Saturday, September 30, 2006

The S&P 500 Index and Its Multiple Personality

Here is the 2003-2006 bull market from three perspectives. The red line is the one we're most familiar with: it is the S&P 500 Index (SPY). The bullish and trending yellow line represents the cumulative price change of the S&P 500 Index outside of normal market hours (overnight). The blue line, which represents only a very modest gain over the entire period, is the cumulative price change of the S&P during the normal day session from open to close.

The correlation between the blue line (Daytrading Index) and yellow line (Nighttrading Index) is .04. What happens to the S&P during normal day hours is wholly independent of what happens to it after the close and before the open. The S&P truly has a multiple personality.

There are several implications to this breakdown:

1) Analyzing the Index as a whole (SPY) to derive patterns for daytraders may be faulty methodology. To the extent that researched patterns include--and are dominated by--overnight price changes, they portray opportunity that the daytrader would never realize;

2) Trend traders operating in the day timeframe would be well advised to extend their holding periods. Their trading methods might better take advantage of the trending component of the overnight market;

3) Because over half of all NYSE volume is program trading, the day session is dominated by arbitrage. Much of the market's directional activity occurs after the close and before the open, which is when many economic reports are released and when many influential world markets (currency, oil) are operating.

Notice that I am not saying that the day timeframe lacks opportunity. Rather, I'm suggesting that daytrading has not been offering a trending opportunity, and it is offering opportunity that is independent of what occurs in the market overnight.

To capture this opportunity, might it make sense to analyze patterns within the Daytrading Index, rather than in the S&P 500 Index itself? While the Daytrading Index is not a true trading index and traders are unlikely to replicate its performance by precisely buying the open and selling the close each day, analyses of historical patterns in the Daytrading Index would provide more accurate alerts to directional movements than analyses that include time periods during which the trader will never hold positions.

One other interesting implication of all this: With the advent of free trading, might it make sense for a trader to actually trade the Nighttrading Index as an instrument? Someone who bought the close and exited at the open each day would have done well, sans commissions, during the past several years.

I will be pursuing Daytrading and Nighttrading Index patterns in my own research and report here on this blog and in the Trading Psychology Weblog.

Friday, September 29, 2006

Market Psychology Update for 9/29/06

9:50 AM CT - Here's my latest Trading Markets article. Hope it's a bit more exciting than this market has been. Volume really slowed down here. I'll be taking off now; hope you have an excellent rest of the day. Update tonight on the Weblog and regular weekend updates as well.

9:39 AM CT - Recent selling has held at that average price area of 1347, but volume on buying after that initial spike on the news has been quite modest. We'll need to see an expansion of negative TICK to sustain any kind of downtrend here. Similarly, we'll need multiple +1000 readings as we had earlier this week to sustain the upside. Until then, it's quite a narrow range.

9:31 AM CT - Some tailing off of volume here. Declines lead advances by less than 100 issues. Very little follow through to short term moves; lots of runups/rundowns and reversals, typical of local dominated trade.

9:25 AM CT - The uptick in rates continues on the heels of the strong economic report. Keep an eye. No major change in Dollar/Euro. Falling rates were a major underpinning of the recent rally; let's see how we respond to a possible rate backup.

9:20 AM CT - So far, it's a 3-1/2 point ES range and the economic numbers have not been sufficient to break us from the range on this Friday, the last day of the quarter. As mentioned earlier, fading moves above and below that average price of 1347 makes the most sense *if* you're going to trade such an environment. There's no outstanding selling pressure thus far, but neither has there been follow through to buying. I'm watching that TICK distribution carefully to see if that shifts.

9:08 AM CT - Strength in the Chicago PMI number was taken well by the market--note the program buying and expansion in the TICK--as we once again get the chance to break and stay above the 1350 area highs, with the 1346 region now providing near term support. Advances lead declines by about 300 issues--nothing to write home about--but upside volume (at offer) really picked up on the number's release. We need to stay above the AM lows to get a good uptrend day out of this; a decisive break below those lows would have me entertaining the idea of an intermediate-term market top.

8:59 AM CT - A pickup of selling took us back to that average price, and volume remains modest--all consistent thus far with the range bound hypothesis. So far, buying has not seen follow through. If that continues, expect a test of those lows around 1343.

8:45 AM CT - Some weakness in emerging markets (EEM) ETF; NQ and semis show weaker performance so far. Volume at bid vs offer pretty even in ES; TICK positive overall, but not robust. Nothing so far to lead me to believe that we're not in a range bound market: volumes are modest, with mostly locals doing their very short-term thing.

8:40 AM CT - TICK positive thus far, though not especially robust. NQ showing a little relative weakness; ER2 a little relative strength. ES trying to hold above that average price to mount an assault on range highs. Waiting for the two economic reports. Advancers over declines by a little less than 500 issues. Back shortly.

8:22 AM CT - Well, the Personal Income and Personal Spending numbers came in pretty much in line. We'll get Michigan Sentiment before 9 AM CT and Chicago PMI around 9 AM. We're hovering around the highs from the past two days, with that 1350 area offering immediate resistance. Note that we're further from the lows in ER2. Multi-day support is at 1343, so that gives us a relatively narrow range going into today's trade. My latest Trading Markets article will come out later this AM and details the many divergences in the current market. For intermediate-term trading, I am not chasing the upside here. The rally is just too narrow-based for my liking. A broadening of the rally, expanding the number of stocks making new 20-day highs and taking the small and mid cap sectors with it, would change my mind. Note that 1347 represents the average trading price of the last couple of days; as yesterday, I look to fade moves above and below that unless we get an expansion of volume lifting offers or hitting bids. But, like the last post noted, staying flexible is the key. Back after the open.

8:15 AM CT - As noted yesterday, this will be my final daily market update. Starting in October, I will resume daily postings to this site and the Trading Psychology Weblog, but won't be tracking the market in real time during the early morning hours. If you are interested in doing occasional free real time training sessions via the Web, with a focus on reading short-term market patterns, drop me a line. My email address is at the right sidebar on this blog. While on the topic of training, I'll be doing the Webinar for the Chicago Mercantile Exchange this Monday at 3:30 PM CT. It's free, but registration is required. Once again, thanks to Advantage Futures and John Conolly of TeachMeFutures for sponsoring the event. I will be doing a live event for the Merc that will also be broadcast over the Web on November 2nd. Details will be on my personal site shortly. Back in a bit.

The Most Underrated Trading Virtue

Those anti-motivational folks at Despair have it right: there's nothing like the winds of change to blow away the unsuspecting trader.

A worthwhile book that I've begun reading is Master Traders by Fari Hamzei of Hamzei Analytics. There's a very nice segment from Jeff deGraff:

Contrary to what 99 percent of the investment population thinks, trading is not about being right. Being right is easy. Trading is about being wrong; and navigating this inevitable occurrence distinguishes the winners from the losers in the long run...The road to riches is littered with the bodies of those who believed that being right required conviction and stamina...but the line between conviction and stubbornness is at best vague (p. 13-14).

Although trading coaches wax poetic about trading plans and maintaining discipline with these plans, rigidity in the face of a plan going sour is no virtue. The winds of market change can shift quite dramatically when large participants enter with directional positions. It is for this reason that mental flexibility is perhaps the most underrated trading virtue.

Yesterday's market update provided a perfect example of the value of mental flexibility. During the opening ten minutes of trade, I observed strength in the Russell futures and a positive tone to the NYSE TICK. My historical studies told me that, under these conditions, the odds of taking out the previous day's highs were well north of 75%. That was my initial plan.

Then came the winds of change.

By 8:48 AM, I was noticing selling in the Russell futures and especially program-driven selling. The presence of institutional sellers as we neared the previous day's high led me to consider an alternate market scenario: perhaps we were in the process of forming a range for the day. By 9:01 AM, I was looking for the previous day's average price of 1347 in the ES to be a midpoint of this developing range, noting an attempt to form a short-term base below that level. (The eventual midpoint was 1346.75).

At 9:14 AM, the market had indeed rallied from this base, but the quality of the rally was substandard: certainly nothing like the opening buying. By 9:34 AM, the winds of change had come full circle. From expecting to take out the previous day's highs, I now work with the hypothesis that we had put in the high for the current day. Instead of buying strength, I was fading rallies--a strategy that worked well for the short-term trader.

Within an hour's time, I had completely revised my view of the market. Had I formed a plan at the start of trading and stuck with it in the name of discipline, the winds of change would have hurled some projectiles at my P/L.

When you're a short-term trader, think of the market as your dance partner. It leads, you follow. Your job is to sense your partner's intentions and move fluidly with each shift of direction. Your trading plans and predictions mean nothing to the market; only ego makes the trader want to lead his or her dance partner.

Be a good follower, and you'll be a market leader.

