A fascinating paper by Lee and Swaminathan hypothesized a "momentum life cycle" for stocks that describes how share price and trading volume are interrelated. This paper has motivated subsequent research that illustrates how price momentum and earnings momentum are related. It does appear that trading volume plays an important role in determining returns. My personal take on this is that volume reflects the money flows of large, institutional traders who ultimately move markets.
I also suspect that it's not just volume in absolute terms, but relative volume that helps to determine returns. That would fit with the momentum life cycle notion, in which low volume winning stocks turn into high volume winners prior to becoming high volume losers (think: Internet stocks), low volume losers, then low volume winners. What is important is whether sectors or markets are attracting fresh capital as they move higher.
Eventually the high volume winning sectors attract so many momentum participants that performance stumbles (due to earnings disappointment, shifts in fundamentals) set off waves of selling and turn the groups into high volume losers. The sweet spot of portfolio selection is to catch groups that are low volume winners before they attract the momentum players.
Another personal speculation is that bull markets don't end until the high volume winners turn over. One "tell" that the August decline was not the harbinger of a freefall was that many of the winning groups (energy, emerging markets) continued to outperform the broad market.
My previous post discussed my efforts to measure "Technical Strength" by measuring the consistency of trending behavior. The momentum life cycle work suggests that an even more valuable metric would capture price change as a function of relative trading volume.
RELEVANT POST:
Stock Market Strength and Short-Term Price Cycles
.
Sunday, September 30, 2007
A Look At Technical Strength: Sector by Sector
Suppose you segment a given lookback period into a number of separate sub-periods. You can conduct a linear regression over each subperiod, set a threshold slope value, and then determine whether the stock or index was in an uptrend, downtrend, or neutral. A technically strong stock or index for the overall lookback period would be one that is uptrending over a majority of the different subperiods. A technically weak stock or index would be downtrending over the various subperiods. A neutral stock or index would be one in which there is mixed uptrending and downtrending across the subperiods.
The Technical Strength Index (TSI) that I compute thus captures the consistency of trending action over time, as well as the degree to which a variety of stocks display such trending. Thus far, my work with the Index has been limited to the S&P 500 stock universe and eight sectors within the index: Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, Health Care, Financial, and Technology.
As of Friday, here are the TSI values for the eight sectors:
* Materials: +180
* Industrials: +300
* Consumer Discretionary: -120
* Consumer Staples: +300
* Energy: +280
* Health Care: +160
* Financial: +140
* Technology: +360
We see quite a discrepancy between Consumer Staples and Consumer Discretionary issues, as housing concerns weigh on discretionary spending by consumers. Note, however, the very strong readings for Technology and Industrials. This is not a market displaying broad weakness. Even Financials, which had been at the bottom of the pack in August, now display positive strength.
Before stocks go into downtrends, they tend to first lose upside strength. By monitoring the trending behavior of a range of sectors, we can obtain early warning signals of market weakness. So far, we have backed off the very strong readings obtained shortly after the Fed announcement, but have not seen broad weakness.
Eventually, I would like to extend the TSI work to a broad universe of ETFs, which would help to uncover strength and weakness across various market themes and asset classes. A further evolution of this research would be to include volume in the measure, to capture the degree to which capital is flowing into sectors and themes. More to come!
RELATED POSTS:
Measuring the Market's Technical Strength
A Previous Reading of Technical Strength by Sector
.
The Technical Strength Index (TSI) that I compute thus captures the consistency of trending action over time, as well as the degree to which a variety of stocks display such trending. Thus far, my work with the Index has been limited to the S&P 500 stock universe and eight sectors within the index: Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, Health Care, Financial, and Technology.
As of Friday, here are the TSI values for the eight sectors:
* Materials: +180
* Industrials: +300
* Consumer Discretionary: -120
* Consumer Staples: +300
* Energy: +280
* Health Care: +160
* Financial: +140
* Technology: +360
We see quite a discrepancy between Consumer Staples and Consumer Discretionary issues, as housing concerns weigh on discretionary spending by consumers. Note, however, the very strong readings for Technology and Industrials. This is not a market displaying broad weakness. Even Financials, which had been at the bottom of the pack in August, now display positive strength.
Before stocks go into downtrends, they tend to first lose upside strength. By monitoring the trending behavior of a range of sectors, we can obtain early warning signals of market weakness. So far, we have backed off the very strong readings obtained shortly after the Fed announcement, but have not seen broad weakness.
Eventually, I would like to extend the TSI work to a broad universe of ETFs, which would help to uncover strength and weakness across various market themes and asset classes. A further evolution of this research would be to include volume in the measure, to capture the degree to which capital is flowing into sectors and themes. More to come!
RELATED POSTS:
Measuring the Market's Technical Strength
A Previous Reading of Technical Strength by Sector
.
Saturday, September 29, 2007
Ideas on the Investment and Trading Radar
* Is Growth Sustainable? - I believe this NYT story touches on a few investment themes--China, natural resources, inflation--that may be increasingly important down the line.
* Gender and Happiness - Why are women less happy than men these days? I see this in many families in which the men are the traders.
* We're Not Wired to be Good Investors - Here's a nice summary of Jason Zweig's recent book. In a nutshell, the parts of our brain that respond to risk and reward are not those that engage in planning and judgment.
* Sovereign Wealth Boom - From the Middle East to China, countries are putting their reserves to work in the markets, far eclipsing the size of hedge funds. Could this be behind the strength of large caps and growth?
* Recession on the Way? - Markman offers a thoughtful analysis from multiple perspectives. Nice to read quality financial journalism.
* Commodities Boom - September was the largest gain for commodities in 32 years. And stocks? They had their largest September gain since 1998. Liquidity from the Fed and very bearish sentiment in August made for a bullish combination.
* Gender and Happiness - Why are women less happy than men these days? I see this in many families in which the men are the traders.
* We're Not Wired to be Good Investors - Here's a nice summary of Jason Zweig's recent book. In a nutshell, the parts of our brain that respond to risk and reward are not those that engage in planning and judgment.
