Emotions as Information

Start with a premise: Suppose you were empathic and could experience the emotions of the trading crowd.

You could feel their fear.

You could sense their greed.

What they felt, you felt.

If that premise were true, then emotion would not be something you would fight, ignore, or minimize.

Nor would emotion be something you'd blindly follow.

For the empath, emotion would be information: valuable information. It would be an indicator no less than market price or volume.

How would it change your trading to view every trading emotion as information to be scrutinized? How would it change your experience of your trading?

Amazing what a difference a premise can make.

RELATED POSTS:

The Fallacy of Controlling Emotion

Somatic Markers and Trading Decisions
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Tracking Intraday Sentiment and Other Ideas for a Fed Day

* Growing Pessimism: Here's a five-minute chart of the CBOE put/call ratio for Fed day on Tuesday. Note how the ratio expanded going into the announcement, but really took off as the afternoon progressed, reflecting growing bearishness. This was a nice tell for the afternoon price weakness across the stock indexes. Combining the intraday put/call ratio with the TICK provides a helpful view of sentiment shifts.

* Reaction to Fed Decision: Charles Kirk has compiled a variety of views. See also his most recent links post, including Fed perspectives.

* Trading Sentiment: Jeff has some interesting ideas regarding sentiment-based trading.

* Recap: Trader Mike recaps the wild Fed day and finds trendline breaks and violations of moving average lines.

* Tuesday Insights: Abnormal Returns finds worthy posts on sovereign wealth funds, momentum trading strategies, and a longer-term variant of the VIX.

* Gratitude: Nice to see Alvaro's thoughtful post on gratitude and happiness picked up by Huffington.

* Online Filing Systems: Interesting compendium of resources for organizing your files. I use Mozy for backup; love it.

* E*Trade Insight: Todd Chalem offers a unique view of Citadel's rescue of the online broker.

A Review of Market Indicators Ahead of the Fed

* Advance-Decline Review - The Advance-Decline line specific to the NYSE common stocks is at a lower high relative to October. October was also at a lower high relative to July. We've additionally seen lower lows over that period. This clearly reflects the relative weakness of the small and mid-cap stocks. The pattern is a little different in the advance-decline line for the S&P 500 stocks, where we see the lower highs, but also a higher A-D Line low at the end of November. This fits with the observation from my prior post regarding relative strength among large caps during the recent decline. When we look at the advance-decline line specific to the NASDAQ 100 stocks, we see a pattern of higher highs and higher lows. The line for the Dow 30 stocks not only shows higher highs and higher lows, but has already hit a bull market peak, having more than retraced the losses from October. The advance-decline line for the S&P 600 small cap stocks is in a clear downtrend, having hardly budged from its recent lows. All in all, this tells us that we're in a very selective (and probably latter) phase of a bull market.

* New High/New Low Review - If we look at 52-week highs and lows among the NYSE common stocks, we also see a pattern of lower new highs and expanded new lows over the course of 2007. On Monday, we saw 102 new annual highs and 9 new lows. In October, we had over 200 new highs; in June/July we had over 300 new highs. Interestingly, this pattern of lower new highs and higher new lows also is present among the S&P 500 stocks. On Monday, we had 34 new annual highs among the S&P 500 large caps, against 5 new lows. We had 70 new highs in October; 90 in July. Among S&P 600 stocks, we had only 16 new 52-week highs on Monday and 3 new lows; in October we had over 40, and in June we had 80 new highs. Despite relative strength in the NASDAQ 100, the same pattern of dwindling new highs is evident. In June we had 24 new highs; in October we had 17; on Monday we had 7. So far this indicator is painting a picture of increasing selectivity over time.

* 20-Day New Highs/Lows - The 20-day new highs/lows continue to show strength. On Monday we had 1628 new 20-day highs and 441 new lows across the major exchanges. As long as we continue to see expanding new highs in the short run, I don't expect a major correction. See my recent post on this topic for a historical analysis. In a nutshell, my primary scenario is for continued near-intermediate term strength in the face of a larger pattern of topping. Given some slowing of upside momentum in the last few days, I wouldn't be surprised to see some pullback from current levels. I also wouldn't be surprised to see such a pullback provide a buying opportunity that enables large caps to test their bull highs.

Much of the recent rally is catch-up action in sectors that had been beaten down. We've seen decent buying among small caps, which is reflected in the very strong NYSE TICK figures (see the Weblog) over the last two weeks. We're also seeing quite nice rebounding among homebuilders and financial stocks. As a whole, however, most of the market evidence for 2007 has suggests a weakening of the broad market over time, even as we've made highs in large cap indexes.