Thursday, September 28, 2006

Market Psychology AM Update for 9/28/06

9:52 AM CT - I'll have more to say about this in tomorrow's blog post, but notice how my view of the market shifted over the course of the AM. I started with favorable expectations for taking out the highs in ES, given the TICK and ER2 strength. Then, with program selling, I started entertaining the idea of bottoming and rangebound trade. Then I questioned the vigor of the rally and started looking to the downside. The point here is to stay mentally flexible, not get hung up on any single perspective or piece of research. The balance between buyers and sellers shifted over the course of the AM: our job is to pick up such shifts. Important support in the 1343 area from yesterday's lows; it will be important to see if we get any further shifts as we approach those. Have a great day; update on the Weblog tonight.

9:40 AM CT - I'll put out an article on the Dow TICK before too long. I continue to see sell programs hit the market, and that's putting a lid on stocks thus far. Note the continued weakness in TICK and ER2. That's going to need to change for us to have a shot at taking out yesterday's highs.

9:34 AM CT - Just had a computer crash; hopefully all will be OK with this update. The rallies continue to look suspect, and we're seeing some downward tilt in the TICK distribution. I'm entertaining the possibility that we put in our highs for the day and that we might give back some of the recent gains--a pattern that would fit with the research mentioned earlier this AM. Advancing stocks now only lead declines by 250. I'm watching that TICK distribution and ER2 once again. They were leading the market early to the upside and have been waning ever since.

9:14 AM CT - Hopefully you were able to see that short-term bottoming form and, at the very least, not get lulled into selling lows. This is not a convincing rally, however; volume is waning, and we continue to see volume at bid exceed that at the offer in ES. The TICK distribution has stayed relatively positive, however, and it's that dynamic that's keeping us in a range.

9:01 AM CT - Note yesterday's average price of 1347. With the failure to take out yesterday's high, we traded through that, and now we're trying to put in a short-term bottom. We want to look closely for evidence for such bottoming, because that would provide us with a support level in a trading range extending up to yesterday's highs. I'm looking to see if volume picks up or dries up at these levels to handicap the odds of bottoming short term. Let's also see if TICK can hold above its recent lows.

8:48 AM CT - My read, FWIW, is that it's not that we have huge volume in the market; it's that a good portion of that volume is program buying or selling by institutions. Mass buying or selling of futures vs. underlying stocks or futures relative to each other creates sudden sharp movements for a number of ticks and then equally sharp reversals. Note the significant NQ and ER2 selling just since my last post and the several swings in the Dow TICK from very strong to very weak and back again. Because the Dow stocks are included in many baskets for program trading due to their liquidity, the swings in the Dow TICK (TIKI) do reflect program activity. That's how we get significant ES selling without negative NYSE TICK readings. This activity could keep us range bound--keep an eye on buying/selling volume (at offer vs bid) as we approach market highs.

8:40 AM CT - Keep watching TICK and ER2. As long as those are strong, we have good odds of taking out the recent highs in ES.

8:38 AM CT - Volume is moderate; nothing to write home about. TICK remains positive, and volume at offer in ES exceeds that at bid. Near term support at 1347.25; we're testing those highs as indicated a few min ago.

8:34 AM CT - Note that we're opening with ER2 above its previous day's high, TICK positive, and over 800 advancers over decliners. We should test yesterday's ES highs if that continues.

8:20 AM CT - Initial claims came in pretty much as expected; GDP a tad weaker, but we're seeing an uptick in interest rates and a bit of dollar strength versus the Euro. The S&P Index in preopening trading has been hovering near its recent highs, but in a narrow range. As my previous blog post indicated, returns five days out following a string of 20-day highs in SPY have been negative, on average. One thing I'm looking at: ER2 is below its highs from last week and, so far, we've seen fewer stocks make new highs this week compared with last. I want to see if this rally broadens out or stalls. If the latter, I'd expect some pullback over the next week. Back after the open.

8:05 AM CT - This has been a nice lull period for me. Having finished my book manuscript and also finished work with a trading firm I had been helping, I've been able to devote a piece of my mornings to these updates. At the end of this month, however, I won't be able to continue the daily updates. A new writing project beckons, and I will begin a couple of projects with new firms. Beginning in October, I'll continue to update the Weblog and this site daily, with illustrations and historical analyses of tradable market patterns. I also hope to extend the analyses to longer timeframes, for swing traders and short-term investors. I just won't be able to comment on the market in real time on a daily basis. My hope is that the real time updates have given you some ideas of things to look for in the markets, so that you can frame your own trading hypotheses. Thanks for your interest and support. Market update soon to follow.

Does It Pay to Buy Multiple Market Highs?

Amidst the attention being given to the new highs in the large cap indices, it's worth asking the question, "Does it pay to buy new price highs?"

In the chart above, I'm taking closing daily prices of SPY and simply calculating the number of days in the past 20 in which we've made new 20-day highs. I subtract from that figure the number of days in the past 20 in which we've made new 20-day lows.

Going back to 2004 (N = 670 trading days), we've had 205 occasions in which the net number of new high days has been five or greater. Ten days later, SPY has been down by an average of -.06% (106 up, 99 down). That is considerably weaker than the average ten-day gain of .38% (282 up, 183 down) for the remainder of the sample.

Note that, at present, we've had a net number of new high days of 8. When that has occurred since 2004 (N = 65), returns in SPY have been similarly subnormal 5-10 days out (31 up, 34 down).

Conversely, when the net number of new low days in SPY is five or greater (N = 55), the next ten days in SPY average a gain of 1.03% (41 up, 14 down)--quite a positive edge.

Quite simply, it's made us money since 2004 to buy the market when SPY has been making multiple new 20-day lows. It has actually cost short-term traders money to buy the market when SPY has been making multiple new 20-day highs.

What that's really saying is that we haven't been in a trending market over this time frame. A trending market is one in which buying highs or selling lows is significantly more profitable than the reverse. There were times during the 2003-2004 runup in which buying multiple new high occasions was profitable. That hasn't been the case, however, for going on three years and-- given divergences in the market among sectors (small/mid caps, NASDAQ)--I'm not inclined to pronounce that "this time will be different".

Note in today's Weblog, however, that a peak in multiple new high days tends to precede short-term market price peaks. Given that we just hit a peak of 8 on Wednesday, it is also reasonable to conjecture that we have not yet put in a top for this particular market move. It's when we've seen price highs at progressively lower net numbers of new high days that, since 2004, the market has tended to correct significantly.

Wednesday, September 27, 2006

Market Psychology AM Update for 9/27/06

9:55 AM CT - Continuing to see a bit of relative strength in NQ and ER2 and that's helping hold the downside. Nothing really happening to change my range view so far, though I suspect that 1350 area will pose important resistance today. That'll do it for this AM; hope you have a great day; thanks for the kind comments re: the blog.

9:45 AM CT - Let's see how well we hold up at 1345 after a couple of selling bouts. NQ and ER2 so far holding up above their recent lows.

9:42 AM CT - The trade is very much like yesterday afternoon's, with program buying coming in sweeps, followed by sharp, short retracements. The elevated volume at these times suggests that it's not just locals playing games. We have some large programs being executed, and those spikes in the TICK create a positive distribution that make it hard to fade the strength. Still, even with the buying, we're having trouble surmounting that 1350 area. We're in a 7 point ES range thus far, and I'm not seeing anything yet to convince me that this will change.

9:23 AM CT - What we've been seeing IMO is a puking of longs, not--so far--an initiation of great selling. Volume at bid only slightly leads volume at offer on the day and, unless that changes, I expect more of a trading range than an outright market rout.

9:15 AM CT - Well, that didn't take long to materialize, either. Quite a rejection of price at 1350. That becomes important resistance and now we look for a range to form.

9:05 AM CT - Nice pop on better than expected housing sales. I'm watching NQ and ER2 closely to see if we hold those gains. I have some doubts, but want to see buyers unable to push prices higher before fading.

8:50 AM CT - Well, that didn't take long to materialize. An upside breakout in the TICK and participation by all indices has led us to test those recent highs. That 1344.75 area is now our near-term support. Staying above that with a positive TICK distribution should help us sustain new highs in the early going. I am not necessarily at all expecting a trend day to the upside, however, given the mixed participation in the recent rise per the recent Weblog entry.

8:40 AM CT - Ahead of the housing number, we're seeing modest volume and a very restrained range in the TICK--all of which suggest muted volatility. So let's keep an eye on that. The longer it persists, the greater the odds of range bound trade. The preopening low of 1343.25 is initial support, and above we have the highs from yesterday and the overnight high. Notice how the restrained response of the dollar and bonds suggested that the initial drop in equities would not become a major selloff. Basically I'm waiting for sellers to take their turn and see how the market trades re: recent lows at that point, to see if it's worth taking a long position for a test of the highs. I want to see some ER2 strength before jumping in; let's see if it holds above preopening lows.