* Sovereign Wealth Boom - From the Middle East to China, countries are putting their reserves to work in the markets, far eclipsing the size of hedge funds. Could this be behind the strength of large caps and growth?
* Recession on the Way? - Markman offers a thoughtful analysis from multiple perspectives. Nice to read quality financial journalism.
* Commodities Boom - September was the largest gain for commodities in 32 years. And stocks? They had their largest September gain since 1998. Liquidity from the Fed and very bearish sentiment in August made for a bullish combination.
Such an Important Key To Trading Success
I mentioned in my last post that I've found that successful traders tend to have more differentiated views of markets than less successful traders. Before I left for New Zealand, I talked with several traders I had been working with. Several of them have come out of the August weakness very strongly and are at their P/L highs for the year.
One common ingredient for these traders who have been doing well is that they recognized fairly early on that the markets were behaving unusually in August and that their usual patterns and ideas weren't making money as they had been. Moreover, instead of becoming frustrated that their bread and butter trades weren't making money, they reduced their size and focused on the few things that were working.
In the last couple weeks, they've noticed that things have returned to a more normal state of affairs, which has allowed them to move back into trading their old themes and patterns.
Less successful traders trade the same way across various market conditions. Worse, when their ideas and patterns stop working, they become frustrated and try to force the action. The more successful traders know that markets change: they shift their trending, and they change volatility. When their ideas stop working, they become risk averse. When their themes are paying them out, they're not afraid to put money to work.
Stated otherwise, the better traders are always adapting to market conditions. The lesser traders hope that markets will accomodate them. It's another example of how a more differentiated perspective helps traders deal with change--and even thrive during times of uncertainty.
RELATED POST:
Qualities of Successful Traders
.
One common ingredient for these traders who have been doing well is that they recognized fairly early on that the markets were behaving unusually in August and that their usual patterns and ideas weren't making money as they had been. Moreover, instead of becoming frustrated that their bread and butter trades weren't making money, they reduced their size and focused on the few things that were working.
In the last couple weeks, they've noticed that things have returned to a more normal state of affairs, which has allowed them to move back into trading their old themes and patterns.
Less successful traders trade the same way across various market conditions. Worse, when their ideas and patterns stop working, they become frustrated and try to force the action. The more successful traders know that markets change: they shift their trending, and they change volatility. When their ideas stop working, they become risk averse. When their themes are paying them out, they're not afraid to put money to work.
Stated otherwise, the better traders are always adapting to market conditions. The lesser traders hope that markets will accomodate them. It's another example of how a more differentiated perspective helps traders deal with change--and even thrive during times of uncertainty.
RELATED POST:
Qualities of Successful Traders
.
Friday, September 28, 2007
How Successful Traders Think: A Parting Thought From Dr. Brett
While departing for the land Down Under, I had a thought that crystallized an issue in my mind. When I talk with traders, I can often sense within the first few minutes of conversation whether the trader is successful and talented or not. What hit me was identifying, consciously, how I was arriving at that assessment.
The really good traders tend to have differentiated market views. Their thinking is of a higher order of complexity. So, for example, they may be bullish on certain themes, bearish on others. They like some stock market sectors, avoid others. They see in range bound terms sometimes, trending on other occasions. Sometimes they'll see a market dominated by locals and trade accordingly; other times, they'll see "paper" (institutions) dominating the trade and they'll make adjustments.
The really good traders see a large playing field. If they see a weak dollar, they think about how that affects bonds, metals, energy, and international returns. If they see a breakout from a multiday range, they see a swing move in the making, not just an opportunity to make a few ticks. They can be daytraders or portfolio managers--it doesn't matter. They see the field across time frames. They see how markets are interconnected. They see how the morning trade relates to the overnight range, and how today's trade is connected to what we did yesterday.
And the less successful traders? They're bullish or they're bearish. That's it. They think in simple terms of causation: We're having a housing slump; that means we'll have a bear market. We're making new highs; that means we should buy because we're in an uptrend. The news is good, so we'll buy. The news is bad, so we should sell. No complexity. Sadly, we see much of that kind of thinking in the financial media.
Jean Piaget, the developmental biologist, emphasized that cognitive development occurs through a process of assimilation (taking in new information) and accomodation (integrating that new information with what we already know). Over time, that enables us to develop increasingly complex (and accurate) models of the world (schemas). I strongly suspect that process is at work in the development of successful traders.
We often hear advice to the effect that traders should keep things simple. Complexity for its own sake is not helpful in the least. Still, when I talk with successful traders, I am impressed by the relativity of their views: they look at how this is related to that and how they can profit from the relationship. It may be a simple relationship, but it's not simplistic.
The difference is important.
RELATED POSTS:
Overlooked Qualities of Successful Traders
Defining Characteristics of Market Pros
.
The really good traders tend to have differentiated market views. Their thinking is of a higher order of complexity. So, for example, they may be bullish on certain themes, bearish on others. They like some stock market sectors, avoid others. They see in range bound terms sometimes, trending on other occasions. Sometimes they'll see a market dominated by locals and trade accordingly; other times, they'll see "paper" (institutions) dominating the trade and they'll make adjustments.
The really good traders see a large playing field. If they see a weak dollar, they think about how that affects bonds, metals, energy, and international returns. If they see a breakout from a multiday range, they see a swing move in the making, not just an opportunity to make a few ticks. They can be daytraders or portfolio managers--it doesn't matter. They see the field across time frames. They see how markets are interconnected. They see how the morning trade relates to the overnight range, and how today's trade is connected to what we did yesterday.
And the less successful traders? They're bullish or they're bearish. That's it. They think in simple terms of causation: We're having a housing slump; that means we'll have a bear market. We're making new highs; that means we should buy because we're in an uptrend. The news is good, so we'll buy. The news is bad, so we should sell. No complexity. Sadly, we see much of that kind of thinking in the financial media.
Jean Piaget, the developmental biologist, emphasized that cognitive development occurs through a process of assimilation (taking in new information) and accomodation (integrating that new information with what we already know). Over time, that enables us to develop increasingly complex (and accurate) models of the world (schemas). I strongly suspect that process is at work in the development of successful traders.