Using a Basket of Stocks to Track the Stock Market

The Advance-Decline Line for my basket of 40 S&P stocks (five highly weighted issues across eight S&P 500 sectors) is now knocking at the door of bull market highs. Notice how the recent decline led to only a shallow pullback in the advance/decline numbers for these 40 super-caps.

In my recent post, I emphasized the need for traders to filter information. One such filter is to limit the number of stocks you follow at one time to gauge sector/market strength and weakness.

A few readers have asked me for the composition of the 40 stocks in my basket. Here they are:

Materials: DD, DOW, AA, IP, WY
Industrials: GE, UPS, BA, UTX, MMM
Consumer Discretionary: CMCSK, TWX, HD, DIS, MCD
Consumer Staples: PG, MO, WMT, KO, WAG
Energy: XOM, CVX, COP, SLB, OXY
Health Care: PFE, JNJ, MRK, LLY, AMGN
Financial: C, AIG, BAC, WFC, JPM
Technology: MSFT, INTC, IBM, CSCO, VZ

I've also found that it's very helpful to track the new highs and lows among these stocks on a 5- and 10-day basis. Divergences frequently help to identify price movements that are likely to retrace. This is particularly the case when fewer than half of the stocks in the basket participate in a move to new highs or lows.

Surges in Stocks Making New Highs: What They Mean

One of the indicators I track most carefully is the number of stocks across the NYSE, AMEX, and NASDAQ that are making fresh 20-day highs and lows. This is more sensitive than the more common count of 52-week new highs and lows. Above we have the 20-day new highs minus lows on a daily basis during 2007. There's been a distinct tendency for this measure to top out ahead of price during cyclical swings; extreme negative values have represented good buying opportunities.

As I noted in the Trading Psychology Weblog, we've had a surge in buying over the past two weeks, with the Adjusted NYSE TICK positive for 11 of the past 12 trading sessions. Over that same time, we've gone from a situation in which we've had over 1000 new 20-day lows to one in which we're now seeing more than 1000 new 20-day highs.

I went back to October, 2002 (N = 1279 trading days; which is when I began compiling data for 20-day new highs/lows) and examined situations in which we have surged from a surplus of new lows to one of new highs. Specifically, I looked for occasions in which the 20-day average of new lows has been above 1000, but the current day's reading of new highs has been over 1000. This captures a situation in which we've had a broad surge of strength following an oversold market.

There have been 32 instances of such surges in new highs since late 2002. Twenty days later, the S&P 500 Index (SPY) has averaged a gain of 1.90% (27 up, 5 down). That is much stronger than the average 20-day gain of .79% for the remainder of the sample (822 up, 425 down).

To be sure, there have been pullbacks along the way: 11 of the 32 instances were actually lower after five days. Nonetheless, broad surges in market strength have tended to be followed by further strength over the next month. On average, it's paid to use these pullbacks as buying opportunities.

RELATED POSTS:

What Happens After Short-Term Surges in New Highs

Stalking the Market With New Highs/Lows

Anticipating Market Turns With New Highs/Lows
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Information Overload and the Need for Filters

I'm sure you've experienced it: You go onto a message board, chat room, or news/blog aggregation site and 90% of the posts are either emotional rants, restatements of the obvious, or surface analyses. I find the same is true of the mainstream media (MSM), whether it's print, online, or broadcast: 90% of what I get out of it comes from 10% of the content.

Much of the problem in the MSM world is that the name of the game is to get as many readers and viewers as possible to justify advertising rates. That means that hardcore market analysis has to be leavened with human interest, that columnists have to take more extreme positions than the facts warrant, and that entertainment has to accompany information.

The aggregators, facing similar pressures to monetize their online efforts, also have to go after the most eyeballs. So they are driven to sign up as many contributors as possible--a formula guaranteed in the aggregate to yield mediocrity. Ironically, it's the bloggers and columnists with the most to contribute that will want to stay away from this homogenization.

With financial seminars and media (books, magazines), there is a parallel tendency to try to pull in as many people by offering the broadest possible array of speakers and the topics of greatest general interest. Think of all the seminars, books, and magazine articles that come out each year. How many have truly left a lasting impact on your trading? If anything, the 90-10 formulation understates the case.

One of the core skills I see among experienced, successful trader is the ability to filter information. Time is precious, and filling your head with the wrong information is worse than a waste of time: it can take you out of your game. If anything, trading requires disaggregation, a separating of wheat from chaff. Portals that throw dozens of articles at traders daily fail at this most basic task and inevitably must fail at it, given their commercial mandates.