8:00 AM CT - A weaker than expected Durable Goods report has sent futures indices lower in pre-opening trade. We had broken out above the 1340 resistance and need to stay above that level to sustain the uptrend. Yesterday's average price on ES was 1341.5; the high was 1347.25. Normal expectations would be to test that high in AM trade; failure to take out the high would target the average price. New home sales come out at 9 AM CT and will provide yet another data point re: economic weakness. Note that interest rates have come down on the AM news, but so far remain above 9/25 lows. No big move in the dollar. In the absence of trending moves in those markets, I do not expect the economic news to create a trending breakout in today's equity trade, the opening drop notwithstanding. Back after the open.

Trading to Win Vs. Trading to Not Lose

Suppose I offer you a sure $500 or the choice of flipping a coin. If the coin lands on heads, you'll get $1000. If the coin lands on tails, you'll receive nothing. Would you take the guaranteed $500, or would you flip the coin?

Most people, given the opportunity for a sure thing, will take it.

Now, however, suppose I confront you with a certain *loss* of $500. The alternative is that you can flip a coin. If it lands on heads, you lose nothing. If it lands on tails, however, you lose $1000. Would you take the guaranteed loss of $500, or would you flip the coin?

Interestingly, in that scenario, a significant number of people will flip the coin. We tend to be more risk-seeking when we deal with losses than when we are faced with gains.

Suppose we are into a trade and can take a sure point out the S&P eminis in a short-term trade. Do we "take what the market gives us"? Suppose the market moves four ticks against us. Do we hold the loss in hopes of coming back to breakeven?

There is a meaningful difference between trading to win and trading to not lose. The average person feels more psychological pain over a loss than they feel pleasure over a gain--particularly once they have already "booked" that gain mentally. If I'm expecting a bonus from my employer, I'll be happy when I receive the paycheck--but I'll be much more upset if I find out the bonus has been rescinded.

When we enter a trade, we expect to be paid out. Mentally, we book a potential profit. When a loss materializes, it is the unexpected event--and we respond more strongly to the unexpected than to the familiar.

What is the solution to this dilemma? The answer, surprisingly, is to book losses before they occur.

It's human nature to not want to think about such unpleasant things as losses. But by knowing our maximum possible loss in advance and by mentally rehearsing what we'll do on those occasions when the loss occurs, we normalize the losing process. That divests it of its emotional grip.

We can never eliminate loss from life or trading; nor can we repeal the basic uncertainties of markets. What we *can* do is develop an edge in the marketplace and, over the course of many trades, let that edge accumulate in our favor.

And, if you're trading well, maybe that losing trade will offer you a fresh perspective about how the market is trading: an insight that can make you money the next time around. Then it's not a loss. It's information that you've paid for.

Tuesday, September 26, 2006

Market Psychology AM Update for 9/26/06

9:53 AM CT - Hope you've been able to track the market's increase in strength early and then its transition from the highs, as sectors began showing weakness even as ES was peaking. These are patterns very worth watching. We're back at the former resistance highs--a pullback into the trading range would target our average price for the AM (1338) and the AM lows. Only 585 more stocks advancing than declining; not as broad a rally as you'd like to see, given the importance of the 1340 breakout. I'll be talking tonight in Naperville; off to finalize that preparation. Also note on the Weblog the Monday Webinar via Teach Me Futures. Have a great morning.

9:40 AM CT - Those divergences at market peaks are killers. Also, although not technically fitting the Odds Maker pattern, I treated that high in ES as a breakout from the first hour range and remembered that it's been profitable to fade those. So much of trading success is just seeing patterns again and again until you can recognize them in real time and act on them promptly. The heaviness in NQ, SMH, and ER2 are a concern for the bulls; I'm also watching to see if we sustain a pattern of lower TICK highs and lower lows.

9:30 AM CT - Note that the recent ES high was not accompanied by a high in NQ; keep an eye on ER2 and TICK to see if we see signs of heaviness there as well. We should stay above the area that had been resistance (1340) to sustain the day's uptrend.

9:20 AM CT - Note the huge volume increase as we pushed to new highs, and the lopsided distribution of that volume at offer vs at bid. SMH is definitely the weak one here, and that will weigh on NQ if it continues. Indeed, some of that is transpiring as I write.

9:10 AM CT - So far the market is following its historical script quite nicely, following through with solid buying (TICK) and solid volume at the offer, testing the recent highs. Now let's see what kind of follow through we get. As long as the indices are in gear with volume at offer exceeding that at bid and TICK positive, the bias is upward.

8:50 AM CT - TICK distribution remains positive, and we're seeing more volume at offer than bid in ES. Upmove not especially broad: advances lead declines by only about 300 issues. I continue to expect a test of yesterday's highs if the TICK and volume patterns remain positive. Note at 8:55 SMH and ER2 weak here; not a broad rally. I will update later; too many Blogger problems. Sorry.

8:38 AM CT - Pretty flat open ahead of the number. 1333 represents support. Volume once again pretty modest, with TICK moderately positive. Major Blogger problems this AM; will try to update as I can.

8:20 AM CT - I'm having Blogger difficulties this AM, so updates may be less frequent than usual. We're between a solid support area around yesterday's lows (also the lows from the 19th and from Friday) and the resistance at yesterday's highs (also the recent highs from last week). As my last post indicated, reversals of momentum have a generally bullish edge in the short run, so I expect another test of those highs. We have consumer confidence numbers coming out at 9 AM CT, so may see somewhat muted trading ahead of the release. Back after the open.

What We Can Learn From Market History

Historical precedent is an extremely fallible guide to future market behavior. In fact, the only investment strategy worse than relying on history is one that ignores history.

After hearing yet one more trader wax optimistic about stocks rallying when the Fed cuts interest rates, I put together the above chart. What we see is the difference in rates between the 20 year bond and the 26 week bill (red line) vs. the S&P 500 Index.

Notice that at the market top in 2000, we had an inverted yield curve. The bills returned a higher interest rate than the bonds. A similar inversion occurs as I write. What happened when the Fed began aggressively cutting rates, sending the bill yields lower (and the yield spread higher)? Observe how the market tanked all during the initial period of easing.

Is this a universal pattern? No. Short rates climbed steadily in 1994 and the stocks underwent a mild but extended correction. Once the Fed eased rates early in 1995, we began a significant rally in stocks.

What is more important than absolute rates, perhaps, is how fixed income competes with equities for capital. At market tops, we've tended to see the spread between fixed income yields and equity yields well above their moving averages. At market bottoms, we've generally seen the reverse. Thus far, fixed rates, especially on the short end of the curve, compete quite nicely with equity yields. It's when fixed rates become non-competitive on a relative basis that stocks tend to attract interest.

Oh yes; one more historical precedent. Friday was a day in which a large number of stocks displayed significant downside momentum, with my Supply measure (an index of the number of issues closing below their short- and intermediate-term volatility envelopes) exceeding 100. Monday, however, showed significant upside momentum, with the Demand measure exceeding 100.

We've only had 10 occasions since 2003 when we've flipped from strong negative to strong positive momentum in a single session. Four days later, SPY was up by an average .58% (7 up, 3 down)--much stronger than the market's average four-day gain of .17% (522 up, 408 down). Five of the last seven of those occasions during 2005 and 2006 have been profitable four days later.

History doesn't tell us everything, but it's very difficult to find market professionals who have sustained long-term success who don't bring a historical perspective to the table.

Monday, September 25, 2006

Market Psychology AM Update for 9/25/06

10:49 CT - A couple of things before I fly the coop. First off, it is confirmed: I will do a free Web seminar sponsored by the Chicago Mercantile Exchange and the Teach Me Futures site. Details will be posted on that site later this AM and also on my Weblog tonight. The topic of the seminar, scheduled for 3:30 PM CT next Monday, will be "Assessing Market Psychology". This Wednesday, I'll also be doing a talk in Naperville; see the Weblog for details. The other thing is just a market thought to leave you with...a speculation, not a prediction. What if the lows from the 19th and the lows from Friday and today are part of a large bottoming pattern? If so, we'd expect the subsequent rise to take us to new price highs. Just a thought...not yet even a hypothesis. Have a great day, y'all. Update tonight on the Weblog.

10:05 CT - Buying continues; we are in a range defined by the 1330-1 resistance mentioned earlier and the recent lows, which are pretty much equivalent to the Friday lows. If that trading range continues, I'd look for the midpoint of the AM range (around 1326) to serve as an average price, where we might look for topping setups above and bottoming setups below. Note how the break below the first hour range was eventually reversed per the Odds Maker setup. Have a great rest of the morning. I'll post again if there are major developments.

