The recent post discussed how we can turn our defeats into development. Since writing that, I received an email from an accomplished prop trader who leads a group within the larger organization. That trader had just sustained the worst losing day of his career. So what did he do to address the situation?
* He stayed constructive. He wrote a detailed analysis of what he did wrong and how he will learn from the mistakes going forward. His focus was on making sure this doesn't happen again, not on blaming external forces for his drawdown. He took responsibility, but didn't stay mired in self-blame.
* He reached out. He sent his analysis to me and to the heads of his trading shop. His commitment to improvement and learning from the setback thus became public. He asked for a phone chat with me. Done. You can tell the workhorses from the show horses, because show horses will never show you their ugly side.
* He role modeled. This is the best part of all. He sent his analysis to the members of his team. He used his setback to help his teammates learn. Instead of trying to look like a guru, he showed them how to handle loss. That is a lesson far more powerfully delivered than in any textbook or blog post.
I predict this trader will be a rock star. By turning his loss into learning for all, he showed leadership, not just management. And, of course, that could never have happened if his firm did not promote team building, learning at the desk, and apprenticeship.
At one hedge fund where I work, portfolio managers are encouraged to build out teams by hiring junior professionals who have particular areas of experience and knowledge. Those developing managers add value to their teams and learn the skills of trading and portfolio management at the desk. The hit rate on their success is unusually high. Why? Because they learn through apprenticeship, not through a classroom or through unguided experience in front of a screen.
When you have a team and can learn from the successes and failures of others, your learning curve is multiplied. Whether you work at a trading firm or independently, a key to success is surrounding yourself with others who are capable of turning losses into lessons. Sharing your experiences with others transforms those lessons into commitments.
By now readers are aware that measures I track closely are buying pressure (demand) in the market versus selling pressure (supply). My measures are derived from a decomposition of the NYSE TICK, which is issued by the New York Stock exchange. The TICK is a running total, updated many times per minute, of the number of stocks trading on upticks versus the number trading on downticks. My buying pressure and selling pressure measures separate upticking from downticking in the time series, treating strength and weakness as distinct variables. While demand and supply are reasonably well correlated in the short-run, that is not the case over a period of days. Any given period can show high amounts of buying and high amounts of selling; high amounts of buying and low amounts of selling; low amounts of buying and low amounts of selling; and low amounts of buying and high amounts of selling. Indeed, the interplay among buying and selling pressure is a useful way of tracking phases of intermediate-term market cycles. As you can see from the charts above, we've recently made fresh highs in SPY. During that period, we've seen below average buying pressure (the zero level is average) and more than average selling pressure (values below zero show heavier selling). That suggests that more stocks have been trading on downticks than upticks, even as the broad market average has risen to new highs. This is the first divergence we've seen in the cumulative NYSE TICK in many months. This excess of supply pressures over demand helps account for the weak breadth of the recent rally. Interestingly, yesterday we hovered at new highs in the index, but only 500 stocks across all exchanges traded at fresh one-month highs, while 389 touched fresh one-month lows. Volume in SPY has also been unusually low during the past several sessions. Since 2013, when SPY volume has been in its lowest quartile, the next ten days in SPY have averaged a loss of -.08%. When volume has been in its highest quartile, the next ten days in SPY have averaged a gain of 1.41%. A break to new highs on expanded volume and breadth would clearly violate the pattern of weakness noted above. Until that point, I don't see an edge in chasing the upside. More on this topic at this evening's gathering. Further Reading: Tracking Market Dynamics
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I'm looking forward to being part of a very special trader's conference in September featuring Jim Dalton, Jack Schwager, and Peter Brandt. Details on the conference will be coming shortly. In upcoming posts, I'd like to highlight a few things I've learned from these seasoned professionals. One of the best posts on trading that I've encountered in years is Brandt's analysis of how randomness affects trading profitability. The same exact trading methodology can yield winning or losing outcomes over a limited time horizon simply due to the random strings of winning and losing trades. This is demonstrated extremely well by Brandt's post, where he assumes a given win rate and ratio of average winning size to losing size and then shows how those metrics can lead to profitability or unprofitability over a run of 100 trades.
There are two important implications of Brandt's analysis:
1) If you ramp up your trading size, the increased risk over a random series of losing trades can devastate your account. Your trading size should not be a function of some high target return that you hope to make, but rather a function of the random strings of losers that you can survive.
