A New York Times article chronicles the impact of novelist/philosopher Ayn Rand on business leaders. It's quite amazing that her 1200-page book, Atlas Shrugged, is now 50 years old but ranked in the top 500 of all books sold on Amazon.
My experience at various trading firms and with traders across settings confirms the NY Times piece: many market participants are attracted to Ms. Rand's philosophy (which she called Objectivism).
Here are a few Objectivist principles that are especially relevant for trading:
1) The Primacy of Reason - There *is* an objective world out there ("existence exists", as Ms. Rand puts it), and our survival depends upon the exercise of our reasoning mind to grasp reality and base our actions accordingly. Following Aristotle, Rand defines man as "a rational animal": reason distinguishes us from other species. There is no greater moral virtue than the independence exercise of one's reason, for that is what enables us to survive.
2) The Virtue of Self-Interest - This is probably the most misunderstood facet of Rand's philosophy, as what she calls "selfishness" is commonly thought of as hurting others in order to further oneself. Rather, Rand declares that each person has the right to live for him or herself and pursue his or own fulfillment, as long as that does not violate the rights of others. Serving others is not perceived as a moral imperative; rather, the idea is to live a heroic life in which one strives effortfully, using one's reason, to pursue worthwhile goals. Rand defines the "good" as that which furthers life.
3) The Imperative of Freedom - If individuals are to live lives guided by reason and the pursuit of life-furthering goals, they must enjoy the political and economic freedom to do so. The ideal State derives its (limited) power from the consent of individuals who possess fundamental rights; the State does not grant rights to individuals or take them away. Freedom in the political sphere is expressed through democracy, fundamental rights, and rule of law. Freedom in the economic sphere is expressed through the right to own private property and the ability to pursue one's own economic goals (capitalism).
Why do I say these basics of Objectivism are relevant for trading? I believe that the successful trader is, in essence, living out these principles: using independent reason and judgment to pursue self-chosen goals and exercising the prerogatives of economic and political freedom.
Perhaps most important from my own perspective is the way that Rand, as novelist, captures the heroic dimensions of human life and what is possible for each of us. In the characters of Howard Roark in The Fountainhead and John Galt in Atlas Shrugged, we encounter people of principle, who fight for those principles, and make a difference as a result. Her novels, I believe, are as much a spiritual compass for readers as a philosophical one: hence their enduring appeal, particularly to young people.
The best Objectivist advice I can give traders is to not be afraid to dream and dream big, but to always have the determination to act on reality, not fantasy. There is much to be said for having your eyes on the stars and your feet on the ground. If your life is a canvas or ball of clay, your mission is to fashion a work of art. Your life belongs to you: not to other people, not to a sovereign State, and not to religions and cults. Make it count.
RELEVANT POSTS:
Trading and Heroism
Blueprint for an Uncompromised Life
.
Saturday, September 15, 2007
Friday, September 14, 2007
Dr. Brett Coming to New Zealand and Australia
This is a reminder that I will be presenting to the Society for Technical Analysis in New Zealand (STANZ) on Monday, October 1st in Auckland. The program will begin at 7:15 PM, and the topic will be "Using Psychology to Improve Trader Performance". I'm particularly happy to report that material from the book I'm currently writing will be included in that presentation.
From there, it will be a trip to Brisbane, Australia and the 2007 National Conference of the Australian Technical Analysts Association (ATAA). I will be delivering two presentations on Friday, October 5th: "Psychology and Trading Performance" and "Becoming Your Own Trading Coach". These sessions also will draw upon my latest material, which will be included in the new book.
I look forward to meeting colleagues in New Zealand and Australia and am currently pursuing the possibility of presenting in the U.K. What better way to get a global picture of markets and trading than to travel the globe?!
From there, it will be a trip to Brisbane, Australia and the 2007 National Conference of the Australian Technical Analysts Association (ATAA). I will be delivering two presentations on Friday, October 5th: "Psychology and Trading Performance" and "Becoming Your Own Trading Coach". These sessions also will draw upon my latest material, which will be included in the new book.
I look forward to meeting colleagues in New Zealand and Australia and am currently pursuing the possibility of presenting in the U.K. What better way to get a global picture of markets and trading than to travel the globe?!
How Hot Heads Make Cool Decisions
An alert reader passed along this article regarding a study of emotions among investors. Unfortunately, the headline of the article--written, no doubt, to attract readers--indicates that "hot-headed investors make better decisions". Only by reading the article text do we find out that this is a four-week simulation (more like trading than investing) and that the actual finding is that, "those who experienced their feelings with greater intensity during decision-making achieved higher decision-making performance."
According to the article, "The conventional wisdom that emotions can make you irrational has less to do with how intense your feelings are than with how much you understand them...those investors who listened to their emotions were better able to regulate them."
In other words, the better decision-makers were not less emotional; they were better equipped to experience, acknowledge, and understand their feelings. Note how this very much fits with the theme of my post yesterday.
The takeaway, I believe, is that all of us have two information processing channels working simultaneously. We process the world explicitly, in an analytical mode, even as we process events implicitly via feeling. Our explicit, analytical channel tells us about the qualities of events and entities that we encounter; our implicit, emotional channel informs us about the self-relevance of those events and entities--whether they pose opportunity, threat, etc.
It's as if we have two antennae: One reaches out and asks, "What is this?" and the other feels around for, "What does this mean for me?"
Both provide information.
Much of our daily life is a delicate interweaving of these modes; our antennae work in concert. Thus, when we're in a conversation, we're processing the logical content of what our partner is saying, but we're also feeling its relevance for us.
When traders shut off emotion--or use action or avoidance to keep feelings out of awareness--it's as if they disable one of their antennae. The result is a loss of information. The study cited by the reader finds that awareness of emotion--utilizing the information from that feeling antenna--aids decision making.
Of course, if one becomes so submerged in the emotional state that it overwhelms the other, rational information-processing mode, the results are also disabling.
Feelings are data: the key is what we do with that information. Many times, we will know what to do if we just allow ourselves to fully acknowledge and experience what we're feeling. A trader I recently worked with was quite frightened when volatility exploded in his market. He didn't like the anxiety, but it told him that things weren't right. He used that information to cut his size and wait for his opportunities. While others at his firm lost significant money, he actually added a bit to his year's results.
The general rule is: When we violate our trading rules and good trading practice, it's often because we're avoiding an emotional experience. We're not honoring our stop loss points because we want to avoid feelings of loss, inadequacy, and failure. We're overtrading because we want to avoid feelings of boredom or confusion about what the market is doing. If we can make friends with the emotions we're avoiding, all those bad practices go out the window. They no longer serve a defensive function.
RELEVANT POSTS:
Bridging the Gap Between Hot and Cold Emotional States
Why Traders Self-Sabotage
Psychological Risk Management
.
According to the article, "The conventional wisdom that emotions can make you irrational has less to do with how intense your feelings are than with how much you understand them...those investors who listened to their emotions were better able to regulate them."
In other words, the better decision-makers were not less emotional; they were better equipped to experience, acknowledge, and understand their feelings. Note how this very much fits with the theme of my post yesterday.
The takeaway, I believe, is that all of us have two information processing channels working simultaneously. We process the world explicitly, in an analytical mode, even as we process events implicitly via feeling. Our explicit, analytical channel tells us about the qualities of events and entities that we encounter; our implicit, emotional channel informs us about the self-relevance of those events and entities--whether they pose opportunity, threat, etc.
It's as if we have two antennae: One reaches out and asks, "What is this?" and the other feels around for, "What does this mean for me?"
Both provide information.
Much of our daily life is a delicate interweaving of these modes; our antennae work in concert. Thus, when we're in a conversation, we're processing the logical content of what our partner is saying, but we're also feeling its relevance for us.
When traders shut off emotion--or use action or avoidance to keep feelings out of awareness--it's as if they disable one of their antennae. The result is a loss of information. The study cited by the reader finds that awareness of emotion--utilizing the information from that feeling antenna--aids decision making.
Of course, if one becomes so submerged in the emotional state that it overwhelms the other, rational information-processing mode, the results are also disabling.
Feelings are data: the key is what we do with that information. Many times, we will know what to do if we just allow ourselves to fully acknowledge and experience what we're feeling. A trader I recently worked with was quite frightened when volatility exploded in his market. He didn't like the anxiety, but it told him that things weren't right. He used that information to cut his size and wait for his opportunities. While others at his firm lost significant money, he actually added a bit to his year's results.
The general rule is: When we violate our trading rules and good trading practice, it's often because we're avoiding an emotional experience. We're not honoring our stop loss points because we want to avoid feelings of loss, inadequacy, and failure. We're overtrading because we want to avoid feelings of boredom or confusion about what the market is doing. If we can make friends with the emotions we're avoiding, all those bad practices go out the window. They no longer serve a defensive function.
RELEVANT POSTS:
Bridging the Gap Between Hot and Cold Emotional States
Why Traders Self-Sabotage
Psychological Risk Management
.
Thursday, September 13, 2007
A Review of Challenges Facing the Markets
* No Relief for Housing - The market is anticipating a Fed rate cut, but housing stocks are not anticipating relief. The housing index, shown above in a weekly chart, is barely hovering above bear market lows, down nearly 50% from its bull peak.
* Also Hovering Near Its Lows - Is Citigroup stock (C). We've seen a little bounce in banking stocks this week, but C has barely participated. The stock is only about 1% off multi-year lows. Credit exposure remains a concern.
* Bailing Out the Homeowner - Bill Gross of PIMCO offers his prescription for the housing mess.
* Dollar Fakeout? - Trader's Narrative finds an analogy to the 1992 market and its reversal.
* Coming Clean - Jon Markman makes the case for banks to tell us what they know about the magnitude of credit problems.
* At the Abyss - Mish finds problems across the country in commercial real estate.
* Do Oil Price Hikes Affect Stocks? - CXO Advisory blog examines the surprising evidence on this and other relationships between the economy and the stock market.
Using Emotion to Change Emotion
In my recent post, I suggested that many of us avoid emotional upset by substituting action for feeling. This is a pattern that lies at the heart of many impulsive trading decisions, including many lapses in trader discipline.
Let's take a common example: a trader is working a bid a bit below the market and suddenly a ferocious sell program takes the market five ticks lower. The trader's order is filled and, in an instant, the market is several ticks against him. He reacts first with shock, then with anger at people who "manipulate the market". In a flash, he buys more contracts, even though this sizes his position much larger than his plan allows. It's a classic revenge trade: he's going to get even. The market moves a few ticks lower, and he is forced out at the worst possible price with a much larger loss than his initial trade planned for. In remorse, he makes a note in his journal that he needs to be more disciplined in his trades.
As long as the trader views "discipline" as his problem, he is sunk psychologically. He sets up a condition in which he is split: part of him is impelled to do something under particular conditions, another part attempts to exercise control by dictating what *should* be done. This is how anorexic and bulimic patients fight with food intake; how addicts fight with drug abuse; how many of us fight with sticking to diets and exercise regimens.
We cannot substitute thought for emotion: shoulds cannot overcome emotional impulses.
The key to moving past an emotional reaction is to experience it fully and then substitute a different emotional experience. Psychologists such as Leslie Greenberg and Robert Elliott have developed emotion-focused techniques to accomplish just that. The basic principles and techniques are straightforward, well-supported by research, and described in detail in a growing professional literature.
What is happening with the trader in the example above is that he first experiences hurt and disappointment. He might also experience a fleeting sense of failure and loss. These are too painful to feel, so he has learned to respond to hurt with anger. He transforms sad to mad and then acts on the angry feeling. What appears to be the problem--loss of discipline--is his way of coping with the *real* problem, which is vulnerability.