We often hear advice to the effect that traders should keep things simple. Complexity for its own sake is not helpful in the least. Still, when I talk with successful traders, I am impressed by the relativity of their views: they look at how this is related to that and how they can profit from the relationship. It may be a simple relationship, but it's not simplistic.
The difference is important.
RELATED POSTS:
Overlooked Qualities of Successful Traders
Defining Characteristics of Market Pros
.
Thursday, September 27, 2007
Note for the Coming Week
Well, I'm taking off for New Zealand and Australia, where I look forward to meeting many traders at my seminars and look equally forward to experiencing two beautiful countries.
My posts to the blog and my "tweets" to the Twitter Trader will be limited during this time, but I'll do my best to stay on top of things half way around the world.
Thanks to Colin in NZ and Charles and Jeff in Australia for arranging the visits. A special thanks to STANZ and ATAA for sponsoring the sessions.
Meanwhile, here are a few favorite sites for staying on top of news and markets:
* Abnormal Returns - Great job of tracking down what's happening in finance; unique perspectives.
* Bloomberg - News, market data updated regularly; comprehensive.
* Daily Options Report - Adam Warner has unique takes on the market, coming from an options perspective.
* Millionaire Now! - Larry finds links trading links across the Web and also adds his own perspectives across different asset classes.
* MSN Money - Check out the commentary section, especially articles by Jon Markman. Excellent coverage of market themes.
* The Big Picture - Barry Ritholtz covers the economy and markets; his weekend linkfests are a great summary of what's been happening and what's coming up.
* The Kirk Report - News, markets, the economy, you name it: Charles finds the best of the Web.
* The Street.Com - James Altucher posts an excellent blog watch, with an eye toward stock picking.
* Trader Mike - His updates consistently find interesting market-related stories, and he tracks the action in the major indexes.
My posts to the blog and my "tweets" to the Twitter Trader will be limited during this time, but I'll do my best to stay on top of things half way around the world.
Thanks to Colin in NZ and Charles and Jeff in Australia for arranging the visits. A special thanks to STANZ and ATAA for sponsoring the sessions.
Meanwhile, here are a few favorite sites for staying on top of news and markets:
* Abnormal Returns - Great job of tracking down what's happening in finance; unique perspectives.
* Bloomberg - News, market data updated regularly; comprehensive.
* Daily Options Report - Adam Warner has unique takes on the market, coming from an options perspective.
* Millionaire Now! - Larry finds links trading links across the Web and also adds his own perspectives across different asset classes.
* MSN Money - Check out the commentary section, especially articles by Jon Markman. Excellent coverage of market themes.
* The Big Picture - Barry Ritholtz covers the economy and markets; his weekend linkfests are a great summary of what's been happening and what's coming up.
* The Kirk Report - News, markets, the economy, you name it: Charles finds the best of the Web.
* The Street.Com - James Altucher posts an excellent blog watch, with an eye toward stock picking.
* Trader Mike - His updates consistently find interesting market-related stories, and he tracks the action in the major indexes.
Trading and Investment Themes and Perspectives
* Why Aren't Stocks Going Down? - A reader asked me that question and I sent this chart. The rise is quite steep. What is it? An index of home foreclosures? A measure of national debt? China's stock market? No, this is a chart of earnings for the S&P 500 stocks from 1954 to the present (weekly data). The five-year rate of change in those earnings is well over 200%, the highest during that 50+ year period. It's tough to sustain a bear market while companies continue to earn record profits.* What's Been Working? - Since its lowest close during the August decline (8/15), the S&P 500 Index (SPY) has gained 7.9%. Here are returns over that period from the S&P 500 sectors:
Materials stocks (XLB): 13.8%
Industrials (XLI): 8.19%
Consumer Discretionary (XLY): 4.48%
Consumer Staples (XLP): 5.07%
Energy (XLE): 13.8%
Health Care (XLV): 5.41%
Financial (XLF): 5.84%
Technology: (XLK): 9.45%
Anything connected to the consumer has underperformed. Materials and Energy, perhaps reflecting strong commodity prices and a weak dollar, have been the big winners. The rise from the lows has been uneven and, if we should see new highs in SPY, I wouldn't be surprised to find many sector divergences.
* What in the World? - OK, let's take a look at international returns since the closing low during the August decline:
U.S. (SPY): 7.9%
EAFE (EFA): 9.6%
Emerging Markets (EEM): 22.9%
Canada (EWC): 16.2%
Hong Kong (EWH): 27.6%
U.K. (EWU): 9.4%
International Growth (EFG): 11.4%
International Value (EFV): 7.8%
As noted in an earlier post, Growth is outperforming Value and just about everything is outperforming the U.S. With the weakening dollar, it would seem we have a bit of the ABUSE syndrome: Anything But U.S. Equities.
* Returns by Capitalization - Back to the U.S., what's been outperforming on this part of the style box since the August decline low?
Large Cap (SPY): 7.9%
Mid Cap (MDY): 6.7%
Small Cap (IWM): 7.1%
Large caps are leading the way, perhaps because it's large cap sectors like Energy and Materials dominating performance. All the U.S. returns are pretty anemic when viewed internationally.
I think it's fair to say that the U.S. dollar is affecting returns here and abroad. Traders like to think that returns are a function of timing, but timing is of limited benefit if you're in the wrong sectors and themes.
RELATED POSTS:
The Global Liquidity Boom
Market Moods and Thinking Like a Portfolio Manager
.
Wednesday, September 26, 2007
Trading and Fading Swings in the Stock Market
If you click on the screen above, you'll see what I was watching during this morning's trade. My last post described a situation in which we had a false downside breakout followed by significant buying and a move to new highs, as shorts were forced to cover. That pattern repeated itself this morning. The chart is from Market Delta; just a quick rundown of the information displayed:
1) Left, Y- Axis: This shows the volume traded at each price, color coded to show volume transacted at the offer (green) and at the bid (red). The resulting histogram, which includes data from the start of the day's overnight session, is a kind of Market Profile. We can see that the majority of the volume had been transacted between 1534 and 1535.5. That represents the value area being created for the day.