2) Just because you're going through a losing period doesn't mean you're trading a losing methodology. Changing sound methods in the middle of a random string of losing trades would be like a batter changing his swing after striking out a few times. That is what helps turn normal setbacks into prolonged mental and performance slumps.
The bottom line is that we can read far too much into short-term trading outcomes. Losing trades don't necessarily mean we're trading poorly and winning trades don't necessarily suggest that we have a hot hand. We can gain knowledge from analytical mistakes and creative insights, but it's also important to retain the wisdom that sometimes we will trade well and lose and other times we can trade poorly and win.
Not every move--of markets, or of profit/loss--is meaningful.
Well, I have a choice. I can either go through my emails (all 16,606) or I can post to the blog a reminder about Thursday's get together for daytraders and other assorted dubious characters. Not one of life's more difficult choices...
We'll convene at 5 PM in NYC at the tasting room of the Whole Foods at Columbus Circle (lower level of the shops at 59th and 8th Ave.) Hope to talk about trading, markets, craft beer, and of course craft beer. Look forward to seeing some of my good colleagues at SMB there as well as a good friend who's quite an experienced prop trader.
I frequently hear from two groups of traders interested in affiliating with trading firms: early career traders interested in experience, learning, and access to capital and experienced traders looking to grow themselves. Two of the types of firms they most often consider for affiliation are proprietary trading groups and hedge funds. Since I've held full-time jobs at both types of trading firms and been involved in the hiring process, I can offer a few perspectives for those contemplating those career directions. What are the differences between prop groups and hedge funds? * Prop groups trade the (proprietary) capital of the firm's owners. Historically, prop groups evolved from market making functions. As algorithmic trading has taken over much of the true market making, most prop firms have retained their short-term roots and trade short-term (largely intra-day) opportunities, making use of significant leverage. Prop firms can operate in futures markets or stocks; occasionally both. * Hedge funds trade the capital of investors, some of whom may be owners/partners in the firm and others who will be high net worth individuals and/or institutional investors. Hedge funds traditionally invest, not trade. They run portfolios of positions, rather than trade in and out of a limited number of instruments daily. Hedge funds trade a wide variety of strategies and often will run different strategies within a single fund to achieve diversification for investors. * A hybrid structure is known as the "family office". This is an organization that manages money like a hedge fund, but trades only the capital of the friends and family of the founder. Very high net worth individuals may establish family offices to avoid the regulation of hedge funds while retaining the practical benefits of hiring portfolio managers. What are the advantages of affiliating with prop groups or hedge funds? * Access to capital. This can be significant, as many early career traders simply lack the capital to earn significant dollar returns. * Access to other skilled traders. This varies greatly from firm to firm and requires due diligence. * Access to superior tools and equipment. Larger firms can afford to invest in software and trading platforms that help traders find opportunities and better manage risk. * Access to structured learning experiences. This varies wildly across firms. Some run actual training programs, some offer mentoring within groups, some offer little if any training. This requires particular due diligence. * Access to markets. Prop firms and hedge funds can open access to markets that might be too expensive or difficult for traders to trade on their own. A prop firm that is a member of an exchange can pass along a favorable commission structure to its traders. A hedge fund with strong relationships with prime brokers can meaningfully expand a trader's access to global markets. What are the pitfalls of affiliating with prop groups or hedge funds? * Fees - Sometimes these can be onerous. There are some bad players out there that make their money more from the commissions and seat fees they charge traders than from facilitating the success of their traders. If you're paying high commissions, you are a customer of the firm you work for, not an employee. Caveat emptor. * Payouts - If you trade on your own, you keep 100% of your profits before expenses. If you trade at a prop firm, that payout may be closer to 50%. If you trade at a hedge fund, it will typically be below 20%. That isn't a problem if you have significant access to capital and if you're getting value in return for the profit-share. But you want to make sure that's the case. * Job Security - If you cannot sustain profitability, these firms will not retain you. That can make it difficult to find a new position. One limitation of making trading a career is that it doesn't readily prepare or position you for alternate careers. This is an important consideration to think through if you're contemplating raising a family and need a measure of stability in your career. How do I break into a prop group or hedge fund? * Build your own trading track record - Even if it's with small capital, you can demonstrate good decision making, sound risk management, and trading skills. * Develop knowledge and skills that make you valuable to a firm - There is always a need for quantitative talent, programming experience, and specialized knowledge of specific markets or regions. * Join an existing group within a firm - This is my favorite way for young professionals to join a hedge fund, but it takes networking and that development of specialized