Over time, this has been the great appeal of the Twitter application for this blog. If I read a good article, I can quickly summarize it and link in a way that will go out to interested people. Others can do the same, subscribe to each other's streams, and create a social knowledge network. To be sure, Web 2.0 has provided us with a variety of ways to share information socially. Many of these, however, just end up creating new portals, new aggregations, new fire hydrants to drink from. What I like about Twitter is that it is brief and selective. If an article says something new and relevant, I can send the link worldwide in seconds. Subscribers or blog visitors can then quickly determine if the topic is relevant for them.

I try to send Twitter "tweets" in clusters of five or less so that people can stay current just by looking at the blog home page occasionally through the day. The full set of posts, along with HTML links, is on my Twitter page and is available as an RSS feed. Many of the "tweets" link articles of interest, but before the market opens each day, I also try to summarize major indicators, upcoming economic reports, and overseas action. If there are ways I can adjust the Twitter app to filter information even more effectively, by all means feel free to add your comments and suggestions to this post. I take those very seriously and often learn a great deal from them. Thanks!

Brett

A Few Of My Favorite Things

* Infiniti G35 6MT coupe - Plenty of torque throughout the range; 295 horses. The last time I owned an automatic transmission as my personal car was 1984. Never again. This one's a pleasure on the open road. I was prepared to buy a BMW but this was the winner in my road tests.

* Breitling SuperOcean - Not fancy at all, and I like that. Just performs well under pressure, as should any fine diving watch. I admire all things that perform well under pressure.

* Premier Massage Chair - Great after sitting hunched over all day. It kneads, taps, rolls from head to back to legs.

* The Roasterie - Great source for Cup of Excellence coffees, the equivalent of the world's finest wines. Real treat for the coffee drinker.

* Lenovo (IBM) ThinkPad X-Series - When you spend as much time on the road as I do (60,000 miles on one airline alone, and I ride several), a light, reliable laptop is golden. Great screen, good-size keyboard, long battery life. Love this one.

* Trumper Men's Products - If you can't get to Mayfair, this might be the next best thing. Skin products, scents, soaps, shaving products: all things for the English gentleman. Wild Fern is my favorite.

* The Economist - My constant companion on those plane rides. It provides a much more global perspective than we typically get in the States, which I find both helpful and refreshing.

* SunBox - This has been in my office for years, pumping out the equivalent of a sunny day every day of the year. Great when your day starts at 4 AM!

* Naperville, IL - Money Magazine named it the second best place to live in the U.S. A picture postcard downtown, complete with Riverwalk; first-rate public schools; low crime; and high family incomes, with a cost of living that won't kill you. Quite a few forest preserves and parks, yet less than an hour from downtown Chicago.

Market Myopia

Does watching the market tick-by-tick improve your trading returns? Clearly, if you're scalping the market (trying to buy bids and sell offers), you have to be glued to the screen. If, however, you're trading over time frames lasting an hour or more, does it add value to be glued to the screen? Does watching each tick lead to better trading decisions or returns, or does it lead to a kind of myopia in which we become reactive and no longer follow our original trading ideas?

My sense is that watching markets tick-by-tick often stems from an illusion of control: that, by monitoring events tightly, we can somehow better control them. Research suggests, however, that getting more feedback about investments leads to risk aversion and reduced returns. This myopia stems from the fact that we tend to perceive meaningful patterns in events even when those aren't present. When we watch markets tick-by-tick, we begin to see patterns that we believe are indicative of shifting supply and demand. This perception leads us to exit positions before they've reached their target or delay entering positions that otherwise offer favorable reward:risk.

I also get the sense that some traders equate working hard with being glued to screens. In reality, the hard work of trading lies in what comes prior to putting the trade on: the research and analysis that pull together observations across markets and time frames to generate valid ideas. To the extent that tracking markets tick-by-tick is an expression of anxiety over one's position, it is not only not productive (in the research/analysis sense), but is actively destructive (keeping oneself in a mindset that is harmful to sound decision-making).

A very useful exercise is to define your trading rules so that you can clearly identify a stop and a target for each of your trades. Then you can see how your discretionary management of the position adds value to simply following those rules. By cutting winners short and delaying entries into good ideas, the trader glued to the screen reduces the risk:reward potential of each trade. Perhaps that is why frustrated traders who are "working hard" find that their trades are hardly working.

