlation between the number of negative words in the show and stock market returns over the following week. Returns were best when the news was most negative.

It is only natural to gravitate toward the positive and shun the negative. Traders do not simply trade to make money; they inevitably trade to maximize their positive moods. This is why sentiment measures--from the options premiums (VIX) to put-call ratios to the predilection to transact at the market bid vs. offer (NYSE TICK)--can be powerful tools for understanding market behavior.

RELATED POSTS:

What Drives Investor Sentiment?

A Different Way to Measure Market Sentiment
.

Resources for Developing Traders

* Articles - Here are approximately 200 of my favorite articles on trading techniques and trading psychology; all free for download and arranged in chronological order. To the best of my knowledge, it's the largest free collection of trading psychology articles on the Web.

* Archives - The TraderFeed archives, arranged by month on the home page, now includes 940 posts on trading techniques, trading psychology, and historical trading patterns.

* Trader Coaching - Here is a key post with further links for those contemplating hiring a coach--or self-coaching!

* Trading Techniques - Here's is a link page to various TraderFeed posts on trading methods.

* The Heroic Aspects of Trading - This post pretty much sums up why I do what I do.

False Breakout or Fresh Bull Market Leg?

In a recent post, I noted that many indicators were not confirming the recent price strength in the large-cap stock indexes. Moreover, money flows in the Dow Industrial stocks have been weak, even as the market moved higher this week.

I just updated the Trading Psychology Weblog and present a more detailed look at the indicators, including an analysis of what happens in the market when a rise in the S&P 500 Index is accompanied by weak money flows in the S&P 500 stocks.

In the chart above, we can see that the market failed to expand the number of fresh 20-day highs minus lows among NYSE, NASDAQ, and ASE stocks during the recent rally. This further supports the view that the recent strength has been selective.

Indeed, if we look at advancing vs. declining stocks on a weekly basis for NYSE issues, we find that, last week, advancers outpaced declines by only about 200 issues despite the gain in the S&P 500 Index of over 1%. That is one of the weakest advance-decline performances for a market up 1+% since the start of 2004.

But what happens the following week when the S&P 500 (SPY) is up over 1% on weak advance-decline numbers?

Going back to the start of 2004 (N = 183 trading weeks), I found 55 occasions in which SPY was up more than 1% for the week. I performed a median split of the data based on advance-decline figures (% of issues traded that were advances minus declines). When SPY was up over 1% and advance-decline numbers were weak (N = 28), the next week in SPY averaged a loss of -.21% (13 up, 15 down). When SPY was up over 1% and advance-decline numbers were strong (N = 27), the next week in SPY averaged a gain of .14% (16 up, 11 down). For all other market occasions, the average weekly gain in SPY has been .28% (75 up, 53 down).

In short, weak rises tend yield subnormal returns going forward. This very much fits with my analysis of returns when money flows are weak, as posted to the Weblog. I will be watching the market carefully early in the week to see if the higher prices attract further buyers or if the market lives up to historical precedent and sees some profit taking--and a possible return to the prior trading range.
.

Stock Market Views for the Weekend

* Continuing to Look Good - Toshiba was the feature of an earlier post. It continues to benefit from its positioning in nuclear energy, particularly in light of India's recent push toward nuclear development and its stated intentions to spend considerable resources on this development.

* Volume Concentrated in the Advancing Stocks - I notice that the 3-day Arms Index (AKA TRIN) for the NYSE ended the week at .57. That's the third lowest level since the start of 2004 (N = 878 trading days), suggesting volume chasing the strong stocks. When the 3-day TRIN has been below .70 (N = 20), next day results in the S&P 500 Index (SPY) have been weak, averaging a loss of -.22% (6 up, 14 down). That weakness has carried over to subnormal (and negative) returns over the next three trading sessions.

* Hot Tech Stocks - The tech sector has been showing excellent money flows, and the large cap tech stocks have been leading the way higher during this recent rally. The StockPickr site tracks the five top growth stocks in the tech universe, according to Goldman Sachs. Also check out StockPickr's tracking of the portfolio of Prince Al-Waleed.

* Putting Trading Principles to Work - I recently outlined 10 principles of short-term trading. Trade Ideas has taken the post to the next level by outlining specific trading strategies for many of the principles. Great post with creative applications.