knowledge and skills. Increasingly, we're seeing prop firms build out groups as a way of leveraging their talent and offering ongoing mentoring of developing traders. Affiliating with a trading firm is definitely not for everyone. You may not want to make trading your career, and you may have sufficient access to capital and other resources to build your own trading business. One structure that is interesting is known as "arcades", where traders bring their own capital, enjoy higher payouts, but share office space and resources. That can be a nice blend of affiliation and independence for experienced traders. If you do decide to look into affiliating with a firm, watch for those sketchy players that take advantage of the hopes and dreams of unwitting early career traders. If a group claims to offer education and training, get the details about their curriculum. If the firm offers great payouts, check out the (hidden) fees and commissions. If the firm promises access to capital, find out exactly how much access their experienced traders have. Finally, culture matters. Some trading firms care a lot more about their traders--and are much more devoted to growing them--than others. Talking with traders already working within the firms is a great way to learn about the culture and the opportunities and pitfalls of affiliation. Bottom line: If you want to join a top firm, learn some top skills and get some specialized experience that will make you an asset to the company. Going with no track record and no specialized skills and loudly proclaiming your "passion" for trading is a great way of failing to distinguish yourself to any solid organization. Further Reading: Joining a Prop Firm
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* Interest rate volatility has not been friendly to the stock market over the last few years. Since 2012, when 20-day realized volatility in TLT has been in its highest quartile, the next 20 days in SPY have averaged a gain of +.35%. That contrasts with an average 20-day gain of +1.35% for the remainder of the sample. A weaker dollar, rising gold prices, a steepening of the yield curve, disappointing economic data releases: are we seeing beginning concerns over stagflation?
* Ivanhoff Capital on the role of luck in success. I would say that success is the result of putting yourself in enough promising situations where good luck can eventually come your way and staying out of enough unpromising situations that you can avoid bad luck. This is why holding losers and selling winners quickly is so damaging: it minimizes the odds of good luck and maximizes the odds of bad luck. * Good book recommendations from Abnormal Returns. I particularly like Ratey's book on exercise and the brain.
* On the topic of books, I was pleased to host a craft beer gathering of portfolio managers last week with Maria Konnikova. I will be posting on important topics from her excellent book Mastermind: How to Think Like Sherlock Holmes. She also spoke about her upcoming book, The Confidence Game, which takes us inside the heads of con artists and their victims. A worthwhile related topic: how we can con ourselves.
I'll be talking more about this topic at Thursday's NYC trader gathering: how market volatility and correlation are related to forward price movement in the broad indexes. The above chart tracks an index that I created that combines volatility and correlation across the major stock market sectors. The bars represent average forward 10-day price change since 2012 when the volatility/correlation index has been in its various quartiles. In general, we see subnormal returns when volatility and correlation are low and unusually strong returns when the two are high. It is in the latter situation that we have seen selloffs, with everything taken down in a risk-off mode. When volume and volatility are low and some sectors are showing strength and others not (weak breadth), that's when we've seen punk near-term returns. We currently reside in the lowest quartile: low volatility and low correlation. The division of forward returns into quartiles based upon a candidate predictor is the start of market analysis, not an end point. At least two further issues remain: 1) What is the variability around the returns in the quartiles? We're looking at averages, but perhaps these are skewed by a relative handful of very low or very high values. Strong differences of means are far more significant when there is little variability around the means than when individual values are all over the place. In practical terms, a given mean difference in returns may not be helpful if pursuing the difference exposes you to large drawdowns. 2) Is your candidate predictor truly unique? Maybe volatility and correlation are low and high simply because the prior X days have demonstrated a strong or weak return. Just because you have a promising variable doesn't mean that the variable is *uniquely* predictive of forward returns. A simple procedure is to construct a stepwise multiple regression where past price change is the first variable entered to see if it is predictive of the next X-day change in index prices. Then add your candidate variable in the second step and see if this accounts for significant further variance in predicting the next X-day change. Even if we pass the above two criteria, what we have left is a hypothesis, not a conclusion. Any historical analysis assumes that the patterns of the past will play themselves out in the immediate future. As a quantitatively informed discretionary trader, I will then look for evidence in the day's session that the predicted pattern is or isn't playing itself out. When price action and market behavior lines up with what the model is predicting, there's the possibility of a trade. When they don't line up, it means that something unique is happening in today's trading session, such that a historical pattern is not playing out. That, too, is information to a flexibly minded discretionary trader.