RELEVANT POSTS:

* Inside the Trader's Brain

* Four Insightful Studies
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Technical Strength and Other Ideas for Week's End

* Technical Strength - We continue to see growing technical strength among the 40 S&P 500 stocks in my basket. These are among the most highly weighted issues in eight sectors; the technical strength measure is a quantification of their short-intermediate term trending. At present, we have 5 stocks qualifying as weak, 1 as neutral, and 34 as strong--a huge change from just a little while ago. The Technical Strength Index is a very strong +1500. This very much fits with the data I sector strength that I recently posted.

* Stock Picking Inspirations - The Kirk Report's latest links include a number of stock picking posts, including a perspective on high-yielding portfolios.

* Innovation, Complexity, and Crisis - This and other insights from Trader Mike's link updates.

* A Better Bet - Abnormal Returns finds more good market perspectives, including a better ETF for oil prices.

* Market Change? - Adam Warner finds volatility reverting to complacency.

* A Different Look - Eddy offers an alternative perspective on employment.

* Weekly Wrap - Larry Nusbaum summarizes the week that was in links.

* Triangulation - Corey tracks consolidation pattern in gold.

* Stock Screening - Chris Perruna shares his strategies.

A Quick Look Sector by Sector

The market has rallied dramatically, as we indeed seem to be in a wide, rangebound mode. Which sectors are participating most in the strength? Here are the percentages of stocks trading above their 50-day moving averages, broken down by S&P 500 sector:

Materials: 55%
Industrials: 75%
Consumer Discretionary: 35%
Consumer Staples: 85%
Utilities: 97%
Energy: 79%
Health Care: 69%
Financial: 57%
Technology: 38%

Utilities are generating interest for safety and yield; consumer staples continue to outperform consumer discretionary in the face of a slowing economy. Financials have strengthened, and the big change is that technology is now lagging. Perhaps this is reflecting weaker growth prospects for tech due to that slowing economy.

Shout out to Decision Point for the helpful data. Here's my earlier look at the market turnaround by sectors.

When Trading Performance Falls Off a Cliff

“I’ve been a successful trader, but lately I’ve been losing money. Nothing I try seems to work. What should I do?”

I’ve heard variations of this problem quite a few times in recent months. Good traders are struggling, despite volatile markets that—on the surface—should offer opportunity. It’s a frustrating and demoralizing situation.

So what should a trader do?

The important thing here is that the trader has been successful over a period of years, not just months. The problem is not simply one of inexperience. This is what makes the problem so perplexing: the trader knows he or she has skills, but it’s as if all that experience has flown out the window.

Let’s take an analogous situation: Suppose you’ve had good health for years, but now feel persistently sick and run down. You’re just not your old self. What should you do?

Clearly, you would seek professional help for a thorough and objective evaluation and for an accurate diagnosis of the problem. What you would not do is let the situation continue to deteriorate. You would also not simply assume that the problem must be “in your head” and immediately seek psychological assistance.

Similarly, the experienced and successful trader whose performance has fallen off a cliff should not let the situation fester and should not assume that the problem is psychological. If health has deteriorated, there’s most likely a health problem that needs to be identified and treated. If the health of one’s portfolio has deteriorated, there’s most likely a trading problem that requires similar assessment and intervention.

Having worked with traders across a variety of markets and strategies—from market making and prop desks at banks to global macro portfolio managers and Chicago prop traders—I’ve found three common sources of performance decline:

1) Diminishing Opportunity in the Trader’s Market – Perhaps you’ve been making markets or trading spreads and the bid-offer has narrowed significantly. Perhaps your market has entered an extended period of reduced volatility. The market has changed significantly and your old strategies no longer work.

2) Altered Market Behavior – Perhaps you’re a short-term trader who looks for advantages in short-term price/volume patterns or in shifts within the order book (depth of market); perhaps you depend on execution (buying bids and selling offers, entering long on pullbacks, short on bounces) for much of your profitability. The presence of new large traders in your market, including automated trading systems/black boxes, has shifted how markets trade in the short-run, disrupting the patterns you’ve counted upon for your profitability.

3) Shifting Market Regimes – Markets that used to behave independently now are more correlated. Countertrend patterns that once ruled markets now are giving way to greater trending moves. Enhanced intraday volatility is making it difficult to participate in longer-term market moves. We’ve seen a variety of changes in market trading patterns and it has been difficult for traders and investors to adapt to these.

Notice that these are variations on a single theme: markets have changed in some ways and what once worked is no longer working. It’s no wonder that struggling traders feel as though they’ve “lost it”. In a sense, they have.