Suppose, however, I ask our trader to go more deeply into the experience of having his order taken against him. As he talks, I notice an unhappy look on his face and a slight slumping of his shoulders. I point that out and ask him to give voice to what he's feeling. He talks about how it seems as though nothing is working in his trading, how he and his wife just bought a new house, and how they're concerned about making the payments.
When I ask what that's like, feeling as though he can't support his family, he acknowledges, "I feel like such a loser". Then, however, he speaks with a different voice: "But I know I can trade. If I would just stop trying to catch exact tops and bottoms with these orders, I can ride moves once they happen."
"So when you're working orders in the book...", I begin.
"I'm being an idiot," our trader interrupts. "I know I shouldn't be working orders that close to the market. It's too thin."
"But you're trying to catch a top or bottom to feel good and help your family," I offer.
"Yeah," he acknowledges. "But I'm f*****g it up."
"So it all starts with you feeling concerned about your family. You have to get something going in the market to make some money, so you throw an order in the book to catch a turning point," I suggest. He nods.
"Could you pretend your wife is in the room right here, right now and talk to her about that concern and what you want to do about it in the market?"
We set up an exercise where our trader talks aloud his concern for his family finances. He has no problem telling his wife that he needs to be patient and trade well in order to regain his success. By the end of the exercise, there's no hint of the angry revenge trader. In its place is the direct experience of facing his worst fear--his feelings of inadequacy--and emerging with a different emotional experience: empathy for his wife (and for himself).
Greenberg notes:
"People can recognize that a feeling is not helpful to them once it has been accepted fully. The paradox is that, if the feeling is judged as not acceptable--as "not me"--it cannot be changed, because it hasn't been accepted. Only when a feeling has been accepted can it be evaluated and changed if necessary" (Emotion-Focused Therapy, p. 93).
Doing can be a way of avoiding feeling, and that keeps people stuck in problem patterns. Ironically, the solution is to deepen the feeling that is being avoided. At the other end is a very different--and usually quite constructive--emotional experience.
RELEVANT POSTS:
Brief Therapy Techniques for Traders
What Works in Trader Coaching
.
Let's take a common example: a trader is working a bid a bit below the market and suddenly a ferocious sell program takes the market five ticks lower. The trader's order is filled and, in an instant, the market is several ticks against him. He reacts first with shock, then with anger at people who "manipulate the market". In a flash, he buys more contracts, even though this sizes his position much larger than his plan allows. It's a classic revenge trade: he's going to get even. The market moves a few ticks lower, and he is forced out at the worst possible price with a much larger loss than his initial trade planned for. In remorse, he makes a note in his journal that he needs to be more disciplined in his trades.
As long as the trader views "discipline" as his problem, he is sunk psychologically. He sets up a condition in which he is split: part of him is impelled to do something under particular conditions, another part attempts to exercise control by dictating what *should* be done. This is how anorexic and bulimic patients fight with food intake; how addicts fight with drug abuse; how many of us fight with sticking to diets and exercise regimens.
We cannot substitute thought for emotion: shoulds cannot overcome emotional impulses.
The key to moving past an emotional reaction is to experience it fully and then substitute a different emotional experience. Psychologists such as Leslie Greenberg and Robert Elliott have developed emotion-focused techniques to accomplish just that. The basic principles and techniques are straightforward, well-supported by research, and described in detail in a growing professional literature.
What is happening with the trader in the example above is that he first experiences hurt and disappointment. He might also experience a fleeting sense of failure and loss. These are too painful to feel, so he has learned to respond to hurt with anger. He transforms sad to mad and then acts on the angry feeling. What appears to be the problem--loss of discipline--is his way of coping with the *real* problem, which is vulnerability.
Suppose, however, I ask our trader to go more deeply into the experience of having his order taken against him. As he talks, I notice an unhappy look on his face and a slight slumping of his shoulders. I point that out and ask him to give voice to what he's feeling. He talks about how it seems as though nothing is working in his trading, how he and his wife just bought a new house, and how they're concerned about making the payments.
When I ask what that's like, feeling as though he can't support his family, he acknowledges, "I feel like such a loser". Then, however, he speaks with a different voice: "But I know I can trade. If I would just stop trying to catch exact tops and bottoms with these orders, I can ride moves once they happen."
"So when you're working orders in the book...", I begin.
"I'm being an idiot," our trader interrupts. "I know I shouldn't be working orders that close to the market. It's too thin."
"But you're trying to catch a top or bottom to feel good and help your family," I offer.
"Yeah," he acknowledges. "But I'm f*****g it up."
"So it all starts with you feeling concerned about your family. You have to get something going in the market to make some money, so you throw an order in the book to catch a turning point," I suggest. He nods.
"Could you pretend your wife is in the room right here, right now and talk to her about that concern and what you want to do about it in the market?"
We set up an exercise where our trader talks aloud his concern for his family finances. He has no problem telling his wife that he needs to be patient and trade well in order to regain his success. By the end of the exercise, there's no hint of the angry revenge trader. In its place is the direct experience of facing his worst fear--his feelings of inadequacy--and emerging with a different emotional experience: empathy for his wife (and for himself).
Greenberg notes:
"People can recognize that a feeling is not helpful to them once it has been accepted fully. The paradox is that, if the feeling is judged as not acceptable--as "not me"--it cannot be changed, because it hasn't been accepted. Only when a feeling has been accepted can it be evaluated and changed if necessary" (Emotion-Focused Therapy, p. 93).
Doing can be a way of avoiding feeling, and that keeps people stuck in problem patterns. Ironically, the solution is to deepen the feeling that is being avoided. At the other end is a very different--and usually quite constructive--emotional experience.
RELEVANT POSTS:
Brief Therapy Techniques for Traders
What Works in Trader Coaching
.
Wednesday, September 12, 2007
Support, Resistance, and Market Views for Mid-Week
* Support Becomes Resistance: As the daily chart of the ES futures notes, the 1500 level, which had been market support is now serving as resistance. With an important Fed meeting looming, the big market question is whether an interest rate cut would be sufficient to vault us above this level. It seems to me that a cut is baked into market expectations, perhaps leaving us more open to disappointment than surprise and euphoria. Note how equity prices have changed very little since early August despite significant volatility.* Joining the Gold Rush: The Raw Greed blog outlines the precious metals stocks that they are following closely as gold rallies.
* Recession in the Works?: The Kirk Report links several worthwhile perspectives on possible economic weakness ahead.
* 20/20 Hindsight: Excellent post from A Dash of Insight on outcome bias and its effect on traders and investors.
* Promising ETFs: Tom Lydon and Seeking Alpha note opportunities in water and high yields.
* Who We Need for the Current Crisis: Financial Ninja makes the case for a Paul Volker in today's markets and examines the evidence.
* Interpreting Spikes in Options Volume: Lots of call volume might not mean what you'd think. Here's an excellent perspective from Daily Options Report.
* Congratulations on 1001! - Abnormal Returns does such a fine job of finding relevant and worthwhile posts on markets and the economy, including their 1001st post, which includes a look at how much recession is already priced into markets.
* Know Your Symbols? - InvestorGuide offers its Ticker Game as a challenge to traders.
When Traders Prefer Action to Emotion
Think of how many trading problems take the form, "I know I should do X, but I wind up doing Y instead."
For example:
"I know I should trade small, but I end up putting on large positions."
"I know I should get out of the trade, but I wind up riding the loser all the way down."
"I know I should wait for a setup confirmation, but I front run my signals."
In each case, the trader tends to focus on Y--what they did wrong--as the problem. They approach me, their trading psychologist, in the vein of, "How can I stop doing Y?"
So often, the behavior pattern they tell themselves they should be engaging in is one of restraint: keeping trades small, honoring stop levels, waiting for signals, etc. The behavior they want to stop is one of impulse: acting without fully thinking through the consequences.
But what if the impulsive act is not the problem, but a way of coping with a more fundamental problem: the fear of what might happen under conditions of restraint? Instead of openly acknowledging and dealing with that fear, action becomes a defense--a way of making the fear (temporarily) go away.
If so, simply trying to motivate oneself to do less of the impulsive behavior--or even reinforcing the proper, restrained behavior--is not enough. When traders take action to avoid unpleasant emotional experience, the answer is to learn how to transform those emotions.
In an upcoming post, I will be posting on a set of techniques from the therapy literature that accomplish just such a transformation. Not by replacing emotion with reason, but by learning how to replace emotion with other emotions.
The key to these emotion-focused methods is to figure out what it is that the trader is running from: what emotional experience is so scary that it is preferable to act on impulse, with all the consequences that entails?
Asking that question opens us up to novel and highly promising modes of self-change.
RELEVANT POSTS:
Mood, Emotion, and Trading
One of Trading's Greatest Emotional Pitfalls
For example:
"I know I should trade small, but I end up putting on large positions."
"I know I should get out of the trade, but I wind up riding the loser all the way down."
"I know I should wait for a setup confirmation, but I front run my signals."
In each case, the trader tends to focus on Y--what they did wrong--as the problem. They approach me, their trading psychologist, in the vein of, "How can I stop doing Y?"
So often, the behavior pattern they tell themselves they should be engaging in is one of restraint: keeping trades small, honoring stop levels, waiting for signals, etc. The behavior they want to stop is one of impulse: acting without fully thinking through the consequences.
But what if the impulsive act is not the problem, but a way of coping with a more fundamental problem: the fear of what might happen under conditions of restraint? Instead of openly acknowledging and dealing with that fear, action becomes a defense--a way of making the fear (temporarily) go away.
If so, simply trying to motivate oneself to do less of the impulsive behavior--or even reinforcing the proper, restrained behavior--is not enough. When traders take action to avoid unpleasant emotional experience, the answer is to learn how to transform those emotions.
In an upcoming post, I will be posting on a set of techniques from the therapy literature that accomplish just such a transformation. Not by replacing emotion with reason, but by learning how to replace emotion with other emotions.
The key to these emotion-focused methods is to figure out what it is that the trader is running from: what emotional experience is so scary that it is preferable to act on impulse, with all the consequences that entails?
Asking that question opens us up to novel and highly promising modes of self-change.
RELEVANT POSTS:
Mood, Emotion, and Trading
One of Trading's Greatest Emotional Pitfalls
Tuesday, September 11, 2007
Making Sound Financial Decisions Under Conditions of Fear
I recently received a call from a Wall St Journal reporter asking good questions regarding the role of fear in trading and investment decisions. This topic is particularly relevant, given recent market volatility.
As this excellent summary indicates, a wealth of research finds that people make suboptimal decisions under conditions of high emotional arousal. Different regions of the brain are responsible for decision-making under high vs. low risk conditions. Excessive activity in these centers for processing emotions leads to either excessive risk-taking or excessive risk aversion.
Similarly, distortion of information due to how decisions are framed is mediated by activity in the amgydala, which is implicated in our processing of emotional stresses.
Quite simply, our brains function differently under conditions of fear (and greed!) than under cooler emotional conditions. As a result, we can make decisions with our money that later (in our more calm modes) seem puzzling to us.
How can we minimize such distortions in our decision-making? One simple way is to clearly articulate the rationale behind each of our investment or trading decisions. Specifically, we want to map out:
1) Why we are making this decision; what we expect to happen; why we think that current prices are away from true value;
2) What would lead us to take profits; what would be fair value that would lead us to exit the position;
3) What would lead us to exit the position if it goes against us; what would tell us that we are wrong in our initial assumptions.