Good trading occurs at the intersection of rigorous analysis and keen pattern recognition.
There are few topics more important than that of self-leadership: how we guide and manage our lives. This is particularly true when the business of life also includes a business as a trader or investor. Managing our trading means that we are deploying our capital efficiently and effectively: finding the right balance of risk and reward over time. Leading our trading business is something different altogether. When we are the leader of our trading enterprise, we determine whether we are pursuing the right risks and rewards. Markets change; opportunity sets change: do we change with them? That is a question of leadership. A major pitfall for active traders is that they spend so much time managing risk and opportunity that they fail to properly lead. They work hard, but struggle to succeed if they're pursuing unfruitful directions. But if you're an investor or trader, you're more than a manager and more than a leader. You are also a venture capitalist. You are funding your trading enterprise. Here's a great exercise: Put together a pitchbook proposal as if you're actually pursuing venture capital. Your pitchbook will consist of four sections: 1) Your background, history, and experience that qualify you for an investment of capital; 2) Your core strategy or strategies and what, specifically, gives them a distinctive edge in markets; 3) Your track record, including monthly profit/loss, drawdowns, and overall risk-adjusted returns; 4) A detailed description of your trading process, from the generation of ideas to the management of risk, along with sample trades that illustrate the process in action. Once you assemble the pitchbook, set it aside for a day or two and then read it with a fresh set of eyes, imagining that you're an investor being asked to invest in this trading business. Would you make an investment? Would you feel comfortable asking others to read your pitchbook and consider making an investment? Would a savvy trader or investor invest in your business? If not, what improvements and changes would you need to implement to justify an investment?
The answer to that question takes you from management to leadership. Further Reading: Self-Leadership and Success
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One of the interesting commonalities among the Market Wizards interviewed by Jack Schwager is that many suffered blow ups early in their careers. Those implosions turned into important lessons that shaped their future success. Their success came, not just from winning, but from turning the downs in their trading into ups. Without the failures, they would not have achieved their successes. I find this is true in relationships as well. It sometimes takes a seriously failed relationship to teach a person what they truly need in a good relationship. Many a happy marriage has been preceded by an unhappy prior relationship. The same is often found in career development. One doesn't find the right direction until pursuing some wrong ones. The downs in life provide fuel for the ups. That is part of being alive.
Here's a great exercise for your trading journal. Divide the page into three columns:
In the first column of the journal entry, identify your greatest trading failure during the past week. Was it a missed opportunity that your process should have picked up? Was it a trade taken that truly lacked an edge? Was it poor implementation of a good idea or an idea that you simply took from the crowd?
In the second column, assess the consequences of that trading failure? How much did that failure cost you? In actual losses? In lost opportunity? In your mood or focus? In subsequent bad trading? We don't change our patterns unless we sustain awareness of their costs. When we emotionally recognize the consequences of our actions, we find the motivation to make changes. In the third column, clearly formulate a plan of action for correcting that trading failure over the coming week. This becomes your mandate, your overarching goal for the week. You will assess the success of the week based upon your ability to turn trading defeats into your development as a trader. Imagine sustaining such a journal project for an entire year. Imagine a parallel project for improving yourself as a spouse, as a parent, or as a professional in your work. Turning failure into success fuels growth. Continuously turning failure into success fuels resilience. This journal exercise, over time, builds the spirit as well as the performance. Further Reading: Five Features of Great Traders
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A worthwhile exercise for your trading journal: Track physical variables, including sleep (quality and amount); exercise (amount and type); eating/drinking (amount and type); and overall energy level. Track your daily productivity (amount of work you get done; quality of the work you get done); quality of your idea generation (how well you're seeing markets and generating trade ideas); quality of your trading (making right decisions at the right time); and quality of your learning from your trading (journaling, work on yourself). Does better work lead to better attention to those physical variables? Does more attention to the body lead to better performance in trading? How are you behaving during your best periods of trading? Your worst? How consistent is your lifestyle relative to optimal performance? Are you like an athlete in training or do you lack training? Further Reading: The Performance Benefits of Exercise .
As posted earlier, I am organizing a craft beer get-together for NYC area traders a week from Thursday (May 21st) at 5:00 PM. We will meet up at the tasting room of the Whole Foods on Columbus Circle (59th Street and 8th Avenue) in midtown Manhattan. I'll be joined by the good folks at SMB, who will share a few perspectives from the front lines of the prop trading world. This is not a formal talk or presentation and I guarantee there will be no sales pitches. Rather it's an opportunity to meet other traders, share perspectives, and hopefully make some contacts that can enrich and inform.