9:57 AM CT - OK, let's step back and review. Good economic news could not sustain higher prices. In those circumstances, you have to figure, "If good news can't push us higher, nothing will." We came down, hit the Friday average price, and then tested the Friday lows. As that happened a couple of divergences occurred. We saw higher TICK low readings as ES made new lows, and NQ/SMH showed some buying interest. That led me to cover up. If a trend is going to materialize or accelerate, it has to carry all the sectors. That wasn't happening. That's worth chart review after the close.

9:46 AM CT - Unusual buying in semiconductors led me to cover shorts here. Let's keep an eye.

9:36 AM CT - At crucial support; ER2 trying to put in a bottom; watching to see if we see rising lows in TICK as well. Failure to do so could give us that breakdown in prices.

9:19 AM CT - Nearing Friday's lows in NQ and close in the other indices. Note how failure to maintain the upside promptly sent us to the Friday average price--and now below. Friday's lows represent important support. A break with expanded volume at bid and with a broad number of stocks participating to the downside would likely bring a significant price decline.

9:12 AM CT - NQ leading the downside here, putting a crimp in any attempt to find a trading bottom. Inability to sustain volume at offer during rally after the number a negative for stocks. Note pickup in volume after the number and recent pickup in volume at bid in ES.

9:02 AM CT - OK, the number came out not so bad and buying resulted. The big question here is whether we can put in a bottom in this 1326 area or retrace the gains from Friday afternoon and overnight. I'm looking to see if we can get that bottom and challenge the 1330-1 overnight recent highs.

8:52 AM CT - Big bids and offers close to the market; that occurs most often when locals aren't afraid of institutions coming in and swiping them. Of course, that could change after the economic release. We're in a nice 3 point range for much of the overnight and early AM; it's the breakout from that range that will make the AM trade. Note, however, that ER2 is retracing much of its Friday and overnight rally. NQ also ran into a wall of selling as it tried to rally above recent resistance. Advancing and declining stocks now almost even. It's going to take some pretty favorable news to power this market higher.

8:45 AM CT - Sidebar: This idea keeps popping up--the notion of the U.S. escalating its military activities in the U.S. It's not just from the political left; see this Israeli Debka article...Meanwhile, the relative strength belongs to NQ in the early going...TICK positive throughout the AM so far, but ER2 looks heavy...1330-1 continues to repel buying so far. Volume tepid in advance of the housing number...I wonder what kind of number it would take to combine with the lower interest rates and kickstart a "worst of housing is over" speculation...Note a bit of AM selling in emerging markets ETF (EEM).

8:35 AM CT - One of the things I'm tracking early is ER2 vs. ES. If we are, as I suspect, in a topping process, I'd expect relative weakness in the broad market and relative strength from large caps. So far, the market is showing buying interest, with advancing stocks over decliners by about 450 issues, with positive NYSE TICK, but only modest ES volume at offer over that at bid. Early volume nothing to write home about; consistent with locals dominating and range bound trade--but let's see how that evolves. That 1330-1 area is still key resistance.

8:25 AM CT - Remember, per the Odds Maker results reported on the Weblog, we'll be looking at breakouts from the first hour range as potential opportunities to fade the market move...Shout out to excellent site, with solid tracking of upcoming economic reports and their expectations...That 1330-1331, BTW, shaping up as important early resistance.

8:14 AM CT - The yield on the ten-year note is under 4.6% and oil broke $60/barrel overnight. These dynamics, bespeaking the emerging economic weakness, have been a positive for stocks in the pre-open, but recall that it was the weak data from the Philly Fed that led to the recent downturn in equities. What's playing out is the ambivalence about "weakness as soft landing" vs. "weakness as recession/hard landing", with each economic update adding fuel to the debate. At 9 AM CT, we'll have yet another data point re: housing. We're trading well above the average trading price (1324) from Friday and should find initial resistance in the 1331/2 area; overnight support around 1327. Any bounce is occurring in the context of a market that is making fewer new highs with each rally (see today's Weblog entry)--something we need to keep in mind for the longer timeframe. Back after the open.

Becoming Your Own Trading Coach

In a recent post, I suggested that coaching for traders could be valuable if properly structured. But is it possible for traders to coach themselves for success? Can the process of expertise development be self-generated?

There is actually a fair amount of research on this topic. The general conclusion of this work, which I review in my upcoming book, is that the importance of mentoring to performance success is specific to each performance field. Team sports, for instance, universally rely upon coaching for expertise development. It is impossible, for instance, for an individual to become proficient at a game such as ice hockey without having a team to practice with.

Other sports and performance fields are more entrepreneurial. Chess, jazz music, and poker are examples of fields where high levels of attainment can be achieved through individual practice and a minimum of formal instruction. These are fields in which learners can execute performances on their own, obtain feedback, and steadily make improvements. Many of the jazz greats, for example, developed their talent by playing night after night in local clubs.

The research of Benjamin Bloom and his colleagues at the University of Chicago suggests that the role of mentors varies across the learning curve. Early in development, a coach teaches basics, as in the case of a Little League coach or a beginning piano teacher. Later, practice becomes more structured and extended as part of competence and expertise development. A coach at these later phases needs to have a solid mastery of the performance activity to structure practice properly and provide meaningful feedback.

Many of the highly successful traders I've known and worked with have acquired their skills through self-development and a relative minimum of guidance from senior traders. In these situations, we can break down their learning activities into four components that I call P3R:
  • Prepare
  • Plan
  • Perform
  • Review

Prepare refers to activities that orient the performer to the upcoming challenge. Running drills helps prepare a football team for a game; reviewing charts and market data prepares a trader for the upcoming trading session.

Plan relies on an assessment of strengths and weaknesses to guide how the performance will be undertaken. A military leader develops a battle plan out of intelligence information about the enemy and an evaluation of his own troop strength and strategic position. A trader's plan includes the patterns he or she will trade, the capital to be allocated to trades, allowable risk, etc.

Perform is the execution of a plan, with mid-course correction as needed. A basketball team will call time out if the performance is not going according to plan. A trader may reassess a plan in light of unexpected economic news and a price breakout.

Review comes after a performance, as part of assessing what was done right and wrong. The military leader conducts an after-action review following a mission to tweak the overall battle plan and correct any weaknesses that might have emerged. A trader utilizes review to identify flaws in trading plans and the execution of those plans, using the feedback to begin a new cycle of Prepare.

Notice that, in good mentorship, Prepare-Plan-Perform-Review is a cycle, not a linear sequence. The idea is to create learning loops in which you the performer/student can also be the mentor/teacher. Incorporating structured feedback into future preparation and planning is key to self-coaching.

Trading journals are a time-honored tool for self-mentoring, structuring and documenting the P3R process. Increasingly, we're seeing online tools for journaling that incorporate graphics and market data into the trading journal. Platforms such as CQG mark charts with the points at which you made trades and worked orders in the book, allowing you to add your own comments. These can be readily printed out for future reference and review. Programs such as Trader DNA allow users to print out charts of trading results and tables of performance, summarizing a variety of performance metrics that highlight strengths and weaknesses.

I'm increasingly impressed with the Stock Tickr program, which now has a Pro version that integrates an online journal with charts of one's trades and statistics about trading results. Users of the program have the option to keep their journals private or share with others in the Stock Tickr community. This latter option opens the door to peer mentorship and coaching.

The most valuable service I can perform for traders, I believe, is not to become their trading coach, but to help them mentor themselves. My upcoming presentation at the Futures Trading Summit will be largely devoted to this topic, stressing ways that traders can accelerate their own development. My hope is also that the morning market updates and trading Weblog can also help traders better Prepare, Plan, Perform, and Review their way to success. A list of additional resources to aid your mentorship is available on the Trader Development page of my personal site.

Subscribe to TraderFeed

Sunday, September 24, 2006

The Cumulative NYSE TICK: A Valuable Measure of Short-Term Sentiment

Readers of my Weblog and the daily morning updates on this blog know that I utilize the NYSE TICK statistics quite extensively in my own trading and analysis.

Why? The NYSE TICK represents, at any given moment, the net number of stocks in the broad market that are trading at their offer prices minus those trading at their bids. When the NYSE TICK becomes very positive, it means that traders are lifting offers in the broad market: buyers are quite aggressive. When the TICK becomes very negative, it means that traders are hitting bids in the broad market: sellers are very aggressive.

The swings in the NYSE TICK during the day, then, represent relative swings in short-term trader sentiment. The beauty of the measure is that it is assessing what bulls and bears are actually doing in the marketplace; not what they report as their sentiment or what they try to fool others into believing.

The above chart tracks the Adjusted NYSE TICK (TICK readings rescaled to produce a zero mean and to include high, low, and close readings every minute of each trading day) on a cumulative basis. That means we add the TICK readings to each other (like an advance-decline line) to track the ongoing ebb and flow of trader sentiment.

Let's see what we can learn from the chart.