In many performance fields, such as Special Forces military training, people are taught to follow decision-making routines under highly stressful conditions. By making these routines explicit and repeating them to the point of internalization, we make it easier to access them even when the blood flows in our brain are activating our flight or fight responses.
Reducing trading and investment decisions to a few criteria and then mentally rehearsing those--keeping them explicit--is a great way to stay grounded during periods of uncertainty and volatility. The goal is to make the same decisions under conditions of pressure that you would make in calm conditions. Mentally rehearsing various pressured ("what if") scenarios and walking yourself through the steps you'd take in each situation is excellent preparation for real-time risk.
RELEVANT POSTS:
Handling Volatile Markets: Lessons From Neuroeconomics
Inside the Trader's Brain
.
As this excellent summary indicates, a wealth of research finds that people make suboptimal decisions under conditions of high emotional arousal. Different regions of the brain are responsible for decision-making under high vs. low risk conditions. Excessive activity in these centers for processing emotions leads to either excessive risk-taking or excessive risk aversion.
Similarly, distortion of information due to how decisions are framed is mediated by activity in the amgydala, which is implicated in our processing of emotional stresses.
Quite simply, our brains function differently under conditions of fear (and greed!) than under cooler emotional conditions. As a result, we can make decisions with our money that later (in our more calm modes) seem puzzling to us.
How can we minimize such distortions in our decision-making? One simple way is to clearly articulate the rationale behind each of our investment or trading decisions. Specifically, we want to map out:
1) Why we are making this decision; what we expect to happen; why we think that current prices are away from true value;
2) What would lead us to take profits; what would be fair value that would lead us to exit the position;
3) What would lead us to exit the position if it goes against us; what would tell us that we are wrong in our initial assumptions.
In many performance fields, such as Special Forces military training, people are taught to follow decision-making routines under highly stressful conditions. By making these routines explicit and repeating them to the point of internalization, we make it easier to access them even when the blood flows in our brain are activating our flight or fight responses.
Reducing trading and investment decisions to a few criteria and then mentally rehearsing those--keeping them explicit--is a great way to stay grounded during periods of uncertainty and volatility. The goal is to make the same decisions under conditions of pressure that you would make in calm conditions. Mentally rehearsing various pressured ("what if") scenarios and walking yourself through the steps you'd take in each situation is excellent preparation for real-time risk.
RELEVANT POSTS:
Handling Volatile Markets: Lessons From Neuroeconomics
Inside the Trader's Brain
.
Monday, September 10, 2007
The Effect of Dollar Weakness on Stock Market Performance
The pink line in the chart above (click for greater detail) shows the cash S&P 500 Index from 2000 to the present. The blue line is also the cash S&P 500 Index, but adjusted for the value of the U.S. Dollar Index. The dollar has been weakening as stocks have risen. As a result, the bull market in large caps since 2003 has been far more anemic in world currency terms than in dollar terms. With growing calls for interest rate cuts, that doesn't bode well for the dollar, and that invites questions about who would want to own dollar-denominated assets when the dollar is shrinking.
The Flight to Quality Accelerates
If you click on the chart, you'll see the breathtaking decline in 10-year yields in the past several months. That decline has accelerated in the past two days, on the heels of the weak jobs report.
As investors flee to the quality of Treasuries, yields fall. But the same fear that fuels the desire for bills and bonds also pressures stock prices. The weakness in yields has thus provided a great sentiment indicator for trading those market ranges.
UsingTrading Range Information to Frame Trades
If you click on the chart above, you'll see a portion of my premarket preparation for trading. My goal with this perspective is to identify and understand relevant trading ranges that are likely to affect the coming day's trade.Note that, after Friday's weak jobs report came out, we made an initial decline just below the 1465 level in the ES futures. This is what I view as the market's efficient response to the data: it is the market's estimate of how equity prices should be revalued in light of the new information.
After an initial, weak attempt to move higher than this 1465 level, we moved lower still, all the way down to below 1455. This I view as the market's emotional response to the data; it represents the "giving up" of the bulls once it becomes clear that the market will not reverse its initial decline.
For fundamental reasons we cannot sustain a move above 1465; the market no longer views such pricing as value. As long as that's the case, I view us as being in a short-term downtrend. The market is repricing value lower over time.
But for sentiment reasons--inability to find sellers to sustain a move below 1455--we've essentially moved nowhere since midday Friday.
That is the relevant trading range that I work with. Some of the best day trades occur at the edges of those ranges, as we either fail to sustain moves out of the range (and return to at least the range midpoint) or we see that moves out of the range attract additional volume and encourage a repricing of value (trending move).
It's when the moves to or slightly beyond the range extremes fail to attract volume and are not accompanied by meaningful repricings in other, related markets (dollar, rates, equity sector indices) that I am most likely to fade these moves. Conversely, large moves in rates and the dollar are most likely to encourage repricing of value among stocks.
By focusing on longer-term ranges and trends in rates and currencies and then following short-term volume flows (such as Market Delta), sector movements, and sentiment (NYSE TICK), I'm handicapping the odds of moving out of or back into these ranges. One or two such trades per day can catch worthwhile swings in a market with decent volatility. Much of the rest of the market's movement I treat as noise. By requiring myself to frame trades in this manner, I gain clarity about what would make the trades wrong (stop levels) and where to place targets to take profits. I also avoid those impulsive trades based on market noise.
RELEVANT POSTS:
How to Identify and Trade Breakout Moves
The Importance of the Overnight Range
Anatomy of a Market Breakout
*
Sunday, September 09, 2007
Finding Your Calling and More Ideas to Start the Week
* The Importance of Dreams - Here's an interesting post from Fast Company's site, relevant to the topic of finding one's calling. Here's a unique exercise for finding one's interests.
* Assessing Trader Sentiment - Thanks for Barry Ritholtz for pointing out Yahoo!'s effort to quantify investor/trader sentiment via board postings. See also Barry's weekend linkfest, including a worthwhile post on whether China is dumping U.S. bonds.
* Economic Perspectives - Are among the Sunday links offered by Abnormal Returns, including a consideration of solvency vs. liquidity crises.
* Rise in NASDAQ Volatility - Adam Warner tracks VXN and finds it outperforming VIX. See also this volatility index comparison from VIX And More.
* Picking Winners - Winners in the Kirk Report's stock picking contest will be sharing their methods with members.
* Weak Dollar Makes for Strong Commodities - Here's an eye-opening rundown from Larry Nusbaum and a look at gold strength from Musings of a Trader.
* Near-Term Risk-Reward Ratio - Doesn't look favorable for Henry Carstens' systems.
* Where to Find Worthwhile Blogs? - Check out Value Blog Review for reviews of financial blogs. Some great nuggets there.
* Housing Market Woes - Are not evenly distributed. Here's an interesting perspective from Goldman Sachs passed along by The Kingsland Report.
* What LIBOR is Telling Us - WSJ Online blog reviews the significance of rates that are out of whack.
* Assessing Trader Sentiment - Thanks for Barry Ritholtz for pointing out Yahoo!'s effort to quantify investor/trader sentiment via board postings. See also Barry's weekend linkfest, including a worthwhile post on whether China is dumping U.S. bonds.
* Economic Perspectives - Are among the Sunday links offered by Abnormal Returns, including a consideration of solvency vs. liquidity crises.
* Rise in NASDAQ Volatility - Adam Warner tracks VXN and finds it outperforming VIX. See also this volatility index comparison from VIX And More.
* Picking Winners - Winners in the Kirk Report's stock picking contest will be sharing their methods with members.
* Weak Dollar Makes for Strong Commodities - Here's an eye-opening rundown from Larry Nusbaum and a look at gold strength from Musings of a Trader.
* Near-Term Risk-Reward Ratio - Doesn't look favorable for Henry Carstens' systems.
* Where to Find Worthwhile Blogs? - Check out Value Blog Review for reviews of financial blogs. Some great nuggets there.
* Housing Market Woes - Are not evenly distributed. Here's an interesting perspective from Goldman Sachs passed along by The Kingsland Report.
* What LIBOR is Telling Us - WSJ Online blog reviews the significance of rates that are out of whack.
Self-Coaching: Lessons From Basketball
Yesterday I hit the basketball court for the first time in years. I used to be quite the gym rat, but long ago replaced hoops with more practical exercise: jogging, weight-lifting, etc.
I was surprised how quickly my shot came back to me. Very shortly after coming onto the court, I was launching and hitting jumpers from beyond the three-point range. My legs had lost some spring, and my stamina was reduced. I wasn't yet ready for prime time.
Most surprising to me, however, was how the self-coaching kicked in. After years of being in a team environment, that coach's voice had become more a part of me than I realized.
My first free throws were off the mark: I was only hitting 50-60% of them--and that's *really* bad for me.
So, as if I had never missed a beat from college, I shot free throws. One after another. Again and again.
Each time, I made subtle adjustments. In my head, I talked with the coach's voice: square your body and distribute your weight, extend the follow-through, keep your eye on the front of the rim as you shoot.
When I'm at the foul line, every shot follows a routine: I center my body in front of the rim, with my feet just behind the line; I bounce the ball three times, look up at the rim and take a very deep breath; I bounce the ball one more time and place my hand on the ball with the middle finger touching the same part of the ball (part of the ball's labeling) each time; I fix my eyes on the rim, launch the shot, and follow through.
Bounce, bounce, bounce. Deep breath, look at rim. Bounce. Center the hand on the ball. Eyes on the rim. Follow through.
Every shot the same.
But it's the subtle factors that take a shooter from 50% accuracy to 80%. As I stood out there in the heat, I quietly coached myself in those subtleties. In the end, it turned out I had two problems:
1) My fingers were not sufficiently widely spaced on the ball. With my fingers close together, I was getting a bit less arc on the shot and putting a little too much launch into the shot. With the fingers spread just a little more widely, the ball hit nothing but net.
2) I needed to take just a little more time--just an extra moment--in that initial look at the rim after the deep breath. By slowing myself down and fixing my eyes more carefully on the rim, I made the rest of the shot more automatic.
Little differences, repeated and made routine, yield major results. But they have to be the *right* differences.
On the court next to mine, a group of teens was playing a three-on-three game. It was almost more like three one-on-one matches going on simultaneously. Each player first looked to shoot the ball, only later to pass. Many opportunities to drive the lane, draw defenders, and dish off to open teammates were lost. They couldn't really see the whole court or the high percentage plays. They wanted to shoot the ball, not play basketball.
Every so often they looked my way. They probably wondered what in the world I was doing at the foul line all that time, bouncing and shooting.
I had to keep missing my shots--in practice, not in a game--to get things right. The focus had to be on the process of shooting, not making points.
I left the court thinking how very much like the trading world it all was.
RELEVANT POSTS:
Becoming an Agent of Continuous Learning
What Works--and Doesn't--in Coaching Traders
.
I was surprised how quickly my shot came back to me. Very shortly after coming onto the court, I was launching and hitting jumpers from beyond the three-point range. My legs had lost some spring, and my stamina was reduced. I wasn't yet ready for prime time.
Most surprising to me, however, was how the self-coaching kicked in. After years of being in a team environment, that coach's voice had become more a part of me than I realized.
My first free throws were off the mark: I was only hitting 50-60% of them--and that's *really* bad for me.
So, as if I had never missed a beat from college, I shot free throws. One after another. Again and again.
Each time, I made subtle adjustments. In my head, I talked with the coach's voice: square your body and distribute your weight, extend the follow-through, keep your eye on the front of the rim as you shoot.