I'll be sharing some perspectives regarding the trading experiment I've been conducting. One of the more interesting early findings is that spending much more time in preparing for trades (research, personal preparation) and greatly limiting actual trades to well tested patterns has already improved my hit rate, profitability, and overall trading experience. Active use of Evernote as a journaling tool has been important to the process. I find it is very different planning a trade in my head versus writing out everything that goes into a trade. When trades are in your head, they're intended. When they're written out and elaborated, they're planned. There's an important difference.
Look forward to meeting up. If you can't make it, don't worry; there will be other events as we move toward summer!
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It's interesting to note that, according to the excellent screening tools at FinViz, the three U.S. stock market sectors that have been down over the prior two quarters have been Conglomerates, Basic Materials, and Utilities (top chart). Those are also the highest yielding sectors (bottom chart); the ones most sensitive to movements in interest rates. With bonds down recently (rates higher), recent weakness we've seen in stocks has been pronounced among rate-sensitive issues. The three sectors down most over the past week are--you guessed it!--Conglomerates, Utilities, and Basic Materials. Yesterday, we came within a few points of an all time high in the ES futures. We closed with 387 stocks across all exchanges making fresh monthly highs and 374 making fresh monthly lows. Much of the breadth weakness in stocks is related to the recent backup in yields. Further Reading: A Different Way of Tracking Stock Market Strength
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Traders write to me and talk with me about a lot of things. Sometimes it's about problems they're having in their trading; sometimes it's trying to make sense of markets. Few traders talk about new discoveries they've made; fresh challenges they've undertaken; or new and promising approaches they're taking to markets. If I had to describe the stance of most traders I encounter through the blog, it would be "coping". They're weathering the vicissitudes of markets, hoping to not blow up, hoping to get paid at the end of their efforts. There's a lot to be said for coping, especially relative to the alternative. But there's nothing magical in coping; nothing energizing, ennobling, exciting, or stimulating. It's no way to approach a marriage or a career. You might make it through and arrive safely as a well-preserved body, but have you lived? My recent post outlined an experiment I'm conducting with my trading. It might turn out well; it might go bust. Part of the fun is finding out how the story ends. Either way, I intend to arrive in a cloud of smoke, thoroughly worn out, happy for the ride.
I'm starting a trading experiment and will be recording the results on the blog periodically. The experiment has involved going back to my research and identifying robust, replicable patterns in the ES futures contract and SPY ETF. I specifically selected patterns that play out over a multiday period, with average holding times of several days. The patterns demonstrated a distinct edge in 2012 and 2013 trading and then were tested independently on 2014 data as an out-of-sample test and then were further tested independently on 2015 data to date. Now it's time for live trading. There are three general patterns: 1) Failure Pattern - A market advance loses breadth and momentum and reverses. 2) Reversal Pattern - A market decline leads to broad weakness and expanded volatility, resulting in a reversal bounce higher. 3) Momentum Pattern - A market rise occurs with solid breadth and momentum and continues higher in the short run. In the experiment, I will only trade those patterns. That means plenty of days of not trading and sizing up days when patterns occur. Each pattern is defined by a scorecard of criteria; if all criteria are not met, no trade is taken. A first unit of risk is entered when the signal fires; further units are added on evidence that the signal is playing out as expected. Entries and exits for those further units are discretionary, based on intraday trading patterns. A journal will track all signals and trades and how I traded them, with observations translated into goals for continuous improvement. The experiment is thus also an experiment in self-coaching. I hope to share lessons learned via the blog. At the craft beer networking event a week from Thursday (May 21st), I will discuss the project further with interested traders. A notice about that event will go out this coming week.
Imagine if a group of likeminded, dedicated traders conducted their own experiments and shared results. That would generate quite an accelerated learning curve. There's a big difference between years of market experience and a single year's experience repeated many times over. That difference is deliberate practice and a structured learning from experience.