First, note that--over time--we're getting somewhat lower Cumulative TICK highs and somewhat higher Cumulative TICK lows. I have found in my research a significant correlation between the volatility of the TICK numbers and intraday volatility in the S&P 500 Index. The lower highs and higher lows are telling us that the 2003 - 2006 period tracked is one of declining volatility. I do not think we can confirm that this bull market is over until we see that pattern change: with lower lows in the Cumulative TICK. That would indicate expanding volatility fueling expanded negative trader sentiment.

Second, note the arrows and Xs. It is very common, on a short-term basis, for the Cumulative TICK to top out ahead of the market and to bottom out ahead of the market. The Xs mark price highs unconfirmed by the Cumulative TICK; the arrows point to unconfirmed price lows. In other words, we frequently see shifts in trader sentiment ahead of actual price turns. That makes the Cumulative TICK a useful heads-up when it is above zero and not confirming new price highs and vice versa.

Finally, you can see that short-term market returns are superior when the Cumulative TICK is below zero than when it is above. When the Cumulative Line is above +4000, returns are negative 5-10 days out--a scenario that is unfolding at present. When the Line is below -1000, returns are superior 20+ days out. Relatively consistent high and low (sell and buy) points can be derived by additionally adjusting the line for volatility.

It has been common for the Cumulative TICK to top out well in advance of price during short-term bull swings. Quite often, the measure has regressed toward zero before the ultimate price high was made. I will be watching to see if this pattern plays out in the current market.

Saturday, September 23, 2006

Tracking Significant Market Days

When analyzing market patterns, are all data points equally meaningful? I've begun looking at market indicators in a different way, eliminating all neutral values and instead focusing only on extremes.

Above we have a chart of the S&P 500 Index ($SPX) from January, 2005 to September 21, 2006. The red line is the closing daily price of the index. The blue line is a 20-day moving average of the net number of "significant" market days in SPX. A significant day is defined as one that is one standard deviation or more greater than or less than the median price change over the past 65 trading sessions. The net significant number of days is simply the number of large up days over the past 20 sessions minus the number of large down days.

As markets top out--and often when they bottom--they produce fewer significant days. The net number of significant days very frequently tops out ahead of short-term market price highs. A sharp shift from net negative to net positive significant days is common during the transition from market bottoms to new short-term bull phases.

Note how our net number of significant days topped out well ahead of the recent market.

Clearly, it will take further investigation to establish the value of tracking significant days. The idea behind the measure is applicable to any stock, commodity, or index--and indeed could be applied to such indicators as advances/declines, TICK, and TRIN. The basic idea is that, just as the largest traders determine market order flow and short-term market movement, the largest market days establish the overall market trend. I will report further on these significance indicators in the Weblog.

Friday, September 22, 2006

Market Psychology AM Update for 9/22/06

10:40 AM CT - One other observation: Note how the TICK bottomed out well ahead of the major averages and then made higher lows as the averages tested their lows. That drying up of selling pattern in the TICK is one that is pretty common at short-term market bottoms. Have a great remainder of the day.

10:23 AM CT - Trying to put in a bottom here. Keep an eye on that TICK distribution; we've seen higher lows. Gotta run; have a great weekend.

10:00 AM CT - My best guess is that institutions are selling ER2 as part of a "weak economy" play. As long as that's the case, we have a chance to take out those recent lows.

9:55 AM CT - Interesting sell program just hit ER2 and not the large caps.

9:42 AM CT - As you can see, the continued negative distribution of the TICK is indicating that we haven't shifted from sellers being aggressive to buyers taking the lead. And we're at key levels. While I'm cautious chasing weakness, I'm also not buying until volume in ES and TICK show me a better shift toward buyers.

9:35 AM CT - There's a bit of a bid underneath NQ and ER2 right now and that's a shift from earlier this AM. It may peter out, and I'll be ready to short again, but I'm not discounting the possibility that all averages hold their lows from the 19th as part of a wide trading range.

9;28 AM CT - Market at an important point here, testing the lows of the 19th as suggested earlier. Hope you've been able to fade the bounces thus far. It's how volume responds from here that will determine whether or not we wash out. Watching ER2 closely as well as NQ. Note NQ did not make a low when the others did a bit ago, which led me to cover shorts for the time being.

9:03 AM CT - Significant step up in selling once we broke those lows mentioned earlier, but ER2 was telling you the story first. TICK distribution weak, volume predominantly at bid in ES; this is a weak market looking to test those lows of the 19th, it appears.

8:53 AM CT - Continued selling, and NQ and ER2 are leading the weakness. Looking to test yesterday lows in ES; already have done so in the other averages. Volume hitting bids predominantly in ES. Not drying up of selling at this juncture.

8:40 AM CT - Moderate volume; lots of big bids and offers in the book, with a skew in the TICK and ES volume toward sellers. ER2 underperforming, and we tested the lows from overnight early on. I'm watching carefully to see if selling dries up or accelerates. We're getting near important downside levels in the indices.

8:20 AM CT - My sense is that we're at an important market juncture. We've seen pretty solid selling as we've gotten above the 1335 level in ES, and we've seen pretty solid support in the low to mid 20s. As I note in my last post, we're seeing elevated levels of new highs *and* new lows, and the expected returns two weeks out are subnormal when that occurs. I do think we can make another run at new highs if we can stay above the bottom area from the 19th, with selling pressure drying up. A break below support on expanded volume, negative TICK, and volume hitting bids would represent, IMO, an important trend shift. 1326 is the overnight low; 1325.50 is yesterday's low; 1322.75 is the low from the 19th. Normal expectations would be for a test of yesterday's lows. If we hold, 1331.50/1332 represents a resistance level I'd expect us to test. Note the continued drop in interest rates and fall in the dollar. An important shift yesterday was that stocks responded negatively to this dynamic, fearing economic weakness more than they celebrated the low inflation. That's a regime worth keeping an eye on. Back after the open.

New Highs and New Lows: What They Tell Us

When we think of new high and new low data, we normally think of the commonly published 52-week highs and lows. For a short term trader, however, 52-week data is a relatively blunt instrument. Many days, the majority of issues make neither annual highs nor lows. It's when we examine the number of stocks making fresh highs or lows on a shorter time frame that patterns become apparent.

This approach to new highs and lows reflects two principles that have guided my market research:

1) Examine, not just what market indices are doing, but what is happening among the majority of individual stocks. Many times, the market index is less than the sum of its parts.

2) Examine data that other traders aren't looking at. The most common market information is also the most picked over. Investigate measures and time frames that others aren't scouring.

The chart above is an example of these principles in action. The data are taken from the Weblog on my personal site and represent the number of stocks on the NYSE, NASDAQ, and ASE that have made new highs (blue line) or new lows (red line) over the past twenty trading sessions.

Notice two things:

1) Recently, we've been making fewer new highs than we did earlier in the month, despite the large cap indices moving to new price highs;

2) Even as new highs have recently been over 1000, we're also seeing over 500 issues making new monthly lows.

What does it mean when we have a market in which many stocks are making new highs, but also many are making new lows? And is this bullish, bearish, or neutral for stocks going forward? Let's take a look.

Since 2003 (N = 927 trading days), we've had 402 days in which there have been more than 1000 issues making fresh 20-day highs. Ten days later, the S&P 500 Index (SPY) is up by an average of only .06% (217 up, 185 down). Conversely, when we've had fewer than 1000 issues making 20-day highs (N = 525), SPY has been up ten days later by an average of .67% (336 up, 189 down).

In other words, the entire bullish bias of the 2003-2006 period has been eliminated for traders who bought the market when it was strong (i.e., when 1000 or more issues were making fresh 20-day highs).

How about when, as recently, we have more than 1000 new 20-day highs, but also more than 500 new 20-day lows. Since 2003, we've had 62 of those occurrences. Ten days later, SPY has been down on average by -.24% (26 up, 36 down). During 2006, we've had 21 days with more than 1000 new 20-day highs and more than 500 new 20-day lows. Ten days later, SPY has been down by an average of -.47% (11 up, 10 down).

What this suggests is that a market with relatively high new highs *and* relatively high new lows is frequently a market in the process of topping. The new highs reflect the strong stocks that are taking the broad averages to new price highs, but the new lows reflect underlying weak sectors that eventually drag down the broader market.

A rising tide is supposed to lift all boats. If some boats remain underwater, one must question the strength of the tide.

Subscribe to TraderFeed

Thursday, September 21, 2006

Market Psychology AM Update for 9/21/06

11:57 AM CT - You can see from movements in interest rates (down sharply) and the dollar (weaker vs Euro) that this economic news (weak Philly Fed) was not priced into the market. Those situations are the ones most likely to lead to stock market revaluations, and we're seeing that in the break below the AM (and yesterday PM) lows, with a distinct shift toward selling (negative TICK, dominance of volume at bid vs offer in ES). The 1322 lows represent important support; next support at 1328/9. Have a great remainder of the day.