* U.S. and U.K. Hedge Fund Perspectives - Interesting finance shorts from the Moneyscience site, including a link to a contest to spend time with a London hedge fund manager and an interesting view of hedge fund shorting in the S&P 500 futures.

* Top 100 Finance Blogs - Thanks to InstantBull for its blogroll of the most popular trading and investing blogs according to Alexa and Technorati stats. I'll be using this list to check out blogs that I'm not familiar with in hopes of providing some additional visibility for the best ones in future posts.

* Worthwhile Reading - Several valuable posts from the Short-Term Trading blog, including a view on how dollar depreciation may not help the trade deficit, the risks of collateralized debt obligations, and a very interesting view on the Fed model as a market predictor.

* VIX and Options Trading - BZB Trader sees a head-and-shoulders top in the VIX, implying further market strength to come. The VIX and More site also has some thought-provoking posts on the VIX as a timing tool, including a look at the Trading Markets rule. Adam Warner has some valuable thoughts about trend following with a deep options strategy.

* Concentration of Income - This morning's New York Times reports an interesting fact: Until now, there have been only two other periods in American history when the top 1/100th of 1% of the population owned 5% of the country's wealth: 1915/1916 and in the late 1920's. Both were periods of wealth that preceded major stock market crashes.

Three Good Questions to Ask About Your Trading

There's an interesting interview with Apple co-founder Steve Wozniak in the book Founders at Work by Jessica Livingston that illuminates an important aspect of trading. Wozniak advises tech entrepreneurs:

If you can just quickly whip something out and it's done, maybe it's time, once in a while, to think and think and think, "Can I make it better than it is, a little superior?" What it does is not necessarily make the product better in the end, but it brings you closer to the product and your own head understands it better. Your neurons have gone through the code you wrote, or the circuits you designed, have gone through it more times, and it's just a little more solidly in your head, and once in a while you'll wake up and say, "Oh my god, I just realized a bug that's in there, something I hadn't thought of."...Or, if you have to modify something, or add something new, you can do it very quickly when it's all in your head...You don't make as many mistakes (p. 55).

There are times when trading is going well and we can simply "whip out" the profits. The majority of traders, I find, relax their efforts to understand their markets and improve their trading at these times. Wozniak's insight is that it's work when things are going well that turns good results into superior ones.

Under peaceful conditions, Nietzsche wrote, the warlike man turns upon himself. When there isn't a worthy adversary to fight "out there", the competitive individual finds noble challenges within.

Here are three questions that might assist traders' development under peaceful conditions:

1) How many distinct setups do you trade? - When you look day to day, week to week, how well correlated are your trading results from these setups? If they're quite positively correlated, are they really distinct and do you really need them all? If they're not well correlated, are you allocating your capital to them ideally to diversify your risk?

2) What are the outcomes of your largest vs. smallest trades? - Do you really have a good sense for when there is opportunity and do your largest trades take advantage of this awareness? If your largest trades don't have a distinctly better track record of success than your smaller ones, should you be raising your risk when you don't have an expanded edge in your favor? If your largest trades are less successful than the others, might size be adding to your stress and performance problems?

3) Is the distribution of your long and short trades consistent with the market's direction at the next largest timeframe? - Are you making more long trades (and holding long trades longer) when there is an established uptrend (and vice versa)? Are you trading with a directional bias when the market is rangebound? Do you have an edge in your trading when you trade with the trend? When you trade countertrend?

My latest entry to the Trader Performance page of my personal site elaborates some of these evaluation criteria. That page includes 45 posts that reflect my own thinking about the improvement of trading, much of which is based on my recent trading experience. You may find material in some of these posts to be relevant to your own work on yourself, especially at times when things are going well.

Going Without the Flow: The Changing Dynamics of this Bull Market

In my last post, I summarized indicators that suggest that the current market is not as strong as the recent move to bull highs might suggest. The chart above, showing the Dow Jones Industrial Average (DIA; blue line) plotted against raw 5-day money flows for the 30 Dow stocks shows why this is the case.