When I'm at the foul line, every shot follows a routine: I center my body in front of the rim, with my feet just behind the line; I bounce the ball three times, look up at the rim and take a very deep breath; I bounce the ball one more time and place my hand on the ball with the middle finger touching the same part of the ball (part of the ball's labeling) each time; I fix my eyes on the rim, launch the shot, and follow through.
Bounce, bounce, bounce. Deep breath, look at rim. Bounce. Center the hand on the ball. Eyes on the rim. Follow through.
Every shot the same.
But it's the subtle factors that take a shooter from 50% accuracy to 80%. As I stood out there in the heat, I quietly coached myself in those subtleties. In the end, it turned out I had two problems:
1) My fingers were not sufficiently widely spaced on the ball. With my fingers close together, I was getting a bit less arc on the shot and putting a little too much launch into the shot. With the fingers spread just a little more widely, the ball hit nothing but net.
2) I needed to take just a little more time--just an extra moment--in that initial look at the rim after the deep breath. By slowing myself down and fixing my eyes more carefully on the rim, I made the rest of the shot more automatic.
Little differences, repeated and made routine, yield major results. But they have to be the *right* differences.
On the court next to mine, a group of teens was playing a three-on-three game. It was almost more like three one-on-one matches going on simultaneously. Each player first looked to shoot the ball, only later to pass. Many opportunities to drive the lane, draw defenders, and dish off to open teammates were lost. They couldn't really see the whole court or the high percentage plays. They wanted to shoot the ball, not play basketball.
Every so often they looked my way. They probably wondered what in the world I was doing at the foul line all that time, bouncing and shooting.
I had to keep missing my shots--in practice, not in a game--to get things right. The focus had to be on the process of shooting, not making points.
I left the court thinking how very much like the trading world it all was.
RELEVANT POSTS:
Becoming an Agent of Continuous Learning
What Works--and Doesn't--in Coaching Traders
.
Saturday, September 08, 2007
When the Trading Dream Dies
This post, like the one previous, was inspired by a reader comment. Responding to my column on creating change through powerful emotional experiences, the reader indicated that his dreams of trading riches had died and that he had to "just be happy with the person I am". He then referred to this perspective as "depressive".
I have so many responses to this comment that it's hard for me to know where to begin.
So let me start by saying that I have felt much the same feeling. There's a part of me that would love to be a super-successful trader, even as I know deep within myself that this is neither where my greatest talents nor passions lie. In recent years, I've been what I consider to be a competent trader--I've made money after costs--but I haven't traded the size or achieved the returns that would assure me (and my family) of the lifestyle we now enjoy.
It must be how many decent college basketball and football players feel. They've excelled in high school and made it to their university teams, but they never quite make it to the pros. They're good--but they're not among the elite. Those dreams of success in the "big leagues" can be difficult to put aside.
Some of those competent college players--Bob Knight, Dean Smith, and Jim Boeheim in the basketball ranks come to mind--end up becoming superlative at coaching. Others find their success in another life arena, apart from sports. They've made the transition from mourning the loss of a dream to crafting a new one. Most important, they've brought something from their first, sports endeavors (discipline, competitive drive, self-development) to their new pursuits.
So, hopefully, it can be with trading. For me, trading has been life-in-miniature: a crucible in which I've learned to deal with risk, reward, uncertainty, fear, greed, overconfidence--just about all the emotions that affect what we do and how we do it. I'm a better psychologist for having had trading experiences, and I'm certainly better equipped to understand the challenges specific to traders.
When the trading dream dies, it is a loss and that can feel depressing. The challenge is to figure out how that trading experience is going to equip you for the next dream, the next pursuit that may be better suited to you and your talents and interests.
Now a separate response, apart from the reader's comment:
My experience, particularly with young traders, is that trading often doesn't express a dream. A dream is what motivates an entrepreneur: someone who founds their own business, develops their own products, and spends long hours refining those, marketing them, and finding financing for growth. For many young traders, however, trading is a fantasy. It is not connected to a concrete business plan, and it certainly is not accompanied by long hours of dedicated effort. What makes it a fantasy is that it is an effort to achieve success without such effort.
When that fantasy dies, it opens the door to reality. That is sobering, to be sure. But it is also the first step in finding oneself: discovering a career and calling that are so meaningful and stimulating that the real work necessary for success won't feel like work at all.
RELEVANT POSTS:
Four Overlooked Qualities of Successful Traders
Resilience and the Courage of Your Convictions
.
I have so many responses to this comment that it's hard for me to know where to begin.
So let me start by saying that I have felt much the same feeling. There's a part of me that would love to be a super-successful trader, even as I know deep within myself that this is neither where my greatest talents nor passions lie. In recent years, I've been what I consider to be a competent trader--I've made money after costs--but I haven't traded the size or achieved the returns that would assure me (and my family) of the lifestyle we now enjoy.
It must be how many decent college basketball and football players feel. They've excelled in high school and made it to their university teams, but they never quite make it to the pros. They're good--but they're not among the elite. Those dreams of success in the "big leagues" can be difficult to put aside.
Some of those competent college players--Bob Knight, Dean Smith, and Jim Boeheim in the basketball ranks come to mind--end up becoming superlative at coaching. Others find their success in another life arena, apart from sports. They've made the transition from mourning the loss of a dream to crafting a new one. Most important, they've brought something from their first, sports endeavors (discipline, competitive drive, self-development) to their new pursuits.
So, hopefully, it can be with trading. For me, trading has been life-in-miniature: a crucible in which I've learned to deal with risk, reward, uncertainty, fear, greed, overconfidence--just about all the emotions that affect what we do and how we do it. I'm a better psychologist for having had trading experiences, and I'm certainly better equipped to understand the challenges specific to traders.
When the trading dream dies, it is a loss and that can feel depressing. The challenge is to figure out how that trading experience is going to equip you for the next dream, the next pursuit that may be better suited to you and your talents and interests.
Now a separate response, apart from the reader's comment:
My experience, particularly with young traders, is that trading often doesn't express a dream. A dream is what motivates an entrepreneur: someone who founds their own business, develops their own products, and spends long hours refining those, marketing them, and finding financing for growth. For many young traders, however, trading is a fantasy. It is not connected to a concrete business plan, and it certainly is not accompanied by long hours of dedicated effort. What makes it a fantasy is that it is an effort to achieve success without such effort.
When that fantasy dies, it opens the door to reality. That is sobering, to be sure. But it is also the first step in finding oneself: discovering a career and calling that are so meaningful and stimulating that the real work necessary for success won't feel like work at all.
RELEVANT POSTS:
Four Overlooked Qualities of Successful Traders
Resilience and the Courage of Your Convictions
.
Finding Solutions to Trading Problems
My readers have outdone me! I like my post on creating powerful emotional experiences, but the reader comments to that post are even better. Please read the comment by Glen Bowman, Ph.D.; it is unusually insightful.
There are several lessons to be learned from his experience:
1) Psychological change does not come all at once - His valuable point is that change occurs a little bit at a time, day after day, as we create new experiences for ourselves. Over time, we internalize the feedback from those new experiences and they become parts of our identity. Making one big effort is not nearly as powerful as making focused, consistent efforts over time. In that sense, psychological development is like physical development: you have to work out with regularity to see lasting results.
2) The solutions to trading problems are within you - If you have a trading problem, a powerful way to address it is to figure out how you've dealt with a similar problem in a different area of your life. If, for example, you're in a trading slump and doubting yourself, it's worthwhile figuring out how you've gotten past dips in self-confidence at other times in your life (at work, in relationships, etc.). Whatever you've done to aid your confidence and trust in yourself at those times may well hold the key to what will work for you in the trading situation. Dr. Bowman drew upon his experience with social anxiety to address trading anxiety. Brilliant.
3) When implementing new solutions, start small - Dr. Bowman uses the example of trading 100 SPY rather than 50 ES contracts. That is exactly the right approach. Why? It removes the pressure of profit/loss from the trading and allows you to simply focus on making changes to your trading processes. Once you get the processes down with consistency, then you gradually raise your trading size. But you have to earn the right to trade 500 SPY if you've been trading 100 and 200; you have to earn the right to trade multiple ES contracts if you've been trading a single one. So often, the difference between success and failure among developing traders is that the successful traders make just as many mistakes as the unsuccessful ones; they just make them smaller and thus survive their learning curves.
My thanks to Dr. Bowman and the many readers who take the time to comment on the blog posts. I hope readers take advantage of these fine insights.
RELEVANT POSTS:
A Solution-Focused Linkfest
Solution-Focused Trading
.
There are several lessons to be learned from his experience:
1) Psychological change does not come all at once - His valuable point is that change occurs a little bit at a time, day after day, as we create new experiences for ourselves. Over time, we internalize the feedback from those new experiences and they become parts of our identity. Making one big effort is not nearly as powerful as making focused, consistent efforts over time. In that sense, psychological development is like physical development: you have to work out with regularity to see lasting results.
2) The solutions to trading problems are within you - If you have a trading problem, a powerful way to address it is to figure out how you've dealt with a similar problem in a different area of your life. If, for example, you're in a trading slump and doubting yourself, it's worthwhile figuring out how you've gotten past dips in self-confidence at other times in your life (at work, in relationships, etc.). Whatever you've done to aid your confidence and trust in yourself at those times may well hold the key to what will work for you in the trading situation. Dr. Bowman drew upon his experience with social anxiety to address trading anxiety. Brilliant.
3) When implementing new solutions, start small - Dr. Bowman uses the example of trading 100 SPY rather than 50 ES contracts. That is exactly the right approach. Why? It removes the pressure of profit/loss from the trading and allows you to simply focus on making changes to your trading processes. Once you get the processes down with consistency, then you gradually raise your trading size. But you have to earn the right to trade 500 SPY if you've been trading 100 and 200; you have to earn the right to trade multiple ES contracts if you've been trading a single one. So often, the difference between success and failure among developing traders is that the successful traders make just as many mistakes as the unsuccessful ones; they just make them smaller and thus survive their learning curves.
My thanks to Dr. Bowman and the many readers who take the time to comment on the blog posts. I hope readers take advantage of these fine insights.
RELEVANT POSTS:
A Solution-Focused Linkfest
Solution-Focused Trading
.
Friday, September 07, 2007
More Good Reading to Start the Weekend
* When Trading Gets Out of Control - Too many traders rationalize addictive patterns of trading as a "passion" for markets. Well, I guess that's what an addiction is: having a passion for something that brings numerous unwanted consequences. It's nice when traders face the problem squarely and get their lives back. See this very insightful post from the CXO Advisory Blog re: how the internet has changed the emotional experience of trading.
* Cognitive Neuroscience Interviews - The SharpBrains blog offers a set of 11 interesting interviews on different facets of brain function and performance. I'm pleased to see that cognitive therapy pioneer Judy Beck will be next on the interview list. I'll be appearing with her at the Annual Meeting of the American Psychiatric Association in May. I recommend her work highly.
* How Do Americans Rate Various Industries? - Here are some insights from the Gallup organization. See also how Americans feel about public education and especially how they feel about the economy.
* Disaster - That's how Mish describes the recent jobs report. See also his insightful post on gold as a holding during times of inflation and deflation.
* Cognitive Neuroscience Interviews - The SharpBrains blog offers a set of 11 interesting interviews on different facets of brain function and performance. I'm pleased to see that cognitive therapy pioneer Judy Beck will be next on the interview list. I'll be appearing with her at the Annual Meeting of the American Psychiatric Association in May. I recommend her work highly.