10:04 AM CT - Well, so far it's a range bound market, oscillating between the overnight highs and yesterday PM lows, with a rough midpoint around yesterday's average price. So that leads me to look at the possibility of fading moves above and below the average that test edges of the range--as long as volume stays muted. The positive shift in TICK distribution continues, though NQ is a bit muted. I'll update again if any major developments; otherwise, my other life as a trading shrink beckons. Have a great AM. Update tonite on the Weblog.

9:50 AM CT - Sure enough; buy programs hit the Street at 9:45 and 9:46 AM. Notice the drying up of the negative TICK on pullbacks prior to that move. We've moved back to yesterday's average price and will see if we can once again test the highs.

9:42 AM CT - For the most part, we're seeing relatively small bid and offer sizes near the market in the book. In the past when this has happened, it's because locals sense the presence of larger institutions in the market and don't want their orders swiped. Could be a temporary phenomenon, but something I watch...

9:34 AM CT - Trying to put in a bottom here, following some buying interest at yesterday PM lows. Patience pays off...not always in profits, but often in keeping you out of bad trades. Chasing those lows wouldn't have worked out well thus far...

9:20 AM CT - I'm playing it very close to the vest here and seeing if we can bottom out (see selling dry up) in this 1332.50 region. I'm also looking carefully at ER2 and NQ to see if they break down below yesterday afternoon lows. Often those more volatile indices will lead the way on valid breakouts. Patience, patience.... :-)

9:17 AM CT - Financial and energy sectors look stronger within the S&P 500 than the other main sectors. Interest rates are down again. We've had relatively little positive TICK sustained, and volume at bid in ES continues to dominate. Testing afternoon lows from yesterday. Need to see volume at bid expand to sustain breakdown.

9:07 AM CT - We're retracing a fair amount of the afternoon gains following the Fed selling yesterday, especially in ER2. Volume has picked up, though not dramatically so, and volume at bid exceeds that at offer pretty handily in ES. TICK has deteriorated thru the AM so far. 1332.50 represents pretty important support; how we trade vis a vis that point and the TICK distribution during that time will determine whether we go back to retest previous days' lows or whether we stay rangebound for the day.

8:52 AM CT - Nice example of a typical trade I make: wait for the bulls to take their turn, buying to dry up, notice the lack of volume, and play for a reversion to the mean. Not all pan out, to be sure, but the basic trade idea is grounded in how the market is trading.

8:49 AM CT - Volume continues light, and so far we're not breaking above overnight highs. That's leaning me toward tests of that average price and ideas re: a range bound market today. Part of the light volume may be due to waiting for the 9am economic report, of course. So let's see how that shapes up.

8:40 AM CT - Volume on the low side, but skewed so far toward buyers, with a positive TICK and more ES volume at offer than bid. To sustain a break above the overnight highs, we need to see more participation. Failure to take out 1340 targets that average price from yesterday.

8:20 AM CT - We've been bumping up against yesterday's highs in the pre-opening. No great reaction to the Initial Claims numbers; 9 AM will be LEI and 11 AM CT will be Philly Fed. ER2 is most off its highs; NQ a tad stronger. Overnight support is 1335; afternoon support is 1332.50; 1340 is the overnight high. Normal expectations would be to test that high in AM trading; if volume is lackluster, expectations are to test the previous day's average price of 1336.25. We've absorbed selling quite well over the past several days, and that leads me to think we have yet to see the highs of this bull move. Still, it's hard for me to pound the bull table when we've made a 20-day price high on only moderate momentum and new high stats (see Weblog). Expectations over the next five days when we have 20-day highs and modest momentum/new highs are subnormal--no bullish edge since 2004. So my leaning is to let the market show its hand and be prepared to bargain hunt if selling kicks in and we get one of those transition patterns mentioned recently. Back after the open.

Trading Coaches: What Works?

It's rare that a week goes by that I don't get inquiries about the "coaching" of traders. I also frequently receive solicitations from individuals who offer educational, coaching, or mentoring services for traders. But does such coaching work? Is it worthwhile?

I recently completed a review of research regarding behavior change and the factors that enable people to alter their patterns of thought, emotion, and action. The PowerPoint slide above summarizes many of the findings.

What the research suggests is that simply talking with a coach, mentor, or counselor is of limited benefit. Yes, it can provide perspective and insight. Actual change, however, requires that people engage in new experiences. These enable individuals to internalize revised views of themselves and the world.

For example, talking with a couple about their frequent arguments and how to reduce them is less effective than requiring each member of the couple to argue right there in the office, but with each person taking the side of the other. That is, Spouse #1 has to argue from the point of view of Spouse #2 and vice versa. This discrepant experience helps people see themselves--and each other--in a new light.

Similarly, talking with a trader about trading a longer time frame is not as effective as actually observing a trader on a simulator attempt to hold positions longer and then process problems as they occur.

As a rule, when it comes to change, experience trumps talk.

The best forms of helping get people involved in the change efforts emotionally and behaviorally. If people experience strong emotions during the change process--and if they actively engage themselves in change daily--the new patterns are more likely to take root than if coaching is a bland, one-day-a-week effort.

For instance, when a trader is experiencing inhibition in a particular trading situation, I find a historical set of days on a simulator for the trader to trade that will involve frequent exposure to that situation. I then work with the trader while he/she is trading to face the emotions involved, rehearse cognitive and behavioral self control methods, and implement trading plans and strategies. That brings helping efforts to life.

A very large body of research suggests that people are likely to relapse into old behavior patterns if they do not actively rehearse their new changes. Such repetition is essential to internalizing a new set of experiences. My experience is that people are most likely to benefit from change efforts when they utilize new techniques and methods on a daily basis. Self-help guru Tony Robbins makes the claim that, if you do something new the same way, every day for 30 days, you'll have that new pattern for life. The research backs him up.

Because of the commitment of time and effort that such change takes, only those truly ready for change are likely to benefit from coaching. Surprisingly, many people seek help, but are ambivalent about changing. They don't really want to trade a different market, time frame, or strategy. They are not sure they want to cut their position size and implement strict risk management. Research tells us that people are most likely to change when they are in an action phase of readiness: prepared to do what it takes to tackle a problem.

Finally, the research on change is unanimous on one major point: The quality of the relationship between helper and person seeking help is a major factor in whether change efforts will succeed. The successful coach is a kind of mirror to traders: a way that traders can see themselves in a new light. This mirroring can only occur if the coach is trusted, and if traders feel that the coach is committed to their success.

So will coaching work for you? If you're ready for it, if you're committed to doing things new ways and not just talking about change, if you're willing and able to practice new skills, the answer is yes. The average change that people make as the result of counseling is on the order of a full standard deviation. That's one standard deviation of greater confidence, less anxiety, etc.

Will coaching work if you are simply looking to talk about your problems to a caring soul? If you hope that you can cut the cost by holding "sessions" weekly over the phone? Save your time and money. Relapse rates for most common problems are on the order of 75% without proper change efforts.

A variety of free trading psychology articles on my personal site might help you decide if coaching is right for you. This post should help you get started. I do not coach individual traders myself--my work with firms and my own trading keep me plenty busy as it is!--but I am happy to help traders with referrals and recommendations if I can. Mentorship and counseling don't always work, but under the right circumstances they can provide skills and perspectives for a lifetime.

Wednesday, September 20, 2006

Market Psychology AM Update for 9/20/06

11:15 AM CT - Volume has greatly tailed off here and will likely remain muted going into the Fed announcement. Overall, we've had solid buying interest, but I can't say efficiency has been great: that is, we haven't seen a huge price bang for the volume buck. I personally don't trade off announcements until I can pick up a solid read of who is in the market and what they're doing. Very often the first move after news comes out is reversed. I am alert for the possibility that traders today bought on the rumor and might sell on the news. But as long as we stay above the recent trading range highs with positive TICK, the bias will remain to the upside. Have a great day; update tonite on the Weblog.

9:45 AM CT - Volume picked up on the recent rise and remains solid. No changes in the market dynamics so far: An uptrend, remember, is one in which the market makes successively higher price lows on pull backs in the TICK. So far, that's what we've been seeing. Very strong buying interest, with essentially no negative TICK all AM long so far. As long as that's the case, the bias is to the upside. I'll be getting ready for my Chicago presentation; will likely post later today. Thanks for all the warm feedback re: the blog.

9:33 AM CT - Huge buying interest in the broad market is powering ER2 and NQ as well. Those offers are getting taken in ES, but they're slowing that market's advance, so it lags the other two. Following the TICK has been a solid strategy here, and I would not be shorting this market as long as buyers are lifting bids among NYSE stocks. More on the TICK tonight in the Weblog.

9:27 AM CT - Some big offers continued to sit on ES at those highs.