Note that the rising action of the Dow in late 2006 and early 2007 was accompanied by breakout highs in money flow. This means that large volume tended to be transacted at the market offer rather than the bid, indicating aggressiveness among institutions in owning stocks.

During the recent move to new highs, however, money flows have been consistently weak. Indeed, every day out of the last six has seen flows below the 200 day average. Of the 30 Dow stocks, only INTC, JNJ, MSFT, and WMT display positive 10-day money flows that are above their 200 day averages. (HPQ comes close).

On the other hand, we see 10-day net dollar outflows from AIG, DIS, KO, and (interestingly) XOM.

What this means is that we're still seeing money coming into stocks, but it's a relative trickle compared to the torrent experienced earlier.

This very much fits with the recent, weak NYSE TICK data, which shows that--across the broad stock universe--traders have been hitting bids despite the rising large cap index prices. It also helps to explain why, as of Friday, we were seeing 1421 new 20-day highs, but also a surprisingly high 612 new 20-day lows.

In sum, I don't see the recent market rise as indicative of a broadening demand for stocks. Instead, strength appears selective, with money flows most positive among large cap tech stocks. Just as I doubted the sustainability of market dips over the past several months in the face of strong money flows, I question the sustainability of market rallies in the face of weak flows. While that doesn't necessarily mean a bear market is in the offing, it does raise the possibility of returning to the lengthy trading range we've experienced since May.

RELATED POSTS:

What's Behind the Bull Market: Money Flows

Relative Dollar Volume Flows

Ten Principles of Short-Term Trading
.

How Strong Is This Rally?

Here are a few observations regarding the recent rally that I will be elaborating in my weekend update to the Trading Psychology Weblog:

* It's the Weighted Stocks Leading the Way - We saw bull market highs in the S&P 500 Index (SPY) the last two trading sessions, but the unweighted S&P 500 Index (RSP) remains even with its early June peak. Those mega-cap issues that are highly weighted may also be benefiting from new lows in the U.S. dollar, supporting international sales.

* Small Caps are Lagging - The Russell 2000 Index (IWM) very slightly eclipsed its early June high today before pulling back. The weak NYSE TICK readings are reflecting lukewarm buying interest among the small caps. Indeed, advancing issues barely outnumbered losers today (+174) despite gains in the large cap indices.

* A Number of Sectors Aren't Participating in the New Highs - Even within the S&P 500 universe, only Materials (XLB), Industrials (XLI), Energy (XLE), and Technology (XLK) sectors have made new annual highs this week. We have not seen highs in Utilities (XLU), Consumer Discretionary (XLY), Consumer Staples (XLP), Healthcare (XLV), or Financial (XLF) sectors.

* Many Individual Stocks Aren't Participating in the New Highs - On Thursday, we had 234 NYSE stocks make fresh 52-week highs, down from about 300 last month. Similarly, we had 76 new highs among the S&P 500 stocks, down from about 90 in early June. Only 56 stocks among the S&P 600 small caps made 52-week highs on Thursday, down from 80 last month. Perhaps most surprisingly, we only had 8 new highs among the Dow 30 stocks. Only the NASDAQ 100 Index has shown fresh peaks in annual new highs. When we look at the broader NASDAQ Composite universe, however, only 211 stocks made new highs, equivalent to levels registered last month.

My next look will be at money flows to see if institutions are truly putting fresh capital to work in this recent rise. We are trading above the value area from a long flat correction that goes back to May. I believe we'll need to see expanded participation in the rally or risk a move back into that value region.

Perspectives on a Stock Market Rally--And More

* Questioning the Rally - Several traders on Thursday asked me about the viability of the market rally, given that we did not see NYSE TICK readings exceeding +1000. One rather experienced colleague confidently told me that he saw a great opportunity to short the S&P 500 late in the afternoon--just before the big spike upward. It's a great example of getting caught up in details and not, as noted in the recent post, thinking in principles. The NYSE TICK distribution was considerably stronger (more positively skewed) than the distributions from the prior two days. Moreover, we saw an expansion of 20-day new highs on Thursday to 1434 and an expansion of 65-day new highs to 906, both eclipsing the levels of new highs at the prior market peak. Moreover, my measure of stocks closing with significant positive momentum (Demand) was 178, while Supply (an index of stocks with significant downside momentum) was 33. That is quite a positive shift from the prior two trading days. Markets that expand their strength and momentum tend to follow through with further strength in the near term. That's what we saw Thursday afternoon, though some, as noted by Barry, saw it as a bullshit rally.