Does this mean that trading problems don’t have a psychological component? Not at all. When markets change and traders are caught in the transitions, the usual outcome is frustration, then self-doubt. These emotional reactions can interact with the trading problems to create vicious downward spirals, both in mood and P/L. What begins as a trading problem can escalate into emotional one. Frustrated, reactive trading can undermine serious efforts at adaptation.

My advice for traders in a prolonged tailspin is severalfold:

1) Cut Risk – It’s that “above all else, do no harm” principle. If you don’t have a feel for the market, trade small while you regain your feel. Preserve as much of your capital as possible to lay the foundation for your recovery;

2) Focus on Your Strengths – It’s not unusual for frustrated traders to try to make all kinds of changes in their trading in a frantic effort to gain some traction. These efforts can compound difficulties by getting traders further and further from their strengths. During rebuilding periods, you want to focus on the markets and strategies that you know most about, that represent your strengths.

3) Reach Out – It’s especially helpful to reach out to traders who trade markets and strategies similar to yours. Are they also struggling? If so, this suggests that market changes, indeed, may be at the root of the problem. If the traders you contact are succeeding, try to find out what they’re doing differently from you. It may well be that a simple tweaking of execution, holding times, and risk management could turn your performance around.

4) Stay Constructive – You may well be in a rebuilding period. This happens to the best athletes and sports franchises. It doesn’t mean you’ve lost all talent and skill. Identifying the kinds of trades that are working for you is a start toward rebuilding: you want to find the common denominators behind your successful trades so that you can emphasize these going forward.

5) Work on Your Self-Talk – Hard as it is, it’s important to stay positive during a rebuilding period. The last thing you want to do is create additional interference by beating up on yourself and dampening your motivation. This is one of the areas where coaching can be helpful. Setting attainable goals and creating plans for learning new patterns and trading strategies can fuel optimism, determination, and focus.

6) Control the Budget – It very much helps to have a cash cushion to weather these rainy day periods. Living within one’s means also helps greatly. I’ve generally found that traders can adapt to shifting markets if they have enough time to make the transition. It’s when the pressures of bringing in money month to month add to the performance pressures of a drawdown period that turnarounds become difficult to sustain.

Perhaps the best advice, however, is preventive. Identify slumps early and control losses before they get out of hand. Perform regular inventories of your winning and losing trades, so that you’re always on top of what’s working for you and minimizing what’s hurting performance. During your best times, remember that markets always change and keep powder dry to weather the inevitable lean times. Ironically, the best way to master declines in trading performance is to embrace them early and turn them into prods for learning and development.

RELEVANT POSTS:

The Most Important Question to Ask When You're in a Slump

Common Sources of Trader Stress
.

A Note of Thanks From Dr. Brett

This month represents the two-year anniversary of the TraderFeed blog. Yesterday also marked the 1 millionth visit to the blog over the course of those two years. In two years, there have been over 1200 posts to the blog and an equal number to the Twitter application.

TraderFeed began simply as a vehicle for me to crystallize my thoughts about markets and psychology. In the first few months, daily visits were in the very low one hundreds. Visits now are in the thousands each day, and the blog has become a phenomenal means for meeting traders from around the world.

About 2/3 of all TraderFeed visits come from the U.S., and about a quarter of all visits are from outside North America. It is a marvel of recent technology that one can write a simple blog from one's home and reach a global audience of readers.

I want to thank readers and other bloggers for their support, and I want to encourage skilled traders to share their ideas through blogs. The thinking out loud and sharing of inspirations enriches us all. Special thanks to Trader Mike, Charles Kirk, Barry Ritholtz, Abnormal Returns, and the many other fine bloggers who have been supports and inspirations.

The most special thanks, however, goes to readers who have taken the time to comment on blog posts, adding valuable content and discussion to the posts. You're the best.

Brett

The Stock Index Futures Premium as a Sentiment Measure

A reader recently inquired about my use of the S&P emini stock index futures premium as a market indicator. The premium, which in e-Signal goes by the symbol $EPREM, represents the difference between the S&P 500 emini index and the S&P 500 cash index. When traders are bullish and buying the futures this premium will expand; when they're bearish and selling the futures, the premium collapses.

In practice, there are bounds to how much the premium expands or collapses. If the premium goes too far above (below) fair value, arbitrageurs will sell (buy) the futures and buy(sell) a corresponding basket of stocks to capture the price differential.