2) Footprint Bars on the Chart: We're looking at 10-minute bars from 9:00 AM CT through 10:25 AM. Within each bar are two numbers: the volume traded at that time when that price represented the market bid and the volume traded at that time when that price represented the market offer. When more volume is traded at the bid (sellers accepting the bid to get out of their positions), the color of the bar at that price turns red. When more volume is transacted at the offer (buyers accepting the offer to get into their positions), the color of the bar turns green.
3) Bottom, X-Axis: We have two sets of numbers on the bottom X-axis. In blue is the total volume for that 10-minute period. Below that, coded in red or green, is the net volume at the market bid vs. offer. When more volume during the ten-minute period occurred at the market bid, the net volume is given a negative value and is shaded red. When more volume during the period was transacted at the offer, the net volume is positive and shaded green.
So now we can see what happened this morning. We ground lower through the early part of the morning and moved below the market's value area for the day. Around 9:43 AM CT, we broke to new price lows. Note that net volume (that bottom number on the X-axis) was not in any serious downtrend at that point. Indeed, the distribution of the NYSE TICK at that point was positive, suggesting that traders were not broadly selling stocks.
Nor did downside volume pick up following the downside break. In fact, we saw a burst of buying (lifting of offers) at 9:53 - 9:54 AM CT and again at 9:57 - 9:58 AM CT. That returned us quickly to the morning range. Moreover, as the ES futures were making their downside break, the ER2 futures, banking stocks ($BKX), and semiconductor issues (SMH) were all holding above prior AM lows.
As we moved back into the AM range, note how volume--and volume at the market offer--picked up. You can see within the footprint bars how the higher prices were attracting more volume (see total volume for each bar on the X-axis, top number). That was our indication that the market was primed to sustain a break above the morning range.
Later in the day, volume dried up above the early morning highs and we returned again to the value area. It takes volume to initiate a breakout, but it also takes volume to sustain a trending move.
Knowing how volume is flowing, where we're at relative to value, how various sectors are moving--all of these are invaluable in gauging whether to trade or fade market swings. The market is like a chessboard, with many pieces in various alignments. The successful trader is one who doesn't become too focused on one piece or one portion of the board. Seeing the entire board and the broader configurations is what enables the chess master to develop effective strategies and tactics.
RELEVANT POSTS:
Identifying Breakout Moves
Example of a Breakout Trade
.
Opening Range Breakouts: False and Real
If you click on the chart above, you'll get a clearer view of trade in the S&P 500 emini futures (December ES) vs the NYSE TICK for yesterday morning. Volume in the futures is captured on the bottom X-axis. The chart was created in Real Tick.One way short-term traders attempt to gauge direction early in the market day is to look for opening range breakouts. That is, they note the high-low range of an opening market period and then look for breakouts above or below that range. The problem is that such breakouts are just as likely to reverse and return to their range as to continue in a trending move.
The first yellow arrow indicates where we saw the market attempt a breakout from the opening minutes of trade. The NYSE TICK to that point had been in a clear negative range, and note that the attempted breakout did not attract any enhanced volume. The return to the range was an indication that we were likely to at least probe the lows of the range as the market sought to establish value.
When the 10 AM ET economic news came out, the initial reaction was a burst of selling. There we did see enhanced volume and a downside break of the opening range. Not all sectors were participating to the downside, however: the semiconductors and many NASDAQ stocks, for example, were holding their own.
Very shortly thereafter, also on enhanced volume, the market ripped higher and the NYSE TICK made an upside breakout of its range (second yellow arrow).
So think about what that meant: The market attempted a downside break, but buyers came in within two minutes and swiftly returned stocks to their range. Moreover, the buying was broad, lifting the TICK to a morning high.
That is not how stocks behave if they're in a downtrend. Lower prices attracted buyers, suggesting that longer time-frame participants perceived value at those levels. We never returned to those levels for the rest of the day. The sellers are forced to cover their positions, helping turn a false downside breakout into an upside trending move.
If you understand, in Market Profile terms, what happened yesterday morning--how lower prices can attract value-oriented buyers and prevent a downtrend--then you are well on your way toward understanding the August market downdraft and the subsequent market reaction.
The principles are the same. Only the time frame changes.
RELEVANT POSTS:
Failed Opening Range Breakouts
Trading Opening Range Breakouts
.
Tuesday, September 25, 2007
What I'm Reading Midweek
* Please note that I'm also posting links each day via Twitter.
* Thanks to Trader Mike for pointing out the InfoNgen tool that pulls together and organizes material from RSS feeds. Very promising.
* Great link collection from The Kirk Report, including a look from Hulbert at a historical analogue to today's market and a view from Goldman that the worst of the credit crisis might be behind us.
* Dr. Bruce Hong outlines what traders should consider in assembling a trading plan. Excellent site.
* Here's another fine site: A Dash of Insight, written by a professional money manager, shares their ETF model picks and tracks their performance.
* Excellent research: Bespoke Investment Group isn't yet seeing recession in the Chicago Fed data, but offers a view of house price appreciation that isn't for the meek at heart.
* My thanks and appreciation to the pros who take the time to share their views via the blogosphere. You rock.
* Thanks to Trader Mike for pointing out the InfoNgen tool that pulls together and organizes material from RSS feeds. Very promising.
* Great link collection from The Kirk Report, including a look from Hulbert at a historical analogue to today's market and a view from Goldman that the worst of the credit crisis might be behind us.
* Dr. Bruce Hong outlines what traders should consider in assembling a trading plan. Excellent site.
* Here's another fine site: A Dash of Insight, written by a professional money manager, shares their ETF model picks and tracks their performance.
* Excellent research: Bespoke Investment Group isn't yet seeing recession in the Chicago Fed data, but offers a view of house price appreciation that isn't for the meek at heart.
* My thanks and appreciation to the pros who take the time to share their views via the blogosphere. You rock.