* What the Weak TICK Really Signifies - We saw an absence of buy programs among the Russell 2000 stocks, keeping the TICK restrained. I will be watching closely to see if this rally gains participation from the small caps or if the small caps lead the way back into the prior trading range. As the Afraid to Trade blog nicely observed in its charting of the major markets, the Russell has been the laggard in this rise.

* Great Call From Kevin - The Dow exploded higher, just as he anticipated in his prior posts. Excellent work from a blog worth following.

* Another Fine Site - The VIX and More blog tracks record volume in the VIX options and examines new highs/lows for market timing. Great blog.

* More Fine Links - Some excellent readings from Abnormal Returns, including a look at some creative, new ETFs and ways that activist hedge funds are leveraging their influence. Also take a look at Trader Mike's recent links, including a discussion of a vitally important topic: risk of ruin. Adam weighs in with views on the running of the bulls and how markets behave during and between trading hours.

* Improving Your Performance - Here's a worthy post from The Kirk Report comparing the mindset of the golf pro to the mindset of the trader. Also check out this offering from StockTickr, illustrating how to use the program's journal and tagging to understand what works and doesn't work in your trading.

Ten Principles of Short-Term Trading

The recent action in the market, coming on the heels of the weak rise noted in the Trading Psychology Weblog, calls to mind several principles of short-term trading that have served me well over the years. I hope to elaborate on these in coming posts, with market examples and trading implications. The useful thing about these principles is that they apply to many time frames:

1) Strength Begets Strength - A market rise that expands the number of stocks making new highs and that finds more stocks trading with strong upside momentum tends to persist in the short run.

2) Weak Rises Tend to Reverse - When markets move higher with fewer stocks making new highs and with fewer stocks showing strong momentum, the rise tends to reverse in the short run, often entering a trading range prior to making an extended decline.

3) Broadly Weak Markets Tend to Reverse - When the market is very weak (many stocks making new lows and many stocks displaying strong downside momentum), it is common to see the market make marginal new lows in the short run, but reverse after that. Wednesday's action in the S&P 500 Index was a good example of that, coming on the heels of Tuesday's weakness.

4) Weak Tests of Prior Market Highs or Lows Tend to Reverse - When we get a market trading above or below its value area on low volume, few stocks making fresh new highs/lows, and weak momentum, we tend to get a "mean reversion"--a trade back into the value area. That's basically what this week's action has been about.

5) Strong Tests of Prior Market Highs or Lows Tend to Persist - When we see expanding volume and expanding new highs or lows on a move above or below the value area, such a breakout move tends to becoming a short-term trend. The longer the prior consolidation period (the heavier the volume within the value area), the more extended the subsequent trend tends to be.

6) Weak Pullbacks Following a Strong Move Will Reverse - When we have a strong market move that expands new highs/lows and momentum, a pullback on weak volume and with relatively few stocks participating will lead to at least a test of the impulse highs or lows and often to a resumption of the strong move.

7) Markets Are Dominated by the Sentiment of the Largest Participants - Look for how volume behaves during market rises or falls to see if higher/lower prices attract the interest of large traders. Examine the distribution of the NYSE TICK and the volume transacted at bid vs. offer to see if large traders are predominantly hitting bids (selling weakness) or lifting offers (buying strength).

8) Important Market Moves are Often Set Up on Larger Time Frames - Always track what the market is doing one and two time frames above your own trading time frame. Short-term trends are set up by strengthening and weakening dynamics at those larger time frames.

9) Important Market Moves are Often Triggered by Intermarket Events - Economic news and intermarket dynamics affect bonds (interest rates), oil, and currencies. Big trends in the stock market tend to be accompanied by important shifts in these other markets, as investors reprice equities in light of new developments.

10) Watch for Reversals When Sectors Fail to Travel Together - The rising tide should lift all boats and the falling tide should bring the boats lower. When you see sectors failing to make new highs or lows when the broad, weighted averages are hitting new peaks or valleys, watch for reversal. Inefficiency--the inability for significant buying/selling pressure (such as NYSE TICK) --to move sectors to new highs or lows frequently precedes reversal.