The chart above, which depicts the last 90 minutes of trading for Tuesday, December 4, tracks what I call the Adjusted Premium. Here, instead of comparing the current premium value to fair value, I simply subtract a 2 hour moving median of the premium from each subsequent premium value. Hence, a negative number means that the current 1 minute closing premium is below the 120 minute O-H-L-C median; a positive number means that the current closing premium is above the 2-hour median value.

What I look for with the Adjusted Premium is:

a) How much time is spent above vs. below the zero line as an ongoing sentiment gauge. Readers will recognize that this is also how I evaluate the Adjusted NYSE TICK. I'm looking for shifts in sentiment over time--changes in the distribution of the Premium.

b) How strength or weakness in the Adjusted Premium is associated with price movement. Elsewhere, I've referred to this as "efficiency": the degree to which a unit of sentiment can move the market price directionally.

You can see that about midway on the chart, we had sustained positive Adjusted Premium readings followed by a price high that was not confirmed with a strong Adjusted Premium reading. We quickly returned to the prior trading range, suggesting inefficiency: the buying sentiment could not sustain a directional upward move.

The reason for this is that the buying of stock index futures may or may not represent a directional bet on the part of large traders. They might buy the futures because they're bullish on stocks. Alternatively, they could buy the futures (and temporarily raise the premium), but simultaneously sell stocks or specific stock sectors. When the buying or selling of futures does not express directional bets on the part of large traders, we typically won't see a trending move.

That's what happened with about 45 minutes left in Tuesday's session. There was buying in the futures, but the bullish sentiment could not sustain higher prices. We returned to the prior trading range and proceeded to retrace the day's range. As a rule, when we see extreme buying or selling sentiment (whether in the Adjusted Premium or Adjusted TICK) unable to bring the market to new highs or lows, it's worth fading that sentiment, as buyers/sellers are forced to cover their positions.

In a bull market, sentiment pullbacks will occur at successively higher lows. In a bear market, sentiment bursts will occur at successively lower highs. In a range market, such as we saw on Tuesday, we see sentiment bursts and pullbacks at range extremes, but unable to keep the market out of that range. It's those sentiment-based false breakouts from ranges and subsequent returns to the value areas of the Market Profile that make for some of the best countertrend trades.

RELEVANT POST:

S&P eMini Premium and Divergences
.

A Look at 2007 Stock Market Returns Thus Far

Here's an interesting look at how equity ETFs have fared thus far in 2007:

EFV (iShares EAFE Value): 7.15%
EFG (iShares EAFE Growth): 18.09%
IVE (iShares S&P 500 Index Value): 1.38%
IVW (iShares S&P 500 Index Growth): 7.21%
VBR (Vanguard Small Cap Value): -6.59%
VBK (Vanguard Small Cap Growth): 8.71%

Growth has trounced value across the world; the rest of the world has trounced the U.S.; and large caps have trounced small caps. The declining dollar appears to be making U.S. stocks less attractive to overseas investors, and it seems to be making large multinational companies with substantial export businesses more attractive than smaller, domestic companies. Financial issues have clearly weighed on the value indexes; relative strength among technology shares have benefited growth.

RELATED POSTS:

A Shift in the Style Box

A Shift Across the Style Cube

Research Worth a Look

* VIX Trading System Ideas - The MarketSci site uses moving averages to produce significant returns, albeit with some drawdown. Interesting starting point for a trading system. See also their moving average crossover ideas.

* Popular Vehicle - Fixed income ETFs are finding greater interest, according to Research Recap. See also their interesting post on why the subprime situation may be less of a mess than has been thought.

* Volatility and Stock Returns - CXO summarizes research that finds superior returns for volatility-based strategies. See also their recent research on the implications of big up and down days.

* Commodity Weakness? - Bespoke Investment Group takes a snapshot of commodities and recent price weakness. See also their post on what the elevated TED spread might mean.

* Interest Rates and Stock Prices - Here's my research from last year on implications of rising rates for stock prices. I'll be updating this in a coming post.

Advance-Decline Lines and More Thoughts for Monday

* Tracking the Advance/Decline Lines - We're only about 5% off the bull market highs in the NYSE Composite Index, but a look at the Advance/Decline specific to NYSE common stocks (just the operating companies, not including funds and preferred issues) shows us in a clear downtrend, with the line well below its previous peak, even after the recent market rebound. An even more evident downtrend in the A/D line can be found among the S&P 600 small cap issues. The A/D lines for the S&P 500 stocks and NASDAQ 100 issues held above their August lows during the market drop, despite a lower high at the prior market peak. Interestingly, the line for the Dow 30 stocks is very near its bull market high. In some ways this market reminds me of the 2000-early 2001 period, in which the large caps held their value while the formerly strong tech stocks entered a bear market. In the present market, of course, it's the financials taking the role of the tech stocks.