9:25 AM CT - I'll be talking with the Chicago branch of the MTA (Market Technicians Assn) later today; in Naperville next week; and looking to schedule a teaching session for October with the Teach Me Futures site. I believe they have a Market Delta session scheduled for today; check it out. October is also the publication date for my new book, and November I'll be doing the Trading Summit sponsored by the major futures exchanges in Las Vegas. My hope is that these little morning updates have been helpful in illustrating one way to look at markets. It's not the only way, and for you may not be the best way. There are many sources of mentorship in trading, and I'll touch upon those tomorrow in the blog. The TICK remains positive; I would not be selling this market aggressively as long as that's the case. Note the breakout in ER2 and NQ.

9:15 AM CT - One of the things that got me taking quick long side profits a few min ago was seeing large offers at the highs. It wasn't the kind of fake offers where they flash and pull them. These were large traders willing to have those offers taken. My general experience is that very large traders got to be that way for a reason and, at least for the short run, I won't be the guy who grabs a piece of their 2400 lot. Some slowdown of volume; TICK distribution remains positive, which keeps a bid underneath the market and ER2 particularly.

9:06 AM CT - That non-confirmation from NQ was useful info; again, it's valuable to watch many sectors, not just the instrument you're trading. If we do stay below these recent highs, I wouldn't be surprised to see a volume slowdown and range bound market ahead of the Fed. Do watch that TICK distribution, however. It remains positive, and that means we could see another assault on the highs. A shift downward in that distribution would support the range bound case.

8:59 AM CT - Watch for drying up of buying; if so, and we move back into the trading range, we have the value-based target mentioned earlier. Keep an open mind, watch how volume is flowing. So far, follow through on the breakout has been modest. NQ a bit heavy here.

8:54 AM CT - Whoa, I guess my concern was justified. That was a nice present from the market. My general observation is that when volume is hitting bids in ES but TICK is strong, it means that the ES volume is part of arb trade and not a real sign of weakness. So I'm willing to buy into that. Volume has expanded meaningfully on the move above the highs. Watch ER2 for signs of leading a new rally vs. pulling back into the range.

8:45 AM CT - Some continued hitting of bids in ES, but TICK distribution remains strong so far. Volume moderating and consistent, so far, with a range bound market. It's volume that we get if we approach the 1336.75 highs, however, that would tell the important story. My concern here is that the market might not wait for the Fed to test the upside.

8:38 AM CT - Some firmness in the broad market, with advances well ahead of declines by over 1000 issues and a positive TICK. Interestingly, we're seeing a bit more hitting of bids than lifting of offers in ES as we approach recent highs. I'm watching the TICK and broad market (including ER2) carefully; if the firmness continues, I expect us to break those highs.

8:30 AM CT - I show the bulk of recent trading volume occurring in a band between 1329 and 1331.50, which represents, in Market Profile terms, an estimate of value. If we cannot sustain buying and new highs early in the AM, I'd expect a reversion to this area. So far, however, in the pre-market, we're seeing price firmness in NQ and ER2. I'll be watching volume flows carefully on any attempted break to new price highs. On a different topic, a couple of my speaking engagements are posted to the Weblog: one in Naperville next week; the other in Las Vegas in November. The latter will be Webcast as well. Keep tuned to the Weblog; I'll be doing more teaching of market patterns there in the near future. Back shortly.

8:15 AM CT - The afternoon strength has carried over to the pre-opening market on the heels of lower interest rates and lower oil prices. When you look at a daily price chart of yields on the ten-year note ($TNX) and the oil market (USO), not to mention gold (GLD), you can see what has been keeping a bid underneath this market. The general expectation is for range bound trade ahead of the Fed announcement, although no great surprises are expected from the Fed, given the muted inflation readings. We've seen nice buying each time ES has gone into the 1320s, and I suspect that's part of a short-term bottoming process. (See my previous post on the structure of market transitions). If so, I'd expect us to decisively take out the recent highs before too long, despite the formidable resistance in that 1336-1337 region. More after the open.

The Structure of Market Reversals: What We Can Learn From Yesterday's Market

Yesterday's reversal in the ES market had an almost aesthetic beauty: it so nicely captured the dynamics of market reversals.

What I'd like to propose is that important turns in the market possess a common structure. Once you understand that structure, it's easier to recognize its formation in real time and profit from those reversals.

The chart above was the Market Delta screen I tracked in the afternoon. The first phase of the turnaround is heavy volume at the bid, leading to sharply lower prices. This means that sellers are eager to exit the market--they're not even willing to work orders at the offer to get out--and they outnumber buyers (those willing to take the offer price). Remember that the volume at bid vs. offer is telling us about the very short-term sentiment of market participants. The first phase in the market move above is negative sentiment and downward price movement.

In the second phase, the negative sentiment continues--we still get a preponderance of volume at the market bid--but now there is less downward price movement per unit of downside volume. I used the term "efficiency" in my Psychology of Trading book to describe this relationship between market inputs (volume, for instance) and outputs (price change). The market is becoming less efficient. It is not moving as far in price terms per unit volume as it did earlier. Very often the market makes its ultimate price lows at this phase. Divergences with the NYSE TICK and among sectors are often apparent.

This drop in efficiency precedes major market turnarounds. It can be quantified. Very often, the efficient and inefficient phases are separated by a significant bout of counter-trend activity. We see this in the chart during the 12:00 bar. Buyers took the market higher, with much more lifting of offers than we had seen in prior bars. This tells us that a group of market participants are perceiving value at the new, lower prices.

The third phase is accompanied by significant cross-currents of buying and selling, with the market ultimately unable to print new price lows. During this phase, we typically see many divergences and a positive shift of the distribution of the NYSE TICK. This tells us that, across the universe of NYSE issues, an increased number of stocks are being purchased at their offer price. From the first through third phases, it's not uncommon to see a decline in market volume as selling dries up.

The final phase of the turnaround occurs when selling is exhausted and buyers are emboldened, pushing prices higher on increased volume. Much more volume is transacted at the offer price and now the market gains efficiency to the upside. This upside efficiency will continue until the rise, like the prior decline, faces serious countertrend resistance and begins its own second phase of less efficient, higher prices.

One of the great challenges of trading is recognizing this basic structure across multiple time frames. Note how we made a bottom from July, 2002 to October, 2002 to March, 2003. You'll see a similar process. The recent market bottom in June and July also possessed a similar structure. The longer it takes for the market to go through its phases, the more extended the move in the opposite direction. This, too, can be quantified.

Many of the classic chart patterns (double tops/bottoms, head and shoulders, etc.) are simply price-based depictions of what is occurring in the market auction over time, capturing the movement from phase to phase in market transitions. Pattern recognition is a function of multiple exposure to different varieties of patterns: that's how radiologists learn to read X-rays, for instance. Once you become sensitive to the shifts between efficiency and inefficiency, you'll be able to see patterns set up in real time. I will try to highlight some of these patterns in the Weblog and in my updates.

And that, as in yesterday's trade, can make the difference between profiting from turnarounds and getting run over by them.

Tuesday, September 19, 2006

Market Psychology AM Update for 9/19/06

11:55 AM CT - Quick note. After today's trade, review *how* the market traded when we finally broke those levels of support in ER2 and NQ. You'll see an expansion of volume, but more importantly, an expansion of large trades hitting the bid. New sellers came into the market, and that has pushed us to a short-term downtrend as long as we stay below the breakout level (1328.75 in the ES). A short-term downtrend means that we look to sell bounces when buying dries up. That having been said, I don't anticipate a lot of downside from here. My longer-term research (which I don't post to my sites) suggests that we are likely to break those May highs in the large cap indices, so I expect some bottoming before too long. Have a great remainder of the day.

9:32 AM CT - So far the averages are holding and volume is not picking up to the point where we can make an easy transition from a range bound market to a breakout/trending one. I'm watching ER2 most closely for indications of downside breakout vs. holding support. Very often, on breakout/trending moves, the more volatile averages will lead the way. Once again, I'm looking to see if TICK and ER2, NQ can hold above their lows on subsequent selling bursts. I'll be preparing for a talk tomorrow to a group of traders, will update later in the day if any major developments. Have a good trading day!

9:25 AM CT - Volume has picked up to the downside; interestingly, fewer declining stocks over advances now than earlier in the AM. We need to see positive shift in TICK distribution to hold above support.

9:20 AM CT - Lots of hitting bids in ER2 and NQ as we approach important support.

9:17 AM CT - We got the rally attempt, but follow through is poor, esp in NQ. I had to bail out of a long trade. Let's watch those support areas.

9:09 AM CT - Trying to make a bottom in that 1330 area given non confirmations of downside by TICK and ER2 and NQ. Move back to that average price likely if we can hold.

8:58 AM CT - That 730 area is very important support for ER2. Ditto that 1644 region in NQ. A break of those with expanded volume/participation hitting bids would be meaningful. Conversely, I expect us to stay range bound as long as selling dries up in those areas. That's the main thing I'm watching this AM. I'm also looking to see if TICK and ER2, NQ hold above early AM lows on this pullback.