* How Do Americans Rate Various Industries? - Here are some insights from the Gallup organization. See also how Americans feel about public education and especially how they feel about the economy.
* Disaster - That's how Mish describes the recent jobs report. See also his insightful post on gold as a holding during times of inflation and deflation.
The Heart of Trader Coaching: Creating Powerful Emotional Experiences
In my post yesterday, I described the case of Pete and the idea that what we consider to be our problems are often coping efforts that once might have been successful, but now no longer fit our situations. Pete prided himself on being a master analyst of the markets, but in fact was dogged by feelings of inadequacy whenever he couldn't figure out market moves. He looked toward success in trading as a way of vindicating himself for prior failures, particularly in college. The feelings of inadequacy were thus quite threatening to him. He avoided them by backing away from working at his analysis and planning during difficult market times, later blaming his "loss of discipline" as the reason for his drawdowns. In reality, his lack of discipline was his coping: instead of trying and failing--his worst nightmare--he simply went on psychological strike and stopped trying.
When I was in therapy myself as a graduate student at the University of Kansas, the most impactful comment my therapist made was that I should "pursue my anxiety". She explained that everyone is afraid of the unknown. But we can only grow and develop as people by going beyond the known. Our anxiety often points the way toward our greatest growth.
In my case, I had a recurring dream of going down a very large and fast slide. It was very anxiety-provoking: I was afraid of losing control and falling. (Other dreams similarly featured a fear of heights). In guided imagery work during the therapy, I had to place myself on the giant slide and release myself downward. An important therapeutic moment occurred when I transformed the rapid fall down the slide into an image of flying (another recurring, but positive dream). In many aspects of life, I was afraid of falling; by facing that fear directly, I could replace it with the joy of soaring.
The important principle is that we overcome fears by experiencing them directly and finding a new, more positive emotional experience.
Pete was hoping to change his behavior with simple advice or positive thinking. In essence, he was hoping that he could bolster his own (maladaptive) coping so that he could preserve his image of himself. What we had to do to create real change, however, was to actually face times of great market uncertainty and use those to double his efforts at analysis and planning. This was the slide he needed to go down.
Of course, this was greatly anxiety-provoking for Pete, and it triggered many thoughts and feelings such as, "What if I'm wrong?" My stance was, "Of course you'll be wrong at times! What trader isn't? The good traders aren't the ones who are always right. The good ones are the ones who survive the periods of being wrong. If you're wrong, let's see if we can learn from it, so that we can become better."
By requiring Pete to make small trades based on his analysis during a period in which he felt uncertain, I created a win-win for him. If his analysis was correct, it would reinforce the notion that he did, indeed, have skills. If his analysis was faulty, it would provide us with the even more helpful experience that he could survive "failure", learn from it, and use it to improve in those areas where he was not yet expert.
The real heart of the work with Pete was seeing him through this facing of his worst fears, helping him rework the anxiety into opportunity. He needed to learn to face his inadequacies without being swamped with the feeling of being inadequate.
All of us are deeper and far more complex than we realize. It's human nature to seek the easy path, the short cut. We look for solutions to our problems that keep us comfortable, that keep us coping in the same ways that haven't been working. What I learned from my own experience in Kansas was that, if you haven't had a powerful emotional experience, you haven't changed.
In facing our demons, we become their master.
RELEVANT POSTS:
Controlling Emotions Is Not The Goal of Trading Psychology
Five Principles of Growth and Development
Techniques for Dealing With Emotional Disruptions of Trading
.
When I was in therapy myself as a graduate student at the University of Kansas, the most impactful comment my therapist made was that I should "pursue my anxiety". She explained that everyone is afraid of the unknown. But we can only grow and develop as people by going beyond the known. Our anxiety often points the way toward our greatest growth.
In my case, I had a recurring dream of going down a very large and fast slide. It was very anxiety-provoking: I was afraid of losing control and falling. (Other dreams similarly featured a fear of heights). In guided imagery work during the therapy, I had to place myself on the giant slide and release myself downward. An important therapeutic moment occurred when I transformed the rapid fall down the slide into an image of flying (another recurring, but positive dream). In many aspects of life, I was afraid of falling; by facing that fear directly, I could replace it with the joy of soaring.
The important principle is that we overcome fears by experiencing them directly and finding a new, more positive emotional experience.
Pete was hoping to change his behavior with simple advice or positive thinking. In essence, he was hoping that he could bolster his own (maladaptive) coping so that he could preserve his image of himself. What we had to do to create real change, however, was to actually face times of great market uncertainty and use those to double his efforts at analysis and planning. This was the slide he needed to go down.
Of course, this was greatly anxiety-provoking for Pete, and it triggered many thoughts and feelings such as, "What if I'm wrong?" My stance was, "Of course you'll be wrong at times! What trader isn't? The good traders aren't the ones who are always right. The good ones are the ones who survive the periods of being wrong. If you're wrong, let's see if we can learn from it, so that we can become better."
By requiring Pete to make small trades based on his analysis during a period in which he felt uncertain, I created a win-win for him. If his analysis was correct, it would reinforce the notion that he did, indeed, have skills. If his analysis was faulty, it would provide us with the even more helpful experience that he could survive "failure", learn from it, and use it to improve in those areas where he was not yet expert.
The real heart of the work with Pete was seeing him through this facing of his worst fears, helping him rework the anxiety into opportunity. He needed to learn to face his inadequacies without being swamped with the feeling of being inadequate.
All of us are deeper and far more complex than we realize. It's human nature to seek the easy path, the short cut. We look for solutions to our problems that keep us comfortable, that keep us coping in the same ways that haven't been working. What I learned from my own experience in Kansas was that, if you haven't had a powerful emotional experience, you haven't changed.
In facing our demons, we become their master.
RELEVANT POSTS:
Controlling Emotions Is Not The Goal of Trading Psychology
Five Principles of Growth and Development
Techniques for Dealing With Emotional Disruptions of Trading
.
Thursday, September 06, 2007
Self-Help Resources and Other Reading for a Thursday
* Figuring Yourself Out - I received a few emails following my post on problems as coping efforts. For those interested in further resources, here's a link to a series of articles on the topic and here's a link to a related article series.
* Keeping It Real - With the exception of selected posts reprinted on the Seeking Alpha site, I have not authorized any other website to be reprinting posts from this blog. If you're reading this on a site other than TraderFeed, I invite you to visit the TraderFeed blog and make use of the Twitter comments on the site as well. The lack of integrity of someone who would post other people's work as their own (or as a tool to further their own traffic) just astounds me.
* Keeping a Trading Journal - StockTickr has been adding features to their electronic journal, including impressive performance reports. Excellent resource.
* What Will the Fed Do? - The market is already pricing in its answer, according to this Seeking Alpha post.
* How Would a Rate Cut Affect Markets? - The market may be anticipating inflation already, Charles Kirk notes, with a rundown on recent strength in gold and gold stocks. See also Kirk's recent links, including a look at what happens after multiple days of 9:1 up:down volume.
* What's the *Real* Unemployment Rate? - The Big Picture offers an eye-opening estimate of real-world unemployment.
* Stock Screening Ideas - Chris Perruna offers some of what's on his radar and also posts his CANSLIM screening candidates.
* More Stock Picks - Here's what the MSN StockScouter is identifying as worthy of consideration. Here's a portfolio of stocks owned by Warren Buffett that have implemented stock buyback programs, as reported by the excellent StockPickr site.
* Keeping It Real - With the exception of selected posts reprinted on the Seeking Alpha site, I have not authorized any other website to be reprinting posts from this blog. If you're reading this on a site other than TraderFeed, I invite you to visit the TraderFeed blog and make use of the Twitter comments on the site as well. The lack of integrity of someone who would post other people's work as their own (or as a tool to further their own traffic) just astounds me.
* Keeping a Trading Journal - StockTickr has been adding features to their electronic journal, including impressive performance reports. Excellent resource.
* What Will the Fed Do? - The market is already pricing in its answer, according to this Seeking Alpha post.
* How Would a Rate Cut Affect Markets? - The market may be anticipating inflation already, Charles Kirk notes, with a rundown on recent strength in gold and gold stocks. See also Kirk's recent links, including a look at what happens after multiple days of 9:1 up:down volume.
* What's the *Real* Unemployment Rate? - The Big Picture offers an eye-opening estimate of real-world unemployment.
* Stock Screening Ideas - Chris Perruna offers some of what's on his radar and also posts his CANSLIM screening candidates.
* More Stock Picks - Here's what the MSN StockScouter is identifying as worthy of consideration. Here's a portfolio of stocks owned by Warren Buffett that have implemented stock buyback programs, as reported by the excellent StockPickr site.
Quick Note re: Twitter and Market Notes
Twitter has been down this AM; I'll resume comments later in the day, assuming it's up. We continue to see support at the 1470 area in ES futures. ECB kept rates unchanged; there's continued credit concerns and risk aversion. 10 yr yield is 4.484%, off the AM lows of 4.463%. Yen has retreated from its test of yesterday's highs. ISM non-manufacturing at 9:00 AM CT. EuroStoxx futures down slightly; ES futures now up 2.25 points after testing the 1470 support area. I continue to watch the financial stocks, yields, and Yen for indications of risk-assumption vs. aversion.
Problems Are Coping Strategies That No Longer Work
Nothing is more upsetting to people than recurring patterns of self-defeating behavior. Many times we know what we're doing wrong, but continue doing it. Why?
An important principle that I discuss in the Psychology of Trading book is that what we commonly regard as our problems are actually coping strategies that we've developed over our life span that no longer work for us. We keep coping the same way, because these strategies have become overlearned, automatic. They may have served a purpose earlier in life, but now no longer fit the situation we're in.
But if what we identify as our problems are actually coping efforts, it follows that the real problems are the underlying conflicts that we're coping with. Many times, those problems are outside of our conscious awareness. As a result, we make surface efforts to shift our coping, never addressing the underlying concerns.
Such was the case with a trader I will call Pete. I met with Pete several years ago at a trading firm. He was a moderately successful trader who prided himself on his "feel" for the market and his ability to read charts (which he reviewed religiously every evening). Every so often, however, Pete would hit a losing streak in which he would abandon his discipline and either stop reviewing the charts or place trades that went against his market ideas.
"I don't know why I do this," he explained to me. "I have a real good sense for what the market will do and then I trade the opposite way."
As Pete's coach, I began with a detailed history. I tried to get a handle on various times in the past when he had these meltdowns. Two observations came out of this:
1) Interestingly, all were periods of anxiety, although this is not how he initially presented the problem. Pete generally presented himself as a savvy reader of markets. Only with an intensive review of occasions when he abandoned his discipline did it come out that he was anxious at these times.
2) Pete's description of his market ideas (including some recent ones) struck me as off the mark. In one case, he badly misread recent action in the equity indexes. My immediate impression was that Pete was less savvy than he presented himself.
I asked Pete to mentally relive the most recent occasions in which he traded poorly. We walked through the start of the trading day, the market action, his various thoughts and decisions, etc. I encouraged Pete to allow himself to feel his anxiety right there in the meeting with me, to describe it in detail, and to share his thoughts when he was in this anxious mode. This was not easy for him. He tended to change the topic and talk about the market, his trading, his preparation for the trade, etc.
This is not unusual. To avoid painful feelings, we frequently use coping methods to keep them at bay. Freud referred to these as "defenses". A common set of defenses is to intellectualize and rationalize situations so that we don't experience the feelings associated with them. What I was doing with Pete was interrupting his defenses, so that he would have to truly experience his emotions.