An interesting meta-analysis (a study that statistically combines many different research studies) found that mentorship is associated with a number of favorable outcomes, including positive attitudes and career success. That study found academic mentoring to be particularly effective, enhancing the motivation, performance, and goal-setting of proteges. In the recently published Forbes interview, Charles Kirk points out that tenacity--the ability to hang in there during challenging times--is an essential component of trading success. He makes a very important point about mentoring. The mentor teaches and supports, but also provides that push in the right direction--particularly when things aren't going so well. In modeling persistence, mentors help their students sustain tenacity. Many times a student won't give up because their mentor refuses. I was recently speaking with Mike Bellafiore of SMB Capital about an interesting development on their trading desk. Senior traders have been taking on junior traders for mentoring, creating their own groups within a group. The senior traders are provided additional financial incentives based on the success of their proteges, and the proteges learn trading at the side of an experienced professional. It's a powerful model, one that lies at the heart of medical education and any career field that draws upon apprenticeships. Mike mentioned that several students have made significant progress under their mentors. In one case, the mentor threatened to shut down a junior trader if he made a mistake a second time. Instead of coming across as punitive, that threat came across as a supportive kick in the pants, much like a basketball coach might give to a player who lapses on the court and fails to properly run the called play. The fatal shortcoming of most efforts in trader education is that they provide teaching but not mentoring. We learn by example, not just by the textbook. Good firms recruit good talent; great firms grow talent. A close look at the Tiger Cubs who have learned under Julian Robertson finds that his involvement in vetting their trades has been essential to their success. There is no better path to winning than studying under a winner.
One of my more reliable measures of market strength and weakness comes from a disaggregation of the NYSE TICK, the cumulative measure of upticks vs. downticks among all NYSE stocks. I treat the upticks and downticks as separate distributions, reflecting buying and selling pressure respectively. In the chart above, we're looking at a 10-day moving average of downticks (raw data from e-Signal; all computations in Excel). Generally, we see a relative absence of selling (high levels of the red line on the chart) preceding market tops and an intensity of selling pressure (low levels of the red line) at relative market lows. Note the increase in selling pressure in recent sessions, taking the measure below -400.
Going back to 2012, when we've had readings of -400 and less (N = 132), the next five days in SPY have averaged a gain of +.71% versus an average gain of +.21% for the remainder of the sample, with 88 occasions closing higher and 44 closing lower.
This and the excess number of sell signals we've been seeing from the technical systems I follow leave me open to the possibility that the market's current choppy range will ultimately find resolution to the upside. I find these kinds of market queries more helpful in formulating hypotheses than hard and fast conclusions. It's when markets look strongest and weakest that it's helpful to look at what has happened historically under those conditions. Very often that tempers any recency bias and tendency to extrapolate the recent past to the near-term future. Further Reading: NYSE TICK
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If you have problems with your old Ford, repairing the car is a worthwhile undertaking. Repairing your Ford, however, will not build you a Tesla. The fundamental insight of positive psychology is that ameliorating life's negatives--resolving conflicts, coping with stresses--is necessary to an optimal life, but not sufficient. Healing physical aches and pains won't make us physically fit. For that, we need workouts in a gym. Positive psychology is a set of cognitive, emotional, spiritual, and social workouts in life's gymnasium.
For years, traders have turned to psychology to help them deal with the emotional challenges and stresses of making financial decisions in uncertain and changing markets. They have an old Ford and they look for repairs. If you ask those traders about their goals, however, they want a Tesla. They want distinctive success, not just fewer problems and setbacks. For that, traders need to actively exercise their strengths, not just correct their mistakes. But how many traders truly treat each trading day as time in the gym, identifying and developing what makes them successful?
One of the greatest costs of a negative mindset are the lost opportunities to develop life's positives. Couples think that working on their communication skills will restore their marriages when the problem is that they no longer engage in the activities and interactions that inspired their initial love. You know a relationship and a career are over when all that's left is working on problems. It's only a matter of time before that old car can't be fixed. A great starting point for finding that new car is to recognize that we have a wide range of capacities and competencies and all of them are subject to the principle of "use it or lose it." The diamond we become depends upon the facets we carve and polish. What do you want to use and develop? What are you willing to lose and set aside? The best gems don't have the most cuts, but the most flawless ones. Here are some resources to kickstart your sojourn in life's gymnasium: 1) Dr. Nico Rose highlights 10 contributors to positive psychology across a variety of domains; 2) Helpful database of researchers working in the field of positive psychology; 3) A wealth of articles on positive psychology topics from The Greater Good Science Center; 4) Comprehensive list of readings in positive psychology; 5) My Forbes blog specifically addresses trading, investment, and positive psychology, with a focus on peak performance. Happy workouts!