When The Words Of Financial Writers Are Indistinguishable From Those of Psychiatric Patients
Over the last week or so--really ever since the Fed decision--I've had a vague sense of dis-ease with respect to many of the online financial columns and blog posts I've been reading. Much of them have seemed oddly bearish given Asian markets that are moving to new highs and S&P 500 and NASDAQ 100 indexes that are not far from bull peaks. But that hasn't been the whole story. Something else has made me uncomfortable with what I've been reading.
When I reflected on how I was reacting emotionally, I suddenly figured it out. Much of what I'm reading is identical to the speech of psychiatric patients. I don't mean this hyperbolically at all. I mean it in a very literal sense. If these writers spoke the words to me that they are writing, I would conclude that they're both emotionally conflicted and constricted.
Allow me to illustrate what I mean:
A man comes into my office, having just lost tens of thousands of dollars in trading. From his facial features, he is clearly upset; it's money his family can't afford to lose. He says to me:
"The market moved away from its average and that made the sellers jump in. It was a large loss and now it's just a matter of looking to the future. Things like this happen. You just have to figure it out. The economy can't be all that bad. Stocks have to come back. Just look at interest rates. That has to give things a boost."
What would I conclude from this speech sample? I would see that our patient is upset, but I would also note that he doesn't own any of it. Indeed, he barely speaks about himself. He doesn't talk about what happened in any detail, and he certainly avoids any kind of talk about his feelings.
In other words, he's conflicted (upset about his loss) and he's constricted (not able to talk about his experience). That's a common combination among psychiatric patients. The role of the shrink is to see behind the words to the experience underneath. That's where the real information lies.
Suppose we treat the writings of financial pundits the way we would treat the language samples of patients in therapy. Fortunately, there is software available to accomplish this for us, developed by James Pennebaker and his research team at the University of Texas. This software, called Lingustic Inquiry and Word Count (LIWC), will parse any text into various categories and components.
So what I did was take 7 financial columns from very respected sources, all with distinctly bearish themes. I then used the LIWC program to analyze the 15 pages of single-spaced text from these columns.
According to LIWC, exactly .55% of the text overall consisted of the word "I". The writers barely acknowledged themselves in their writings. They were offering personal views on the markets, but not presenting those as such.
Despite the profoundly bearish themes of the articles and the evident concern of the writers, only about 4% of the content consisted of emotion-related words. Oddly, those were evenly divided between positive emotion and negative emotion terms. In other words, the actual text of what was said did not match the emotional tone of the underlying message.
So what we have is a group of writers offering their personal perspectives and expressing their concerns about the Fed decision, inflation, the weak dollar, etc. Their texts, however, are written in such a way as to present the material as factual and neutral: not coming from a personal source and not connected to any emotional response.
It's just like the hypothetical patient above: worried people who talk in impersonal, non-emotional ways.
In a patient, this is known as "defense"--avoiding one's true sources of concern. In the world of online journalism, it passes for objective reporting.
Don't get me wrong: I don't think online columns and blog posts are worthless. On the contrary: linguistic distortions mask real, underlying information. Any good shrink knows that.
RELEVANT POST:
The Psychology of Taking Losses
.
When I reflected on how I was reacting emotionally, I suddenly figured it out. Much of what I'm reading is identical to the speech of psychiatric patients. I don't mean this hyperbolically at all. I mean it in a very literal sense. If these writers spoke the words to me that they are writing, I would conclude that they're both emotionally conflicted and constricted.
Allow me to illustrate what I mean:
A man comes into my office, having just lost tens of thousands of dollars in trading. From his facial features, he is clearly upset; it's money his family can't afford to lose. He says to me:
"The market moved away from its average and that made the sellers jump in. It was a large loss and now it's just a matter of looking to the future. Things like this happen. You just have to figure it out. The economy can't be all that bad. Stocks have to come back. Just look at interest rates. That has to give things a boost."
What would I conclude from this speech sample? I would see that our patient is upset, but I would also note that he doesn't own any of it. Indeed, he barely speaks about himself. He doesn't talk about what happened in any detail, and he certainly avoids any kind of talk about his feelings.
In other words, he's conflicted (upset about his loss) and he's constricted (not able to talk about his experience). That's a common combination among psychiatric patients. The role of the shrink is to see behind the words to the experience underneath. That's where the real information lies.
Suppose we treat the writings of financial pundits the way we would treat the language samples of patients in therapy. Fortunately, there is software available to accomplish this for us, developed by James Pennebaker and his research team at the University of Texas. This software, called Lingustic Inquiry and Word Count (LIWC), will parse any text into various categories and components.
So what I did was take 7 financial columns from very respected sources, all with distinctly bearish themes. I then used the LIWC program to analyze the 15 pages of single-spaced text from these columns.
According to LIWC, exactly .55% of the text overall consisted of the word "I". The writers barely acknowledged themselves in their writings. They were offering personal views on the markets, but not presenting those as such.
Despite the profoundly bearish themes of the articles and the evident concern of the writers, only about 4% of the content consisted of emotion-related words. Oddly, those were evenly divided between positive emotion and negative emotion terms. In other words, the actual text of what was said did not match the emotional tone of the underlying message.
So what we have is a group of writers offering their personal perspectives and expressing their concerns about the Fed decision, inflation, the weak dollar, etc. Their texts, however, are written in such a way as to present the material as factual and neutral: not coming from a personal source and not connected to any emotional response.
It's just like the hypothetical patient above: worried people who talk in impersonal, non-emotional ways.
In a patient, this is known as "defense"--avoiding one's true sources of concern. In the world of online journalism, it passes for objective reporting.
Don't get me wrong: I don't think online columns and blog posts are worthless. On the contrary: linguistic distortions mask real, underlying information. Any good shrink knows that.
RELEVANT POST:
The Psychology of Taking Losses
.
The Psychology of Losing
A large body of research conducted by James Pennebaker of the University of Texas, Austin finds that the expression of emotion has long-term mental and physical health benefits. His book Opening Up is an excellent, readable summary of his investigations, with numerous practical applications.