What came out when Pete allowed himself to be anxious was that he felt terribly inadequate when he did not understand what the market was doing and lost money. This feeling of inadequacy led him to question his ability and future as a trader. Having failed at college and experienced conflict with his parents as a result, Pete looked to trading as his way of being a success. The feelings of inadequacy were thus extremely threatening for him. And the reality was, Pete was a good trader, but not an unusually savvy one. My observation was on the mark: many times he missed market themes and patterns.
So what did Pete do to ward off his frightening experience? He puffed up his pride at being a good trader and master chart reader, stopped following his own routines, and then blamed his losses on the "discipline" problem. The problem wasn't that he was a bad trader; in fact, the problem--as he defensively reconstructed it--was that he was a *great* trader who didn't follow his own advice.
The loss of discipline was *not* his problem. It was his avoidant way of coping with the real problem, which was his shaky sense of himself during times when he didn't understand the markets and lost money. Trading was bearing the burden of his self esteem, and the burden was too much to carry.
By attributing the problem to a lack of discipline, Pete could maintain a (false) sense of confidence and worth as a trader. Only when we got at the heart of the matter--his assumption that being disoriented in the market meant that he was a bad trader and his need to make money to prove his worth--were we able to reach some resolution.
My next post will explain how we did that.
In the interim, think about your recurring problems in trading and how they might be (misguided) efforts at coping. If you didn't have the problem, what would be the difficult emotional experience you'd have to deal with? That question puts you on the road to genuine change.
RELATED POSTS:
Understanding Lapses in Trading Discipline
Top Reasons Traders Lose Their Discipline
.
An important principle that I discuss in the Psychology of Trading book is that what we commonly regard as our problems are actually coping strategies that we've developed over our life span that no longer work for us. We keep coping the same way, because these strategies have become overlearned, automatic. They may have served a purpose earlier in life, but now no longer fit the situation we're in.
But if what we identify as our problems are actually coping efforts, it follows that the real problems are the underlying conflicts that we're coping with. Many times, those problems are outside of our conscious awareness. As a result, we make surface efforts to shift our coping, never addressing the underlying concerns.
Such was the case with a trader I will call Pete. I met with Pete several years ago at a trading firm. He was a moderately successful trader who prided himself on his "feel" for the market and his ability to read charts (which he reviewed religiously every evening). Every so often, however, Pete would hit a losing streak in which he would abandon his discipline and either stop reviewing the charts or place trades that went against his market ideas.
"I don't know why I do this," he explained to me. "I have a real good sense for what the market will do and then I trade the opposite way."
As Pete's coach, I began with a detailed history. I tried to get a handle on various times in the past when he had these meltdowns. Two observations came out of this:
1) Interestingly, all were periods of anxiety, although this is not how he initially presented the problem. Pete generally presented himself as a savvy reader of markets. Only with an intensive review of occasions when he abandoned his discipline did it come out that he was anxious at these times.
2) Pete's description of his market ideas (including some recent ones) struck me as off the mark. In one case, he badly misread recent action in the equity indexes. My immediate impression was that Pete was less savvy than he presented himself.
I asked Pete to mentally relive the most recent occasions in which he traded poorly. We walked through the start of the trading day, the market action, his various thoughts and decisions, etc. I encouraged Pete to allow himself to feel his anxiety right there in the meeting with me, to describe it in detail, and to share his thoughts when he was in this anxious mode. This was not easy for him. He tended to change the topic and talk about the market, his trading, his preparation for the trade, etc.
This is not unusual. To avoid painful feelings, we frequently use coping methods to keep them at bay. Freud referred to these as "defenses". A common set of defenses is to intellectualize and rationalize situations so that we don't experience the feelings associated with them. What I was doing with Pete was interrupting his defenses, so that he would have to truly experience his emotions.
What came out when Pete allowed himself to be anxious was that he felt terribly inadequate when he did not understand what the market was doing and lost money. This feeling of inadequacy led him to question his ability and future as a trader. Having failed at college and experienced conflict with his parents as a result, Pete looked to trading as his way of being a success. The feelings of inadequacy were thus extremely threatening for him. And the reality was, Pete was a good trader, but not an unusually savvy one. My observation was on the mark: many times he missed market themes and patterns.
So what did Pete do to ward off his frightening experience? He puffed up his pride at being a good trader and master chart reader, stopped following his own routines, and then blamed his losses on the "discipline" problem. The problem wasn't that he was a bad trader; in fact, the problem--as he defensively reconstructed it--was that he was a *great* trader who didn't follow his own advice.
The loss of discipline was *not* his problem. It was his avoidant way of coping with the real problem, which was his shaky sense of himself during times when he didn't understand the markets and lost money. Trading was bearing the burden of his self esteem, and the burden was too much to carry.
By attributing the problem to a lack of discipline, Pete could maintain a (false) sense of confidence and worth as a trader. Only when we got at the heart of the matter--his assumption that being disoriented in the market meant that he was a bad trader and his need to make money to prove his worth--were we able to reach some resolution.
My next post will explain how we did that.
In the interim, think about your recurring problems in trading and how they might be (misguided) efforts at coping. If you didn't have the problem, what would be the difficult emotional experience you'd have to deal with? That question puts you on the road to genuine change.
RELATED POSTS:
Understanding Lapses in Trading Discipline
Top Reasons Traders Lose Their Discipline
.
Wednesday, September 05, 2007
Credit Concerns Have Not Gone Away
Ask the average trader, and he'll say that the Fed has eased credit fears. All is returning to normal. Around the world, however, liquidity is still very much a problem. LIBOR rates are well above Fed Funds rates, and these elevated rates are increasingly seen as a crisis in London.The two charts above are latest data taken from the Fed website. They show clearly that asset backed commercial paper and lower-rated paper are commanding sizable spreads over AA financial and non-financial paper (and certainly above Treasury bills).
When there is a loss of faith in the assets backing the paper, prices fall and yields rise. Nothing in the Fed's actions to this point has changed that situation.
Meanwhile, 10-year Treasuries hit their lowest yield levels today since the stock market decline began. That flight to safety dynamic has also remained unchanged.
The stock market has behaved quite well lately, today's drop notwithstanding. But the credit markets continue to tell a different story, one that could have negative implications for some banks and the economy overall. That's worth keeping an eye on.
Stock Market Trends and Volume: Tracking Institutional Participation
I recently posted on the topic of how volume from large traders is disaggregated during execution, making it difficult to identify when institutional participants and large locals are moving the markets. From this post, you'll be able to see one way I'm approaching that issue.First, the conceptual underpinnings: I track the median 1 minute volume over a five-day lookback period. If the average trading price for the current minute exceeds the average trading price for the prior minute *and* if the average trading volume for the current minute exceeds the median one-minute volume over the prior 5 days of trading, then I call this a "buying bar". We're getting higher prices on elevated volume.
Similarly, when the average trading price of the current minute is below that of the prior minute *and* the average trading volume for the current minute exceeds the five-day median, we get a "selling bar". That represents lower prices on elevated volume.
All other one-minute bars are ignored. The idea here is that, although individual trades are disaggregated, aggregating them on a one-minute basis enables us to see if there is above average participation in the market at that time.
The top chart (click for greater detail) shows the median one-minute volume in the ES futures over a moving five-day lookback period. This is depicted for the period 7/12/07 through 9/4/07. Note how, during the market decline, average volume steadily increased. Note how volume decreased during the market's last leg down and now how it is increasing during the recent market rise.
The idea is to see if higher or lower prices are attracting increased market participation. That certainly was the case Tuesday, as higher prices brought expanded volume through much of the day.
The bottom chart (click for greater detail) illustrates a one-day (400 minute) moving average of buying bars minus selling bars (as defined above) for the period 8/29/07 through 9/4/07. This tells us whether we're getting more periods of significant buying interest vs. selling interest. Note that, in a bull swing, there is a general expansion of buying vs. selling bars and that expansions in the number of selling bars occur at successively higher price levels.
These are merely first approximations of indicators I'll be developing. Notice that the indicators can be constructed for any size bar and for any stock or futures contract with consolidated volume data. By pairing trend indicators with such volume measures, we can infer whether large traders are participating in directional movement and jump aboard such moves early.
RELEVANT POSTS:
Analyzing Market Volume
NYSE TICK Volume
.
Tuesday, September 04, 2007
An Update RE: The Twitter Trader Comments
A number of readers have expressed interest in the indicators of strength, sentiment, momentum, etc. that I collect daily. As a result, I will use the Twitter comments before and after the trading day to summarize these measures and offer a little perspective. I'll also curtail the intraday comments, focusing instead on helping traders see the big picture. This will keep my time free during the day, when I'm working with traders and writing the new book, and will also keep the comments focused on high-yield information not available elsewhere. My hope is to make the Twitter comments a brief, daily newsletter with timely, actionable info.
Among the indicators I'll be tracking:
* New 20 Day Highs and Lows Among Listed Stocks
* % of Stocks Trading Above and Below Their 50-Day MA for Different Markets
* Cumulative Adjusted NYSE TICK (Daily Cumulative TICK Compared to 20-Day Average)
* Demand/Supply (Index of Stocks Trading Above and Below The Volatility Envelopes Surrounding Their Moving Averages)
* Technical Strength Index (Number of Stocks in My Basket Displaying Strong, Neutral, and Weak Strength)
Together, these measures should provide a worthwhile perspective on whether the buyers or sellers have the upper hand. As always, I'm open to your suggestions and feedback. Thanks for your interest!
Brett
Among the indicators I'll be tracking:
* New 20 Day Highs and Lows Among Listed Stocks
* % of Stocks Trading Above and Below Their 50-Day MA for Different Markets
* Cumulative Adjusted NYSE TICK (Daily Cumulative TICK Compared to 20-Day Average)
* Demand/Supply (Index of Stocks Trading Above and Below The Volatility Envelopes Surrounding Their Moving Averages)
* Technical Strength Index (Number of Stocks in My Basket Displaying Strong, Neutral, and Weak Strength)
Together, these measures should provide a worthwhile perspective on whether the buyers or sellers have the upper hand. As always, I'm open to your suggestions and feedback. Thanks for your interest!
Brett
How Large Traders Disguise Their Presence in the Stock Market
I received a note from BZB Trader after he had posted interesting information to his blog. He had collected data to better understand order flow and had observed two things:
1) Retail traders account for a small proportion of total volume;
2) Large traders are heavily using order execution software to break their large orders into small pieces.
I performed a very simple exercise and examined the first hour of trading in a popular stock, AAPL. There were almost 57,000 trades in the first hour alone.
By my calculation of how the trades were reported, roughly two-thirds of these trades were broken down into small pieces for execution. Over three-quarters of all first-hour trades were 100 shares. Of the small, 100-share trades, I estimate that about two-thirds were part of larger trades that were executed in pieces by specialized software.
In other words, if you were to simply look at trades and trade volume, you'd conclude that small traders were dominating the marketplace. The reality is, however, that large traders continue to hold sway, but have succeeded in disguising their presence.
For the trader interested in determining who is in the market and what they're doing, it is either necessary to re-aggregate the trade data by a conceptual reverse-engineering--a difficult, computationally-intensive endeavor not feasible for most traders--or it becomes necessary to make inferences on the basis of larger time units (1 minute data, etc.) that naturally aggregate the trades.