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Now that's some good cowboy wisdom. No cowboy ever said, "Ride the horse that fits your personality." Hell, no. If you want to win at the rodeo and rope that steer, you ride your best horse. But every rodeo needs its clowns to distract the bulls; it's only markets that have the clowns that distract the bulls and the bears. Once in a while the clowns say something that gets on my nerves, kind of like that guy in the square dance who doesn't know allemande left from allemande right and messes things up. But then I realize that if I'm distracted by the clowns, then I'm the bull, not the bull roper.
The single thing I've done this year that has helped my trading performance is ride my best horse and forget everything else. I examined my winning trades, backtested the most robust patterns over multiple time frames, and now I'm only trading those. If there's no robust pattern, I don't trade. And that's most the time.
It turns out that those patterns occur when the bulls and bears are most distracted by clowns. Very strong markets continue their strength, but people want to fade them. Very weak markets continue their weakness and people stop out in panic. Underreaction and overreaction--those are solid behavioral foundations of market edges.
When I traded patterns that fit my personality, it was like running a clothing store and stocking it only with merchandise that fit my tastes. A successful store figures out the tastes of customers and even anticipates shifts in those tastes. Success is about figuring out the market's personality, not indulging your own. And that personality has a distinct set of behavioral biases if you can just focus on the cowboys and not the clowns.
In the recent article outlining three principles of performance grounded in positive psychology, one of those principles involved the importance of managing your experience first and foremost. Drawing on the Einstein quote, that means prioritizing and engaging in the activities that are associated with the physical, emotional, and cognitive states you most want to sustain. What we do from hour to hour each day shapes our experience, and that determines the resources we're able to devote to the work, play, and relationships most important to us.
The challenge is to staying burning without burning out. We want to live positive, energized, exciting, meaningful lives and yet somehow we find ourselves engaged in activities that take more energy than they give. If daily experience does not incorporate activities that are renewing, we eventually deplete our resources. How do we stay productive, loving, and creative when we're burned out? Tom Rath, in his recent work, outlines three important elements in staying fully charged: 1) meaning; 2) interactions; and 3) energy. We renew ourselves when we:
* Engage in activities we find meaningful; that directly express our deepest values and beliefs; * Engage in interactions that are interesting, rewarding, caring, and loving; * Engage in energizing activities that stimulate and challenge us, from physical exercise to pursuing goals. Rath notes research suggesting that only 11% of people surveyed report having a great deal of energy. Ironically, we would never drive a car that operated as inefficiently as we do in our own daily lives. The greatest mistake we make is that we prioritize the things we need to get done rather than the states in which we best achieve our desired ends. If we match the frequency of the reality we wish to achieve, we're far more likely to live that reality. Further Reading: Why We Fall Short Of Our Potential
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* Above we see a composite measure of breadth specific to SPX stocks (raw data from the excellent Index Indicators site). Specifically, we're looking at a composite of the percentages of SPX stocks trading above their 3, 5, 10, and 20-day moving averages. Note the pattern of declining highs and rising lows in the recent data, as the average has traded largely within a range. A disproportionate share of the market's gains since 2006 have occurred when the breadth measure has fallen in its weakest quartile, with an average five-day gain of +.48%. Conversely, when the breadth measure has been in its strongest quartile, the next five days have averaged a loss of -.09%. Yet another example of how a short-term trend does not necessarily yield short-term momentum. * If you live in the greater NYC area and are interested in participating in a craft beer networking, pencil in the date of Thursday, May 21st. The specific after-hours time and location will be forthcoming. I'll be there to discuss my latest market research and fresh topics in trading psychology and my good friends from SMB will offer trading insights as well. Should be a fun way to meet other traders and enjoy a few good brews! * My Forbes blog is slowly turning into the single largest source of posts on trading that draws upon the relatively new field of positive psychology. The new book, slated to come out in September, will be the first book I know of to specifically go into detail re: how positive psychology can fuel trading performance. It's an exciting area that continues to expand.