One particularly interesting finding is that the venting of emotion alone does not help people deal with traumas and other difficult experience. Rather, it is placing experience into words--either through speech or writing--that helps us achieve a perspective that enables us to move on from difficult circumstances.
Study after study finds that, when people cannot give proper voice to their troubles, they experience significant health problems and increased medical utilization down the line. Perhaps this is why psychotherapy, online social tools, and religion confession are so popular in our culture: they are ways for us to process our daily experience--not just to unburden ourselves, but to find new views of our situations.
The relevance to trading is clear: It may not be losing that damages traders, but unacknowledged losing.
I recall one trader I met with who went through a nasty downturn in his P/L. He felt guilty about his losses and felt that he could not tell his wife, who was going through her own problems at the time. The more he hid the problems from her (and from friends), the more he felt stressed and upset--and the more his emotional state interfered with his trading. Only once we had a couples session and laid everything out was he able to clear the air emotionally and get back to trading basics. The losses were manageable in their size, but hiding them took too much of a toll.
Similarly, a trader who ignores a stop and turns a short-term trade into a longer-term hold is attempting to squelch the experience of loss. Instead, internal tension builds and helps the trader make further bad decisions, such as doubling down on the losing position.
Contrast that with the situation I described in my most recent entry on the Trader Performance page, where I look at the epistemological unit of a trader's thought. When a trade idea is based upon an anticipated market movement, not a single entry/exit, it frees the trader to anticipate a loss in advance and flexibly reverse a position. Psychologically, this means that a loss is processed before it even occurs. It is used as information that can help the trader capitalize upon the anticipated market move.
Increasingly, my trade ideas take the form of "what-if" decision trees that include the possibilities of initial, small positions moving my way and moving against me. The decision trees address adding to positions and scaling out of them, and they enable me to be wrong with the initial small position and still benefit from the larger idea.
By requiring yourself to map out these decision trees, you can process trading experience proactively and constructively. A losing trade is placed into a larger context in which it has potential value.
A trading journal at the end of the day then serves the purpose of reviewing performance, highlighting what you did right and wrong, and setting goals for the next day. Such a journal, too, has its psychological benefits. Pennebaker has found that the same benefits achieved by talking about one's feelings can be achieved by writing for 30 minutes in a journal.
I am increasingly convinced that how traders process experiences of loss--including extended periods of drawdown--separates those who come back strong and those who become bogged down and even traumatized.
PS - I'm now forwarding links to worthwhile readings across the Web via Twitter. If you do not have the Twitter comments automatically sent to your reader, you can check out the daily reading links and indicator summaries on my Twitter page. The most recent five Twitters appear on the TraderFeed home page under the column "Twitter Trader".
RELEVANT POSTS:
Some Painful Truths About Trading
Regaining Your Trading Consistency
Inside the Trader's Brain
.
One particularly interesting finding is that the venting of emotion alone does not help people deal with traumas and other difficult experience. Rather, it is placing experience into words--either through speech or writing--that helps us achieve a perspective that enables us to move on from difficult circumstances.
Study after study finds that, when people cannot give proper voice to their troubles, they experience significant health problems and increased medical utilization down the line. Perhaps this is why psychotherapy, online social tools, and religion confession are so popular in our culture: they are ways for us to process our daily experience--not just to unburden ourselves, but to find new views of our situations.
The relevance to trading is clear: It may not be losing that damages traders, but unacknowledged losing.
I recall one trader I met with who went through a nasty downturn in his P/L. He felt guilty about his losses and felt that he could not tell his wife, who was going through her own problems at the time. The more he hid the problems from her (and from friends), the more he felt stressed and upset--and the more his emotional state interfered with his trading. Only once we had a couples session and laid everything out was he able to clear the air emotionally and get back to trading basics. The losses were manageable in their size, but hiding them took too much of a toll.
Similarly, a trader who ignores a stop and turns a short-term trade into a longer-term hold is attempting to squelch the experience of loss. Instead, internal tension builds and helps the trader make further bad decisions, such as doubling down on the losing position.
Contrast that with the situation I described in my most recent entry on the Trader Performance page, where I look at the epistemological unit of a trader's thought. When a trade idea is based upon an anticipated market movement, not a single entry/exit, it frees the trader to anticipate a loss in advance and flexibly reverse a position. Psychologically, this means that a loss is processed before it even occurs. It is used as information that can help the trader capitalize upon the anticipated market move.
Increasingly, my trade ideas take the form of "what-if" decision trees that include the possibilities of initial, small positions moving my way and moving against me. The decision trees address adding to positions and scaling out of them, and they enable me to be wrong with the initial small position and still benefit from the larger idea.
By requiring yourself to map out these decision trees, you can process trading experience proactively and constructively. A losing trade is placed into a larger context in which it has potential value.
A trading journal at the end of the day then serves the purpose of reviewing performance, highlighting what you did right and wrong, and setting goals for the next day. Such a journal, too, has its psychological benefits. Pennebaker has found that the same benefits achieved by talking about one's feelings can be achieved by writing for 30 minutes in a journal.
I am increasingly convinced that how traders process experiences of loss--including extended periods of drawdown--separates those who come back strong and those who become bogged down and even traumatized.
* * *
PS - I'm now forwarding links to worthwhile readings across the Web via Twitter. If you do not have the Twitter comments automatically sent to your reader, you can check out the daily reading links and indicator summaries on my Twitter page. The most recent five Twitters appear on the TraderFeed home page under the column "Twitter Trader".
RELEVANT POSTS:
Some Painful Truths About Trading
Regaining Your Trading Consistency
Inside the Trader's Brain
.
Monday, September 24, 2007
Why Aren't Stocks Forecasting Recession?
The Council on Foreign Relations notes that news stories increasingly are using the "R" word, contemplating a recession ahead. Indeed, a Google news search for "recession" turns up quite a few stories, mostly examining the Fed move in the light of averting a possible recession.