More on this latter strategy soon to come. Meanwhile, consider how the disaggregation of large trades increases trade volume on the stock exchanges, increases the bandwidth necessary to process market information, and potentially distorts such measures as NYSE TICK, Market Delta, and money flow.
RELEVANT POSTS:
How to Track the Stock Market's Large Traders
What Every Short-Term Trader Should Know
.
1) Retail traders account for a small proportion of total volume;
2) Large traders are heavily using order execution software to break their large orders into small pieces.
I performed a very simple exercise and examined the first hour of trading in a popular stock, AAPL. There were almost 57,000 trades in the first hour alone.
By my calculation of how the trades were reported, roughly two-thirds of these trades were broken down into small pieces for execution. Over three-quarters of all first-hour trades were 100 shares. Of the small, 100-share trades, I estimate that about two-thirds were part of larger trades that were executed in pieces by specialized software.
In other words, if you were to simply look at trades and trade volume, you'd conclude that small traders were dominating the marketplace. The reality is, however, that large traders continue to hold sway, but have succeeded in disguising their presence.
For the trader interested in determining who is in the market and what they're doing, it is either necessary to re-aggregate the trade data by a conceptual reverse-engineering--a difficult, computationally-intensive endeavor not feasible for most traders--or it becomes necessary to make inferences on the basis of larger time units (1 minute data, etc.) that naturally aggregate the trades.
More on this latter strategy soon to come. Meanwhile, consider how the disaggregation of large trades increases trade volume on the stock exchanges, increases the bandwidth necessary to process market information, and potentially distorts such measures as NYSE TICK, Market Delta, and money flow.
RELEVANT POSTS:
How to Track the Stock Market's Large Traders
What Every Short-Term Trader Should Know
.
Monday, September 03, 2007
Trading and the Psychology of Heroism
I have to admit, I found special pleasure reading Dr. Andrew Bernstein's essay on The Philosophical Foundations of Heroism. Andy and I became friendly in New York back in the early 1980s, when I was finishing my graduate education. We were students of Ayn Rand's Objectivism; you'll see that influence in his essay. Reading his article two decades later, I can see that he has lost none of his rhetorical verve; nor has he compromised his views.
What Dr. Bernstein recognizes is that heroism represents a profound psychological need. If you go back to my post on goal-setting research, you'll recall that goals facilitate self-regulation: they direct our efforts, enhance our motivation, and build our sense of mastery and self-efficacy.
But what goals do for us on a day-in/day-out basis, heroism accomplishes over the course of a lifetime. Our heroes provide the horizons by which we direct our life efforts; they supply the emotional fuel that comes from the realization that our deepest values can be attained. Perhaps most of all, our heroes confirm that life is worthwhile; that the struggles to achieve values so aptly described in the Bernstein essay can be won.
It is difficult to find heroes when much of the media is consumed with stories of celebrities in meltdown, lurid crimes, and "reality shows" that portray the less savory aspects of human relationships. I'm convinced that "American Idol" has vaulted to prominence, not just because of the talent of the contestants, but because of the drama it provides of a dream come true. It is a major reason we love sporting contests: each game is life-in-miniature, a tableau of the quest for success.
After reading the Bernstein essay, I made an identification that hadn't struck me previous: So many of the top traders and portfolio managers I work with have undergone a deeply emotional mentorship. They've been taught the business by a valued teacher/friend/mentor. That mentor has become their hero: at times in the marketplace when confusion reigns, they're able to look back on their training and ask, "What would my mentor do?"
Heroes are exemplars: they make concrete the principles by which we hope to live our lives. Perhaps one reason so many traders succumb to fear and greed during volatile market times is that they lack the internal compass--the vision of an exemplary path--provided by heroes. Without such a philosophical and psychological compass, we become as lost in life as in markets.
RELEVANT POSTS:
Blueprint for an Uncompromised Life
A Dozen Reflections on Life and Markets
.
What Dr. Bernstein recognizes is that heroism represents a profound psychological need. If you go back to my post on goal-setting research, you'll recall that goals facilitate self-regulation: they direct our efforts, enhance our motivation, and build our sense of mastery and self-efficacy.
But what goals do for us on a day-in/day-out basis, heroism accomplishes over the course of a lifetime. Our heroes provide the horizons by which we direct our life efforts; they supply the emotional fuel that comes from the realization that our deepest values can be attained. Perhaps most of all, our heroes confirm that life is worthwhile; that the struggles to achieve values so aptly described in the Bernstein essay can be won.
It is difficult to find heroes when much of the media is consumed with stories of celebrities in meltdown, lurid crimes, and "reality shows" that portray the less savory aspects of human relationships. I'm convinced that "American Idol" has vaulted to prominence, not just because of the talent of the contestants, but because of the drama it provides of a dream come true. It is a major reason we love sporting contests: each game is life-in-miniature, a tableau of the quest for success.
After reading the Bernstein essay, I made an identification that hadn't struck me previous: So many of the top traders and portfolio managers I work with have undergone a deeply emotional mentorship. They've been taught the business by a valued teacher/friend/mentor. That mentor has become their hero: at times in the marketplace when confusion reigns, they're able to look back on their training and ask, "What would my mentor do?"
Heroes are exemplars: they make concrete the principles by which we hope to live our lives. Perhaps one reason so many traders succumb to fear and greed during volatile market times is that they lack the internal compass--the vision of an exemplary path--provided by heroes. Without such a philosophical and psychological compass, we become as lost in life as in markets.
RELEVANT POSTS:
Blueprint for an Uncompromised Life
A Dozen Reflections on Life and Markets
.
Overtrading and Other Ideas for a Labor Day
* Why Do Traders Overtrade? - Overtrading is a term traders loosely use to describe a situation in which they either trade too often, too large, or both. The idea is that they are trading more than objective opportunity (and their trading rules) would normally dictate. I was recently asked about the personality traits that are responsible for overtrading. While there are indeed personality factors that affect risk assumption and aversion, my experience is that the main cause for overtrading has nothing to do with personality per se. Rather, traders overtrade because they are trying to make a living from relatively small account sizes. They cannot trade large and thus cannot make much money per trade, so they hope to compensate by trading more often. It's a clear road to ruin.
* Markets Anticipating More Volatility? - Adam Warner sees a persistently high VIX, higher than one would normally expect given the recent rally. This fits with my earlier stated scenario of a volatility bottom during 2006, not unlike how we came out of the 1994-5 period with rising prices, but also rising volatility.
* Looking for the Wrong Solution? - A recent NYT article examines doubt that a Fed cut in short-term rates would address the underlying concerns about credit. Indeed, Mish finds a lot to be skeptical about in all the housing bailout proposals. Abnormal Returns links several articles that offer perspective on the housing situation, including a skeptical look at the President's proposal. Barry Ritholtz, in his weekly review, also finds several articles expressing doubts about the efficacy of Fed easing in this situation, including an interesting look at what happens to stocks when the Fed makes an easing step after a period of tightening.
* Trader Mike Strikes Again - Lots of good updated links from Mike, including a look at how the mortgage situation could affect advertising revenues for GOOG and others. See also Mike's link to the interesting (and skeptical) Economist.com story on Google's growth.
* How Will the Election Affect Stocks? - A Dash of Insight is beginning a look at the stocks that would benefit under various election scenarios. Here's the Election Stocks site.
.
* Markets Anticipating More Volatility? - Adam Warner sees a persistently high VIX, higher than one would normally expect given the recent rally. This fits with my earlier stated scenario of a volatility bottom during 2006, not unlike how we came out of the 1994-5 period with rising prices, but also rising volatility.
* Looking for the Wrong Solution? - A recent NYT article examines doubt that a Fed cut in short-term rates would address the underlying concerns about credit. Indeed, Mish finds a lot to be skeptical about in all the housing bailout proposals. Abnormal Returns links several articles that offer perspective on the housing situation, including a skeptical look at the President's proposal. Barry Ritholtz, in his weekly review, also finds several articles expressing doubts about the efficacy of Fed easing in this situation, including an interesting look at what happens to stocks when the Fed makes an easing step after a period of tightening.
* Trader Mike Strikes Again - Lots of good updated links from Mike, including a look at how the mortgage situation could affect advertising revenues for GOOG and others. See also Mike's link to the interesting (and skeptical) Economist.com story on Google's growth.
* How Will the Election Affect Stocks? - A Dash of Insight is beginning a look at the stocks that would benefit under various election scenarios. Here's the Election Stocks site.
.
Sunday, September 02, 2007
Cumulative Line for the Adjusted NYSE TICK
One of the indicators that I've relied on the most over the years is the Adjusted NYSE TICK. As mentioned in prior posts, this is calculated by subtracting the average one-minute TICK reading over a period of 20 days from each subsequent one-minute TICK reading. I then add up the adjusted TICK readings to arrive at a daily value. This daily value tells me whether, in relative terms, we're getting more buying or selling interest in the market. By cumulating the daily readings (like an advance-decline line), we can detect the waxing and waning of buying and selling pressure.Note above how the line topped out ahead of the market and then failed to continue its decline when the market made its sharp low. (Click on chart for greater detail). Since that time, the line has been in a solid uptrend, making new recovery highs as of Friday. During topping markets, we commonly see price highs that are not confirmed by the Cumulative TICK Line. So far that hasn't been the case.
RELEVANT POSTS:
The Cumulative NYSE TICK: A Valuable Measure of Market Sentiment
Capturing the Intraday Trend With the Cumulative Adjusted TICK
.
Goal Setting for Traders: What Works
It is often thought that setting goals is helpful for motivation and performance. The psychological research, however, suggests that this isn't the case. Goals can either help or hinder performance, depending upon how they are structured. If traders are going to act as their own trading coaches, it is important that they know how to set goals that are most likely to produce good results.
The research of Locke and Latham suggests that goals impact performance in several ways:
* Directing - Goals direct our activity toward priorities and away from aspects of performance that are less important.
* Energizing - Goals can motivate us to pursue particular ends, particularly if the goals are sufficiently challenging that they prod us to make special efforts.
* Persisting - If we have a valued goal, we are more likely to persist in efforts at performance improvement than if goals are lacking.
* Knowing - Goals activate knowledge and skills that are relevant to performance improvement.
Goals will be most likely to accomplish the above if performers are committed to their pursuit and truly value those goals. Locke and Latham note that a public commitment to a goal can be highly effective, enhancing the performer's level of dedication and effort. Performers also need to believe that they are capable of reaching their goals (self-efficacy), and they need to set goals that are neither so easy nor so difficult that they discourage sustained efforts.
A large body of research, including the work on deliberative practice, suggests that goals are not effective by themselves. Rather, it is regular and accurate feedback about goal progress and attainment that facilitates learning, skill development, and motivation. Traders will often set a goal and then set it aside, hoping that the mere act of setting an objective will be helpful. Rather, the value of goals is in their ability to channel efforts at learning. Tracking goal progress and creating new subgoals based on this regular feedback lies at the heart of expertise development.
Goals are also most likely to be effective if they are relatively short-term, channeling immediate efforts and providing rapid feedback. That doesn't mean that long-term goals are irrelevant or unhelpful, but rather suggests that a performer will derive the greatest benefit from dividing long-term goals into concrete short-term objectives.
Finally, there is evidence that process goals can be more effective than all-or-none outcome goals. A process goal for a trader might be to limit losses to a certain number of ticks per trade; an outcome goal might be to make a certain dollar amount per week or month. The latter is highly dependent upon market conditions and not entirely within the trader's control. Process goals, alternatively, focus on what the trader can control directly and thus reinforce self-efficacy.