There is much more to markets than your market, and there is much more to markets than price alone. Observing the dynamics of market behavior opens the door to strategies that exploit intraday and swing shifts in market direction.

RELEVANT POSTS:

Guiding Principles of Short-Term Trading

Trading Psychology and Techniques Links
.

Using Imagery In Accelerating Behavior Change

One of the most common--and useful--tools in the cognitive-behavioral repertoire is guided imagery. Used properly as a component of a change approach, imagery can help to speed the change process. (See this valuable review article for background on the history, philosophy, psychology, and cognitive neuroscience of imagery).

Mental imagery is typically employed by the psychologist as a "stand-in" for real-world experience. Of particular importance to the psychologist, therefore, is the vividness of imagery. Imagery is useful for efforts at personal change to the extent that it can evoke the cognitive and physiological responses that would be present in the real-life equivalent experience. Imagery is thus far more than thinking about a situation; it involves attempts to recreate those situations in sensory detail. Consider, for example, the difference between thinking about a sexual situation and generating a detailed sexual fantasy.

Imagery is valuable because it multiplies experience. That is, a person can face a situation many times in imagery (and practice efforts at mastery) when it would be impossible or impractical to do the same in real-world experience. For instance, it would take me days of actual experience to comprehensively rehearse responses to various opening range situations in the market. In imagery, however, I can generate a panoply of scenarios and rehearse my desired responses to each. If, for example, my research suggests high odds of breaking a two-day range to the downside, I can vividly imagine this situation (repeatedly, with variations) and walk myself through how I would enter, scale into, and exit positions; where I would place my stops; how I would honor those stops; etc.

I refer to this application of imagery as mental preparation. We use the imagery as a stand-in for anticipated situations and then rehearse desired responses. Many times, this preparation is accompanied by efforts at relaxation (muscle relaxation, deep breathing) and concentration (staying focused on the imagery). This evocation of the calm, focused state is an important component of most biofeedback exercises and is associated with the activation of the brain's executive center: the frontal cortex. In a sense, when we engage in mental preparation, we are training the brain.

A second, related application of imagery is the reprogramming of emotional experience. This is relevant in situations in which we've developed negative habits or response patterns. Getting scared out of trades that start to (normally) retrace gains or failing to honor stop levels would be common examples among traders. For reprogramming, we purposely engage in vivid imagery to recreate (with many variations) the problematic situations. While we keep the stress-producing situation vividly in mind, evoking the associated cognitive and physiological responses, we make intentional efforts at coping. Such efforts could include the relaxation methods mentioned above, but can also include cognitive restructuring (exercises to reframe situations by thinking differently about them) and rehearsal of specific coping behaviors (practicing a trading rule during the challenging situation).

As you can see, imagery can be employed to either rehearse and cement desired responses or to undermine negative ones. A comprehensive approach to change will frequently use the two in tandem.

I encourage readers to return to my recent post on hot and cold cognition and re-read that article in the light of the above discussion of imagery. A nice way to think of imagery is as a bridge between "cold" and "hot" modes, helping us develop new ways of responding when we're in the heat of battle. The keys to success in using these methods are vividness, duration, variation, and repetition. Change is facilitated by new experience; the greater the experience you generate for yourself, the quicker and more profound the change. Readers interested in applying these methods to their own trading can check out the free articles on my personal site and the self-help guides on cognitive and behavioral techniques from my book on trading performance.

RELATED POSTS:

What Works in Behavior Change

Becoming Your Own Trading Coach: Part One, Part Two

When Coaching Works and Doesn't Work
.

Tuesday Trading Resources

* Principles for New Traders - This post summarizes my views on trading psychology for developing traders and how new traders can further their development.

* Resources for New Traders - Hats off to Value Blog Review for providing this set of blog resources that have aided their trading profitability. Do check out the site's book reviews and blog reviews, as well.

* Fascinating Research - The Sharp Brains blog does a wonderful job of tracking recent research in cognitive neuroscience, including brain functioning that affects trading behavior. This post covers the link between the sociability of a species and the size of its frontal cortex. The importance of improving those executive functions of the cortex for detecting meaning and deception in markets is but one implication of the article.