When we look at ETFs, however, the market itself seems to be telling a different story. Here are year-to-date returns, as of Friday, for various ETF pairs:
iShares Morningstar Large Cap Growth (JKE): +12.2%
iShares Morningstar Large Cap Value (JKF): +6.1%
iShares Morningstar Mid Cap Growth (JKH): +18.1%
iShares Morningstar Mid Cap Value (JKI): +0.3%
iShares Morningstar Small Cap Growth (JKK): +12.7%
iShares Morningstar Small Cap Value (JKL): -2.9%
iShares Russell 1000 Growth (IWF): +11.0% (-.79%)
iShares Russell 1000 Value (IWD): +4.8% (-2.83%)
iShares Russell 2000 Growth (IWO): +9.1% (-3.65%)
iShares Russell 2000 Value (IWN): -2.4% (-6.72%)
iShares Russell 3000 Growth (IWZ): 10.8% (-1.31%)
iShares Russell 3000 Value (IWW): 4.4% (-3.36%)
iShares Microcap Growth (IWP): 12.0% (-3.54%)
iShares Microcap Value (IWS): 3.5% (-6.55%)
Across every capitalization class, growth has beaten the pants off value year-to-date.
How about since the July market top? Have we shifted regimes away from growth?
The second set of percentage changes for the Russell indices shows the results from July 19th through today. Once again, growth has shown relative strength compared with value. If there is a regime shift, it is toward large caps overall and away from small caps. Perhaps that is because large caps, which on average are more likely to have international sales, can benefit from a weak dollar more than small caps.
In any event, the news and the pundits are saying one thing; the market something else.
If we are headed for recession, why are growth stocks consistently outperforming value?
RELATED POSTS:
A Shift in the Style Box
A Shift Across the Style Cube
A View From the Style Box
.
When we look at ETFs, however, the market itself seems to be telling a different story. Here are year-to-date returns, as of Friday, for various ETF pairs:
iShares Morningstar Large Cap Growth (JKE): +12.2%
iShares Morningstar Large Cap Value (JKF): +6.1%
iShares Morningstar Mid Cap Growth (JKH): +18.1%
iShares Morningstar Mid Cap Value (JKI): +0.3%
iShares Morningstar Small Cap Growth (JKK): +12.7%
iShares Morningstar Small Cap Value (JKL): -2.9%
iShares Russell 1000 Growth (IWF): +11.0% (-.79%)
iShares Russell 1000 Value (IWD): +4.8% (-2.83%)
iShares Russell 2000 Growth (IWO): +9.1% (-3.65%)
iShares Russell 2000 Value (IWN): -2.4% (-6.72%)
iShares Russell 3000 Growth (IWZ): 10.8% (-1.31%)
iShares Russell 3000 Value (IWW): 4.4% (-3.36%)
iShares Microcap Growth (IWP): 12.0% (-3.54%)
iShares Microcap Value (IWS): 3.5% (-6.55%)
Across every capitalization class, growth has beaten the pants off value year-to-date.
How about since the July market top? Have we shifted regimes away from growth?
The second set of percentage changes for the Russell indices shows the results from July 19th through today. Once again, growth has shown relative strength compared with value. If there is a regime shift, it is toward large caps overall and away from small caps. Perhaps that is because large caps, which on average are more likely to have international sales, can benefit from a weak dollar more than small caps.
In any event, the news and the pundits are saying one thing; the market something else.
If we are headed for recession, why are growth stocks consistently outperforming value?
RELATED POSTS:
A Shift in the Style Box
A Shift Across the Style Cube
A View From the Style Box
.
Four Important Conclusions From a Valuable Stock Market Indicator
Readers of the Trading Psychology Weblog and my daily Twitter comments know that one of the indicators I track most closely is the number of stocks on the NYSE, ASE, and NASDAQ making fresh 20-day highs and lows. Above we see daily data on the new highs minus new lows vs. the S&P 500 Index (SPY) from January, 2006 through this past Friday.
Four important conclusions stand out in this chart:
1) We Are In A Bull Market in Large Caps - I know, I know: housing is going to hell; hedge funds are facing redemptions; the dollar is tanking: there's no lack of reasons to be bearish. But the facts speak for themselves. The downward spikes in the new highs minus new lows are occurring at successively higher price troughs. That is how markets climb the proverbial wall of worry: they move higher, shake people out with corrections, and move higher still. If all the fears and turmoil of the past couple of months cannot bring the large caps to a successive low, it's difficult to make the bear case.
2) Not Everything is in a Bull Market - Look at financial stocks within the S&P 500 universe (XLF), and look at the homebuilders ($HGX). They have not made a series of higher price lows from 2006 - present. Now look at the energy issues within the S&P 500 (XLE). They're already making new highs. That tells us this is not a monolithic bull market. If we begin to see a tailing off of new 20 day highs even as large caps churn higher and an increasing number of sectors failing to participate in the new highs, that would be a yellow light for the bull. The bull is maturing, which means that owning the right sectors and stocks will be increasingly important. As bulls age, their rising tide fails to lift all boats.
3) Spikes in New Highs Minus Lows Toward +2000 or Higher Precede Intermediate-Term Price Peaks - The strong and broad momentum that occurs when the vast number of stocks simultaneous 20-day highs tends to persist in the near term. Note the downward pointing arrows where we've had such spikes in new highs. The large caps have tended to churn higher for quite a while before correcting meaningfully. We've just had such a spike this past Tuesday and Wednesday. For that reason, I'm not anticipating a severe market turnaround in the near term, though some consolidation of those gains can be expected. In strong bull swings, such consolidations take the form of flat trading ranges punctuated by upside breakout moves.
4) Drying Up of New Highs Minus Lows Precedes Intermediate-Term Market Bottoms - Note the upward sloping lines below the (pink) new high minus new low data. We tend to get big spikes in new lows prior to intermediate-term price bottoms during market corrections. It's when lower index prices are not accompanied by an expansion of new lows that we are most likely to see a reversal of bearish swings. That happened quite noticeably during the recent market decline.