The proper setting of goals, tracking of performance for feedback, and creation of new objectives is a fantastic use for trading journals. If your goal pursuit and journaling feel burdensome, there's a strong likelihood that you're setting the wrong kinds of goals. Ideally, goals should challenge and motivate us, build our skills, and enhance our sense of mastery.
RELEVANT POSTS:
Building Self-Efficacy With a Solution Focus
Self-Efficacy and the Psychology of Consumer Debt
.
The research of Locke and Latham suggests that goals impact performance in several ways:
* Directing - Goals direct our activity toward priorities and away from aspects of performance that are less important.
* Energizing - Goals can motivate us to pursue particular ends, particularly if the goals are sufficiently challenging that they prod us to make special efforts.
* Persisting - If we have a valued goal, we are more likely to persist in efforts at performance improvement than if goals are lacking.
* Knowing - Goals activate knowledge and skills that are relevant to performance improvement.
Goals will be most likely to accomplish the above if performers are committed to their pursuit and truly value those goals. Locke and Latham note that a public commitment to a goal can be highly effective, enhancing the performer's level of dedication and effort. Performers also need to believe that they are capable of reaching their goals (self-efficacy), and they need to set goals that are neither so easy nor so difficult that they discourage sustained efforts.
A large body of research, including the work on deliberative practice, suggests that goals are not effective by themselves. Rather, it is regular and accurate feedback about goal progress and attainment that facilitates learning, skill development, and motivation. Traders will often set a goal and then set it aside, hoping that the mere act of setting an objective will be helpful. Rather, the value of goals is in their ability to channel efforts at learning. Tracking goal progress and creating new subgoals based on this regular feedback lies at the heart of expertise development.
Goals are also most likely to be effective if they are relatively short-term, channeling immediate efforts and providing rapid feedback. That doesn't mean that long-term goals are irrelevant or unhelpful, but rather suggests that a performer will derive the greatest benefit from dividing long-term goals into concrete short-term objectives.
Finally, there is evidence that process goals can be more effective than all-or-none outcome goals. A process goal for a trader might be to limit losses to a certain number of ticks per trade; an outcome goal might be to make a certain dollar amount per week or month. The latter is highly dependent upon market conditions and not entirely within the trader's control. Process goals, alternatively, focus on what the trader can control directly and thus reinforce self-efficacy.
The proper setting of goals, tracking of performance for feedback, and creation of new objectives is a fantastic use for trading journals. If your goal pursuit and journaling feel burdensome, there's a strong likelihood that you're setting the wrong kinds of goals. Ideally, goals should challenge and motivate us, build our skills, and enhance our sense of mastery.
RELEVANT POSTS:
Building Self-Efficacy With a Solution Focus
Self-Efficacy and the Psychology of Consumer Debt
.
Saturday, September 01, 2007
Rises and Declines on High and Low Volume: Test Before You Invest
I've been hearing a number of commentators speculate on the validity of market rises and declines based upon the volume of shares being traded that day. So, for example, a rise on low volume is discounted and even looked upon bearishly, presumably because the higher prices are not attracting greater participation.
What gives me pause is that I never see any efforts to quantify such commonly-held wisdom. It's part of the technical analysis lore, but is it valid? Does volume on a rise or decline affect the market's subsequent behavior?
I went back to the start of 1999 (N = 2178 trading days) in the S&P 500 Index (SPY) and identified all instances in which the market either rose more than 1% in a day (N = 320) or declined more than 1% in a day (N = 340). I then calculated each day's trading volume as a proportion of the prior 200 days' volume and conducted a median split of the data.
That means that we're looking at strong and weak market days on high or low relative volume.
When SPY has been up more than 1% in a day (N = 320), the next day averages a rise of .02% (164 up, 156 down). When the rise is on relatively high volume (N = 160), the next day averages a flat performance (80 up, 80 down). When the rise is on relatively low volume (N = 160), the next day averages a gain of .04% (84 up, 76 down). Clearly, there's no general indication that a rise on high volume is any more bullish than one on low volume.
If we just look at those occasions in which SPY has been up more than 1% and volume has been twice (or more) the 200-day average (N = 37), the next day in SPY averages a gain of .06% (23 up, 14 down). This is a slight bullish edge in a limited set of circumstances.
If we limit our look to those occasions in which SPY has been up more than 1% and volume has been less than 80% of the 200-day average (N = 53), the next day in SPY has averaged a gain of .08% (29 up, 24 down). Low volume has not led to inferior next day returns for rising days.
Conversely, when SPY has been down more than 1% in a day (N = 340), the next day averages a rise of .15% (191 up, 149 down). When the drop in SPY is on relatively high volume (N = 170), the next day averages a gain of .16% (101 up, 69 down). When the drop in SPY is on relatively low volume (N = 170), the next day averages a gain of .14% (90 up, 80 down). Again, volume plays a very minor role in determining next day outcomes.
When we limit our look to those occasions in which SPY has been down more than 1% and volume has been twice (or more) the 200-day average (N = 57), the next day in SPY averages a gain of .37% (35 up, 22 down). That is a nice bullish edge, again in a limited set of circumstances.
Finally, if we examine occasions in which SPY has been down more than 1% and volume has been less than 80% of the 200-day average (N = 33), the next day in SPY has averaged a gain of .46% (19 up, 14 down). Interestingly, very low volume has been as bullish for declining days as very high volume.
The bottom line, it seems to me, is that greatly expanded volume on a rise or decline may be associated with better returns, but there is no evidence that low volume is followed by weaker daily returns. Indeed, when volume has been very low on rising and falling days, returns have tended, if anything, to be superior. Moderately elevated volume appears to have no significant impact on returns whatsoever.
Moreover, volume as a whole seems to play less of a role in next day returns than the simple fact of whether the prior day rose or fell by 1%. Returns were better following 1% declining days than 1% rising days regardless of market volume.
One has to wonder why traders would follow untested assumptions in putting their capital at risk. We're not talking rocket science here: my analysis required no programming and was conducted entirely in Excel in well under an hour. The moral of the story is to not accept market truisms on face value: Test before you invest.
RELEVANT POST:
Historical Patterns as a Heads Up in Trading
.
What gives me pause is that I never see any efforts to quantify such commonly-held wisdom. It's part of the technical analysis lore, but is it valid? Does volume on a rise or decline affect the market's subsequent behavior?
I went back to the start of 1999 (N = 2178 trading days) in the S&P 500 Index (SPY) and identified all instances in which the market either rose more than 1% in a day (N = 320) or declined more than 1% in a day (N = 340). I then calculated each day's trading volume as a proportion of the prior 200 days' volume and conducted a median split of the data.
That means that we're looking at strong and weak market days on high or low relative volume.
When SPY has been up more than 1% in a day (N = 320), the next day averages a rise of .02% (164 up, 156 down). When the rise is on relatively high volume (N = 160), the next day averages a flat performance (80 up, 80 down). When the rise is on relatively low volume (N = 160), the next day averages a gain of .04% (84 up, 76 down). Clearly, there's no general indication that a rise on high volume is any more bullish than one on low volume.
If we just look at those occasions in which SPY has been up more than 1% and volume has been twice (or more) the 200-day average (N = 37), the next day in SPY averages a gain of .06% (23 up, 14 down). This is a slight bullish edge in a limited set of circumstances.
If we limit our look to those occasions in which SPY has been up more than 1% and volume has been less than 80% of the 200-day average (N = 53), the next day in SPY has averaged a gain of .08% (29 up, 24 down). Low volume has not led to inferior next day returns for rising days.
Conversely, when SPY has been down more than 1% in a day (N = 340), the next day averages a rise of .15% (191 up, 149 down). When the drop in SPY is on relatively high volume (N = 170), the next day averages a gain of .16% (101 up, 69 down). When the drop in SPY is on relatively low volume (N = 170), the next day averages a gain of .14% (90 up, 80 down). Again, volume plays a very minor role in determining next day outcomes.
When we limit our look to those occasions in which SPY has been down more than 1% and volume has been twice (or more) the 200-day average (N = 57), the next day in SPY averages a gain of .37% (35 up, 22 down). That is a nice bullish edge, again in a limited set of circumstances.
Finally, if we examine occasions in which SPY has been down more than 1% and volume has been less than 80% of the 200-day average (N = 33), the next day in SPY has averaged a gain of .46% (19 up, 14 down). Interestingly, very low volume has been as bullish for declining days as very high volume.
The bottom line, it seems to me, is that greatly expanded volume on a rise or decline may be associated with better returns, but there is no evidence that low volume is followed by weaker daily returns. Indeed, when volume has been very low on rising and falling days, returns have tended, if anything, to be superior. Moderately elevated volume appears to have no significant impact on returns whatsoever.
Moreover, volume as a whole seems to play less of a role in next day returns than the simple fact of whether the prior day rose or fell by 1%. Returns were better following 1% declining days than 1% rising days regardless of market volume.
One has to wonder why traders would follow untested assumptions in putting their capital at risk. We're not talking rocket science here: my analysis required no programming and was conducted entirely in Excel in well under an hour. The moral of the story is to not accept market truisms on face value: Test before you invest.
RELEVANT POST:
Historical Patterns as a Heads Up in Trading
.
Technical Strength and Weakness: A Look at the Stock Market's Foundation
A number of commentators have been noting a head-and-shoulders bottom in the S&P 500 Index (SPY). Indeed, when we look at my basket of 40 S&P 500 stocks evenly drawn from eight market sectors, the new high/new low and advance/decline data are supportive of that notion. New 10-day highs continue to exceed new lows (top chart) among the basket stocks (though, interestingly, Friday did not see an expansion of new highs; something I'll be watching), and we are seeing nice strength in the basket AD Line (bottom chart).The momentum data are supportive as well. Yesterday, I introduced a measure of Technical Strength and noted that, within the basket, we had 13 stocks qualify as technically strong, 18 as neutral, and 9 as weak. The Technical Strength Index (TSI) closed at +160. On Friday, that changed to 22 stocks strong, 13 neutral, and 5 weak, for a TSI of +920.
The one thing I don't like is that two of the nine weak stocks in my basket are C and JPM. One would think that, if we were out of the credit/liquidity crunch woods, the investment banks would be one of the great beneficiaries. Conversely, if the worst of mortgage defaults are yet to come, someone, somewhere is holding a lot of questionable paper. Among other stocks not making 10-day new highs with the broad market: GS, LEH, BSC, MER, DB, and CS.
And that's the other thing: the Fed chief seems determined to not cut rates unless it's absolutely necessary. Apparently the recent downdraft in the market has not been enough to trigger such a decision. Yet the markets are clearly expecting cuts in the not-distant future. Either the markets are wrong in their anticipation, or they're expecting that bad news is about to get worse.
So, no question, we're seeing recent signs of strength. But the market pays me to look at what's not obvious. When we're seeing record put/call ratios, huge excesses of new lows over new highs, and panic selling on expanded volume, I question whether we're really going to hell in a handbasket and start identifying yield plays that look attractive. Conversely, when we're seeing broad near-term strength and hear about head-and-shoulders bottoms, I look at weak bank stocks and expectations for Fed cuts and wonder if we're putting in a head-and-shoulders *top* in that AD Line.
I'm happy for now to stand on a pretty strong foundation. Short-term, I'll participate in expanding strength or weakness. But I'm always looking for cracks in that foundation. Those often provide the greatest payoffs.
RELEVANT POSTS:
A Listing of Stocks in My Basket, Along With Their Sectors
Breakdown of Technical Strength by Sector
.
Subscribe to:
Posts (Atom)
Posts