We often hear that traders should be process driven and strictly follow their process as a way of avoiding psychologically-driven biases and poor trading practices. This draws upon an analogy between trading and the running of a manufacturing or service business. In the business setting, you are looking for consistent, high quality. Variability of output = low quality. For example, if you're manufacturing a drug, you want the production process to turn out the same pill all the time. If you're a delivery service, you want consistent on-time delivery--and you standardize each step of the process to make sure that happens. Essential to process-driven quality control are two ingredients: 1) measurement of outcomes and 2) identification of the activities that consistently generate those outcomes. In the world of medicine, that has led to a focus on outcome research and the creation of evidence-based treatment protocols that standardize best practices. If you receive surgery from an evidence-based treatment center, many of the decisions that are made, from the amount and type of anesthesia to the sterility of the operating room and the method of incision, will be laid out as protocols and derived from rigorous, controlled outcome studies. When traders say that they are "following their process", what they should mean by that is that they have intensively studied what makes them money and what does not; identified their best trading practices; codified these best practices as protocols to follow; and then tracked their fidelity to these evidence-based practices. In other words, a trader who is truly process-driven should demonstrate: 1) Reliability - They do the same thing in the same situation each time; 2) Validity - What they do is known to result in greater positive outcomes than following other procedures. Most traders who speak of being process-driven do not truly track reliability and validity. When they talk about being process-driven, what they mean is that they follow a routine. Routines are necessary for quality control, but hardly sufficient. Rowing a boat in a consistent manner doesn't help if you're headed in the wrong direction. If traders don't track outcomes, identify the practices that generate favorable outcomes, and *then* ground routines in those practices, they are not trading with quality. Trading with quality means putting as much time and effort into studying trading performance as studying markets. The process-driven trader doesn't simply define a routine and follow it blindly. Rather, process-driven trading means that you identify and understand what works and then systematically become more consistent in executing that. Would you fly an airline that operated with the same quality control as you demonstrate in your trading? It's all about doing things right and doing the right things. Further Reading: Quality, Minds, and Markets
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In his recent research report, Peter Brandt offered a keen observation: "Profitability comes from a trade finding you, not in you finding a trade. The best trades are the ones you wait for, not the ones you find." I have found this to be the case in most areas of life: the best opportunities find you. When I first returned to blogging, I didn't write about markets; I wrote about our new cat. That was one of the key lessons I wanted to convey: she found us. What was important to that discovery was that we visited many cat shelters and spent quite a bit of time with the three cats at home before Mia clung to my shoulder. A lot of preparation took place before opportunity could find us. So it is with discretionary trading: we look at markets; we look at economic developments; we look at monetary trends; we study various indicators of market behavior--and all of that is preparation. As Peter points out, at any juncture we can take a chart or piece of data and find a trade in it. If we are in a mindset where we want to trade--and need to trade--we can find trades to do. And we don't make money. When we are patient and prepare and prepare and prepare, eventually a pattern presents itself to us. All the analysis falls into place with a keen synthesis. We might conceptualize the pattern in statistical terms, chart-based terms, macroeconomic terms, or some other terms. There are many languages we can speak to capture the patterns in complex phenomena.
The reason patience is important to trading is that it allows us the time and space to synthesize. We can never get to the point of trusting our gut if our heads are cluttered with what we want to do next. It is when we stop doing that the things worth doing come to us. Further Reading: The Greatest Mistake Traders Make
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* On Thursday across the NYSE universe, we saw quite a few more stocks close below their lower Bollinger Bands than above their upper bands. As you can see from the chart above, important intermediate-term lows have occurred in market cycles when we've seen a plethora of stocks trading below their lower bands. I went back to the start of my data set (May, 2014; raw data from Stock Charts) and looked at all occasions in which we registered more than 200 stocks below their lower bands versus above their upper bands, where this was the first occasion in at least two weeks. Interestingly, three days later, SPY was up twice and down five times for an average loss of -.54%. Too small a sample to hang one's hat on, but the point is that markets can display short-term momentum to the downside as well as upside when there is a strong breadth move. * We often hear that your trading style should fit your personality, but what is your trading style and what aspects of personality are important to performance? Too often traders lose money because they drift from one trading style to another, not mastering any and not truly leveraging their strengths. I can think of few more important topics in trading psychology. * Banks are not providing the liquidity they once did. This can lead to mini flash crash situations and is very relevant for risk management. * Two valuable professional activities are networking and not working. Networking exposes us to new ways of thinking and new ideas; as James Clear suggests, not working allows us to renew and rejuvenate, so that we can generate our own fresh perspectives. I'll be announcing a NYC networking event for active traders shortly.
Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), Trading Psychology 2.0 (Wiley, 2015), and Radical Renewal (2019) with an interest in using historical patterns in markets to find a trading edge. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab). I teach brief therapy as Teaching Professor at SUNY Upstate in Syracuse, with a particular emphasis of solution-focused "therapies for the mentally well". Co-editor of The Art and Science of Brief Psychotherapies (American Psychiatric Press, 2018). I don't offer coaching for individual traders, but welcome questions and comments at steenbab at aol dot com.
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