8:49 AM CT - Notice we're around important support on ER2 and NQ. I'm watching carefully to see if that holds. So far, it's a muted TICK distribution. ES volume picked up on the decline; now it's time to see if heavier volume continues. So far not. I'm sticking with a range bound expectation, but have an eye to the downside, given the research posted and the market's tepid response to the good economic news.

8:37 AM CT - Volume is quite moderate; mostly local involvement. Some big bids trying to hold the market up here. ER2 and NQ have retraced much of the pop on the news, and declining stocks actually slightly lead advancers. Not an auspicious response to what should have been excellent economic news IMO. Volume at bid exceeding that at offer in early going in ES.

8:20 AM CT - From 1334.50 to 1336.75 represents a zone in which we've seen considerable selling. The question now is whether or not the favorable economic news (lower inflation, weaker than expected housing starts) that is driving interest rates lower (and dollar lower) will be sufficient to take out that level and catapault us to new highs. If news that favorable can't break the resistance, I'd expect a move back to that average price and a likely retest of range lows. Early volume should tell us a fair amount about *who* is in the market--and that will help us handicap the odds of an upside breakout.

8:00 AM CT - Good morning. The ES market moved below yesterday's lows in pre-opening trade, but both the ER2 and NQ stayed above those levels. A nice bounce on the economic news has taken us well back into the recent trading range. So far, we're seeing good support for the indices during bouts of selling and, if that continues, I'd expect a nice move above the recent market highs. For now, however, a couple of pieces of research suggest we might get a bit of weakness over the next day or two. We're also seeing waning market momentum on the Weblog measures, so I'm not looking for an imminent breakout to the upside. Let's keep an eye on early volume patterns and see if we continue with the rangebound action that we saw yesterday. Note that the average price from the last two sessions has been 1332.75; if we stay range bound, I'd look for failed breakouts of that range to return to that price region--as happened in the pre-opening market this AM. Back after the open.

The Market is Less Than the Sum of Its Parts

If I had to summarize my research approach to the equity indices, it would be this: unique information can be gained by understanding what individual stocks are doing above and beyond the movements of the broad indices. This perspective is captured in the old saying that it's not just a stock market, but also a market of stocks.

A market index is an average--often a weighted one--and, as such, loses as well as conveys information. Knowing that we made a new high in the Dow Jones Industrial Average doesn't tell us whether the broad majority of issues made new highs or whether upside momentum among those stocks is strong or weak.

Above is a chart that I created last month by comparing SPY to the number of stocks in the NYSE, NASDAQ, and AMEX that made fresh 65-day highs minus lows. Notice that, as the market (red line) was making new highs from March through May, new highs were shrinking. Notice also the decreasing new lows as we bottomed between June and July.

I find that shifts in momentum among the broad list of stocks also provides useful information. Readers of the Weblog are familiar with my measure of Demand and Supply. This measure takes every operating company stock and tracks its price against volatility envelopes surrounding two moving averages: one short-term, one intermediate-term. If the stock closes above *both* envelopes, it counts as Demand. If the stock closes below *both* envelopes, it counts as Supply. Thus, what we're tracking is an index of the number of issues that are either significantly strong or weak in price. Everything in between is eliminated.

As mentioned in today's Weblog entry, we had the unusual situation of a market (SPY) making a 20-day high, but showing more stocks closing below the volatility envelopes surrounding their short and intermediate-term moving averages than closing above (i.e., Supply exceeding Demand). Since 2003 (N = 927 trading days), we've had 48 such occasions. Two days later, SPY has averaged a loss of -.17% (20 up, 28 down). That is notably worse than the average two-day gain of .08% (491 up, 436 down) for the entire sample.

Since 2004, when we've had a 20-day high in SPY and a negative Demand/Supply balance (N = 30), the market has been up two days later 10 times and down 20, for a similar average loss. Since 2005, a 20-day high in SPY and a negative Demand/Supply balance (N = 16) has led to an average two-day loss of -.22% (5 up, 11 down).

We see a similar, but less pronounced, pattern when SPY makes a 5-day high, but the market has a negative Demand/Supply balance. Since 2003, there have been 77 such occasions. Two days later, SPY is down by an average -.06% (36 up, 41 down); a subnormal return.

Markets tend to peak by first making momentum highs in which a majority of shares make new highs. Then, as the broad averages grind higher, we see a distribution phase in which some stocks weaken while others continue on to new highs. It's at this phase that we see fewer new highs (as depicted above) and decreased momentum (Demand/Supply). Finally, the weakest stocks begin making fresh short-term lows (trade below their volatility envelopes) and sellers begin hitting bids in the broad list of stocks. That turns the NYSE TICK negative: a decline is typically not far away.

Note that, over the past three sessions that the market index (SPX) has been up, we've had more hitting of bids than lifting of offers among the broad list of NYSE stocks. As mentioned in the Weblog, the Adjusted TICK has been negative all three of those days.

The market index does provide useful information, but it is less than the sum of its parts. Knowing what individual stocks are doing provides important clues to the fate of the broad market.

Monday, September 18, 2006

Market Psychology AM Update for 9/18/06

9:57 AM CT - Just as soon as NQ showed a touch of life, selling hit the market and back we went to that midpoint of the AM range. Being able to discern a range bound market from a trending/breakout one is *so* important. That's it for me today--it's off to my other trader-related activities. Have a great rest of the day. Update tonite on the Weblog.

9:46 AM CT - Turns out that the Odds Maker trade fading the 30 min upside breakout closed pretty flat. We just haven't gotten much selling pressure all AM long, with TICK largely staying above -200. We'll need more of a negative shift in that TICK distribution to sustain a downside move. Volume continues to wane, and it wouldn't surprise me to see continued range bound action. No high relative volume signals to this point in SPY. NQ a little strong here.

9:37 AM CT - A bit of a negative shift in the TICK distribution, but still no strong selling thus far. Nothing to dissuade me that this is anything but a range bound market. So you look to buy near bottoms of ranges, sell around tops, play for those moves back to the mean. Volume slacking off. 100 more advances than decliners. Very mixed market thus far.

9:27 AM CT - Buying dried up as we approached those overnight highs. Nice lead signal by NQ. 1332 is the average price for the day session so far.

9:19 AM CT - NQ looking a bit heavy here; didn't follow the other averages to new highs.

9:15 AM CT - Remember, 1335 is overnight resistance. We got that breakout move with an expansion of TICK and confirmation from NQ and ER2. It's a case where I let my order flow read override taking a signal at the time the signal is given. If we see buying (volume at offer) dry up here, I'd be willing to entertain the short trade. Otherwise, with a positive TICK distribution and volume at offer outpacing that at bid, there aren't too many reasons for getting aggressively short.

9:08 AM CT - I'll be watching for a possible move above the 30 min opening range to see if buying dries up. If so, we have a short entry with a holding time of 30 min. I'll want the confirmation of seeing buying drying up to take that trade, given the modest selling thus far and the fact that we're near the middle of a trading range.

9:00 AM CT - TICK readings never really turned significantly negative so far in the AM and have steadily improved, moving us toward that initial price target. No Odds Maker signals thus far; SPY is not displaying high relative volume--another indication of local-based trade and not heavy institutional involvement.

8:50 AM CT - Volume tailing off here, with mostly local trade. Continues to have me thinking about range bound action today. Let's see sellers take their turn and how the averages hold up. Yesterday's average price is 1332.75 (initial upside target) if we hold the AM lows.

8:40 AM CT - Declines ahead of advancers by over 400 issues; more strength in NQ so far than in ER2. Very muted TICK distribution so far, which suggests modest volatility. I'm watching to see if that continues. If so, odds of a range bound day are quite high. We're trying to put in a low at the 1329 level; I'm watching ER2 and TICK for clues to the success of that effort and a possible move back into the thick of Friday's range.

8:30 AM CT - We've taken a tumble since the overnight highs in response to higher interest rates. My leaning is to wait for the buyers to take their turn and see what they can muster before jumping on the short side. My initial trade idea is to look for a minimum move to the day's average price of 1332.75 if we hold the lows.

8:17 AM CT - We continue to trade in a range between Friday's highs and lows, with overnight resistance at 1335 and Friday support at 1329.50. We're also at May highs in many large cap indices, with quite a few sectors not confirming new highs to this point. So, all in all, some notes of caution. I'll be tracking the "relative volume" measure this AM, per the latest Weblog entry, and will be watching carefully to see how volume flows shift as we approach the edges of the current trading range. How we hold up at the lows early this AM will likely set the tone for the rest of the morning. Let's also keep an eye on breakouts from the opening 30-minute range. Fading those has been a winning trade, according to Odds Maker.