* A Collection of Market Themes - Abnormal Returns tracks a decline in global interest rates, increased stresses on the markets, and unusual bearishness among newsletter writers. Charles Kirk finds some very interesting themes, including the shadow banking system and why it's fragile. Trader Mike updates themes with views on selling tech and questioning the recent market rebound. The Big Picture follows up with a wide variety of views, including concerns over junk bonds, a fresh look at financial issues, and a contrarian view of markets.

* The Importance of Resilience - The Trade by Trend blog offers a great example of sticking with one's convictions through a drawdown.

* Gratitude - Interesting interview with Dr. Robert Emmons on the role of gratitude in personal happiness and positive psychology.

* Indicators Site - Many thanks to gangsTA for passing along this very useful site that compiles market indicators. Very helpful charts.

* Questioning Indicators - I'll be following up on this post shortly, questioning the value of many indicators for daytraders.

Tracking a Stock Market Turnaround

We have bounced solidly off the market lows; Friday saw 865 new 20-day highs across the three exchanges, against 499 new lows. To give an idea of the magnitude of the turnaround, I looked at the 40 stocks in my basket and their Technical Strength (a quantification of trending). Interestingly, only 3 stocks are technically weak, 9 neutral, and 28 strong--quite a reversal of the weakness we had been seeing. Here's how it shapes up, sector by sector:

Materials: +120
Industrials: +100
Consumer Discretionary: +240
Consumer Staples: +180
Energy: +160
Health Care: +260
Financials: +180
Technology: -60

TOTAL: +1180

What is perhaps most fascinating is how one of the strongest sectors (technology) is now the weakest and how two of the weakest sectors (consumer discretionary, financial) are now stronger.

Meanwhile, we continue to see healthy upside momentum. My Demand/Supply measure, which is an index of the number of issues closing above the volatility envelopes surrounding their moving averages, was once again highly skewed to the bulls. Demand was 158 on Friday; Supply was 51. We're now seeing 44% of S&P 500 stocks trading above their 50-day moving averages, up from 20% at the market low. Small caps continue to lag, as only 33% of the S&P 600 stocks are above their 50-day MAs.

At least in the large cap indices, we appear to be in a wide trading range defined by the bull market highs and the August lows. Risk aversion in the credit markets has not disappeared, and we continue to see large caps outperforming the broad market. We are seeing signs of an accomodative Fed, however, and that has been an important ingredient in getting us out of jams in 1987 and 1998. It may, however, also be an ingredient in causing further dollar weakness and further bubble-like strength in commodities--a situation that cannot bode well for inflation and eventual Fed restraint.

RELEVANT POST:

My Previous Look at Technical Strength
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A Dramaturgical Perspective on the Work of a Trading Coach

Beginning with the work of Erving Goffman, there has been an interest in dramaturgical views of human behavior. These liken daily life to theater, in which we all sustain performances, arrange our stagings, and enact various roles. Theodore Sarbin's work in social psychology, derived from the influence of Stephen Pepper's "World Hypotheses", emphasizes that we make sense of the world through metaphor: by finding similarities between what we see now and what we have experienced in the past. Much of that meaning-making takes the form of narratives: the organization of events into coherent stories.

Narratives are fundamental to human experience. Before there was writing, cultures possessed an oral tradition of story-telling. Such narratives tie together causes, effects, intentions, actions, and reactions. They lend coherence to our experiences. After all, what do we do when we want someone to truly understand us? We tell them our life stories.

Essential to any dramatic narrative are roles. We typically occupy multiple roles in our life stories: as spouses, parents, colleagues, employees, friends, etc. Others occupy roles in our life scripts as well. When the roles of two people fulfill mutual scripts, their relationship tends to be harmonious. There tends to be disharmony when a person cannot or will not fulfill the role assigned to him/her by the other.

Our life stories change when we adopt new roles. New roles require us to interact with others in fresh ways. They are novel interpretations of the self. Equally important, new roles require others to respond to us in fresh ways. When the feedback from new role enactments fulfills an emerging life story, that feedback is internalized. The new role increasingly becomes part of the self. We grow through the assumption of new social roles and the feedback generated from that assumption.