* Stock Picking Resource - I attended the Chicago seminar for the Blocks program mentioned earlier. The software is able to screen stocks for various technical and fundamental criteria on the fly--including intraday scans. Its unique feature is an ability to backtest these criteria over user defined time frames and with user defined stocks or stock baskets. While the output of the backtesting is not as detailed as that in TradeStation, Blocks accomplishes the test with no programming whatsoever--just drop down menu selections. Lots of good applications here, including the ability to track indicators for sector groups.

* Socially Responsible Investing - Here's a very worthwhile perspective from The Kirk Report. Also, check out an interesting site devoted to the topic and an article on the growth of SRI alternatives within retirement plans. Some investment themes that capitalize on this trend are worthy of consideration, including alternative energy and the development of water resources--especially given the press devoted recently to pollution and resulting health problems in emerging nations.

* More Good Reading - Abnormal Returns finds some excellent posts on the hedge fund bubble, the prospects for a rate cut, and reversal effects in the UK market.

Bridging the Gap Between Hot and Cold Cognitive States

Behavioral finance researchers observe that our perception, judgment, and decision making in cold cognitive states--those in which we are reasoning analytically--tend to be different than when we're in hot, emotional states. Specifically, we are very poor at predicting our behavior under hot conditions when we're cold. Under the hot influence of emotions such as fear, frustration, and excitement, we tend to be greater risk takers, with very different behavioral preferences.

This slide show from the MIT Sloan School of Management nicely illustrates the dilemma we face of being two different people depending upon our emotional states. One of the conclusions drawn by the research is that self-control problems result from our inability to predict and control our behavior under hot conditions when we're cold.

This is also a major challenge for traders of the financial markets. We tend to make our plans and work on ourselves when we're in a relatively calm, cold state. Under the hot conditions of risk and uncertainty, however, we are apt to behave quite differently.

For this reason, I question the value of simple talk-coaching as a means of changing behavior. If the state you're in when you're working on problems is very different from the state you're in when you engage in problematic behavior, the carry over is likely to be minimal.

A better approach is to use structured, guided imagery to recreate hot situations and then mentally rehearse desired thoughts and behaviors under those conditions. The more vivid the scenarios--the more they evoke hot responses--the more likely it is that rehearsed behaviors will carry over into real time.

It may well be that this technique works because it trains people to activate their "cold" systems precisely when those are likely to be suppressed. If this is the case, it may be possible to minimize some of the biases of "motivated reasoning" when tracking markets--our tendency to perceive and reach conclusions in support of our pre-existing preferences.

In my next post on the trader coaching project, I will illustrate the use of this method.

RELATED POSTS:

Inside the Trader's Brain: Decision Making and Emotional Arousal

Biofeedback for Performance
.

Stock Market Perspectives for a Sunday

* Tracking the Market's Strength - My update to the Trading Psychology Weblog summarizes the indicator data, including money flows, and finds that the recent rally has not been impressive to date.

* Estimating the Coming Day's Volatility - My recent post has generated some emails and questions. I illustrate how I use the VIX and volume data to estimate the day's volatility (size of the high-low price range) in my latest entry to the Trader Performance page.

* Predicting Market Turning Points? - Check out this video unmasking a common guru ploy; thanks to Kevin's Market Blog for the link. Also note interesting posts from Kevin on a bullish pattern in the Dow and how gold stocks are outperforming the metal.

* Red Flags for the Market - CPP Trader notes some worrisome aspects of the recent market, including the poor response to good news. See also CPP's worthwhile observations on buying when the Dow is down.

* An Options Strategy With a Stock Picking Idea - Check out Adam Warner's post on how he's using options to trade the strength in UA. Very nice illustration of participating to the upside and hedging the downside. Plus, hey, you get his music commentary to boot!

* Frontier Markets - Valuable ideas from Random Roger and a nice illustration of how the pros search for alpha.

* Picking Apart the Employment Data - Great analytical post from A Dash of Insight finds strength in the economy and outlines the data to focus on going forward. Here's a skeptical look at the data from The Big Picture and an even more skeptical look from Mish.