Conversely, we stagnate when we are locked into a limited set of roles. Though these roles, quite literally, are self-limiting, they are all we have to make sense of our world. We bring our scripts to new life situations, enacting the same dramas in diferent life arenas. Ironically, we avoid the disharmony of relationships that do not confirm our limited role definitions and seek the harmony of familiar role enactments. This locks us in scripts that may be unfulfilling: increasingly we live a life story that we do not like.

Therapy is effective to the degree that the helping relationship creates fresh social contexts for novel role enactments. The therapeutic relationship requires the individual to break out of stagnant dramas and enact new scripts. For example, someone who has grown up resentful of authority figures will have to find new ways to deal with a therapist who refuses to assume the mantle of authority. The altered scripts within therapy provide opportunities for feedback and revisions of the self.

Fantasies of success, hopes of winning fame and approval, fears of failure and rejection: we bring our life dramas to the markets. It is in this dramaturgical context that the most important questions we can ask when we're exploring psychological impediments to trading are: What has been my role in the trading narrative? What dramas am I enacting?

The successful trading coach, like the successful therapist, nudges the trader to interact with markets in fresh ways, internalizing new experiences and building new scripts. In dramaturgical terms, the coach and trader are both directors and authors in this enterprise, reworking scenes and developing fresh scripts.

The ultimate goal of coaching is for people to become authors and directors of their own life stories. The successful, fulfilled person lives an evolving narrative and guides that evolution. The unhappy individual is trapped in his or her own story. Talk cannot change a person in meaningful ways. Only novel experience that places us in fresh roles and new scripts can evoke the feedback that will lead us to internalize a different self.

RELEVANT POSTS:

The Devon Principle

How to Change Yourself

Becoming Your Own Trading Coach
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A Unique Approach to Emotional Self Regulation

Self regulation refers to a person's ability to monitor and evaluate oneself, activate skills, and pursue chosen ends. Key to self regulation is the capacity to detect discrepancies between current and desired behavior. Such self regulation has been found to be important in sport, and it is essential to building a trading career.

A counter-intuitive approach to building emotional self-regulation is to train yourself to control the facial and muscular expressions of emotion during emotional periods and to rehearse the facial and muscular expression of desired emotions. Biofeedback can be especially helpful for this method.

The gist of the technique is to use imagery to evoke a variety of situations that are associated with negative emotions and high stress. While vividly imagining these scenarios, the individual makes conscious efforts to keep facial muscles, arms, legs, and neck very loose and relaxed. Alternatively, the person can evoke positive images of success, happiness, etc. and make conscious efforts to assume facial expressions and body postures that express positive emotion.

The counter-intuitive aspect to this approach is that you are using the body to change the mind. As William James noted, we can feel happy or sad because our bodies are expressing those emotions. By rehearsing control over the negative expression of emotion and by building greater access to physical expressions of positive emotion, we can greatly aid self regulation during times of challenging performance.

RELATED POST:

Biofeedback as a Performance Tool
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Implications of the Housing Crisis and More Market Readings

* More Than a Correction - The homebuilder's index has been cut in half during over the past two years and the decline accelerated greatly in the past several months. The smart money thinks about this in bigger picture terms: what it means for retirement planning, spending patterns, and risk taking among baby boomers; what it means for tax income for schools and communities--and how this will impact public policy and voting behavior. With returns from home ownership and stock ownership seemingly volatile and uncertain, might we see a longer-term flight to quality/safety in terms of demand for yield? Demand for value and safe blue chips over smaller growth stories? The ripples from the housing decline may extend many years and touch quite a few sectors.

* Afflicting the Comfortable - The previous post was one of those more designed to afflict the comfortable than comfort the afflicted. So much of market success is asking the tough questions of oneself and one's trading and working, working, working on the fundamentals.

* Looking for Opportunity - The Kirk Report's latest linkfest includes quite a few gems, including looks at stocks at 52-week lows attracting insider buying and issues with the most buy and sell ratings.

* What Makes for Good Investment Blogs? - Abnormal Returns takes a look at what it takes to make the A-list.

* Worthy Blogs and a Trading Coach Interview - Those are among the latest update links from Mike.

* Rates and Fed Policy - Great observations from the Aleph blog.

* E-Trade Deal - Paul Kedrosky takes a two-part look at the implications of the Citadel deal.

* Fed Funds Decisions and Stocks - CXO Advisory blog examines research on how stocks move after decisions about Fed Funds.

* Playing BIDU With Options - Once again, Daily Options Report has a creative strategy for a popular trade.

* A Housing Option - Larry Nusbaum explores loan modification and offers some guidance for those with ARMs about to reset.

* Strong Economy? - The Big Picture questions the latest data.