These four relationships can help orient short-term traders as to the market's bigger picture. When we hear worry upon worry, see equity put/call ratios soar above 1.0, and register large expansions of new lows--and still stay above the lows of prior bear swings, that tells us that there's a wall of worry. For now, stocks are still on the ladder, climbing.
RELEVANT POSTS:
What Happens After a Surge in New Highs?
The Market is Less Than the Sum of Its Parts
.
Sunday, September 23, 2007
The Limits of Behavioral Finance and Neuroeconomics
The field of behavioral finance, which studies how subjective elements introduce distortions in decision-making (and presumably inefficiencies in markets), has been successful in broadening ideas in finance based upon assumptions of investor rationality. More recently, the boom in cognitive neuroscience and wider access to imaging has led to a study of brain processes during financial decisions. Variously termed neurofinance and neuroeconomics, these studies have literally enabled us to get inside our own heads to see what happens under conditions of risk and reward.
Two excellent books have recently hit the market to integrate findings within behavioral finance and neuroeconomics. Both are worthy additions to a trader's bookshelf; after reading them, one cannot help but be impressed with the complexity of decision-making and the ways in which we can stray from rationality. For myself as a psychologist and trader, both books also brought more clearly into focus the limitations of these two fields of study.
Inside the Investor's Brain by Richard Peterson is written primarily for an audience of traders and investors. It is well grounded in research and summarizes a variety of themes in the literature, including how emotions affect judgments and various thought-traps that influence financial decisions. He explores the relationship between gambling and financial decision making, illustrating how we typically respond to risk. He also takes a look at how personality shapes our decisions, including the influence of overconfidence, anxiety, and herding. A final section explores techniques for emotion management and several change techniques. The book is very well written and organized.
Your Money and Your Brain by Jason Zweig is aimed more toward a popular reading audience. It is written in an engaging, easy-to-read style, moving swiftly from research studies to everyday examples of skewed decision-making and behavior and back again. Focused more on neuroeconomics than the broad sweep of behavioral finance, the book is organized by emotional themes: greed, confidence, risk, fear, surprise, regret, and happiness. The author effectively illustrates his points, bringing life and human interest to what could be dry laboratory research.
Having surveyed the fields through these two volumes, I cannot help but notice several limits to our current understanding:
1) The Pendulum Has Swung Too Far - The studies emphasize how we depart from rationality, but don't really explain how it is that we do manage to cope in most challenging life situations. Particularly missing are sophisticated accounts of how reflective reason and reflexive emotion work in concert to help us navigate the world successfully. (Damasio's work, for instance, doesn't figure prominently in these accounts, and the large psychological literature on emotion and coping is almost completely absent). As a result, we seem to have gone from a model of investor rationality to one of investor irrationality. But markets *are* efficient, if not perfectly so, and a thorough account of investor and trader behavior needs to account for that fact.
2) Absence of Real-World Validation - For such a large literature, it is noteworthy that so few studies have been conducted with actual traders in actual trading situations. Either the studies create laboratory decision-making tasks or rely on animal models of choice under various conditions. Interestingly, I can't find any studies where the investigators have simply observed traders in the act of trading and interviewed them about their experience or measured their emotional/physiological response patterns. It's all a bit like studying creativity without observing and talking with artists. As a result, some of the conclusions of the research don't ring true to trading life. For instance, there is a presumption that emotions interfere with good decision-making and need, somehow, to be managed. That fails to account for the important ways in which successful traders and investors do manage to profit from their "feel" for markets.
3) Simplistic Portrayal of the Process of Decision Making - Just about every discussion I run into conflates physiological arousal and subjective emotional experience. The two are not the same, and the relationship between the two is an important mediator of coping and performance. At times intuition is described as a function of the body; at times it is equated with emotional feelings. Howard Gardner's important work on multiple intelligences makes room for "bodily-kinesthetic" knowing: the kind of expertise demonstrated by, say, a mime or a dancer. This is different both from reflective/analytic thought and from emotional awareness. That has yet to be integrated into the literatures of neuroeconomics and behavioral finance.
A little while ago, I announced a trader coaching project in which I offered a month of free coaching to a trader in return for the right to post the process to the blog. That work with the trader I called Trader C went well and leads me to consider extending the project. One way of doing so would be to offer free coaching to traders willing to participate in interviews and biofeedback measurement regarding their decision-making experience. Such a project extension would bring needed real-world perspective to a growing and promising literature.
More on what such a project might look like will be coming in October.
RELATED POSTS:
Neurofinance and the Assessment of Trader Performance
Handling Volatile Markets: Lessons From Neuroeconomics
Inside the Trader's Brain
Research From Dr. Andrew Lo
Is Trading Style Hard-Wired?
.
Two excellent books have recently hit the market to integrate findings within behavioral finance and neuroeconomics. Both are worthy additions to a trader's bookshelf; after reading them, one cannot help but be impressed with the complexity of decision-making and the ways in which we can stray from rationality. For myself as a psychologist and trader, both books also brought more clearly into focus the limitations of these two fields of study.
Inside the Investor's Brain by Richard Peterson is written primarily for an audience of traders and investors. It is well grounded in research and summarizes a variety of themes in the literature, including how emotions affect judgments and various thought-traps that influence financial decisions. He explores the relationship between gambling and financial decision making, illustrating how we typically respond to risk. He also takes a look at how personality shapes our decisions, including the influence of overconfidence, anxiety, and herding. A final section explores techniques for emotion management and several change techniques. The book is very well written and organized.
Your Money and Your Brain by Jason Zweig is aimed more toward a popular reading audience. It is written in an engaging, easy-to-read style, moving swiftly from research studies to everyday examples of skewed decision-making and behavior and back again. Focused more on neuroeconomics than the broad sweep of behavioral finance, the book is organized by emotional themes: greed, confidence, risk, fear, surprise, regret, and happiness. The author effectively illustrates his points, bringing life and human interest to what could be dry laboratory research.
Having surveyed the fields through these two volumes, I cannot help but notice several limits to our current understanding:
1) The Pendulum Has Swung Too Far - The studies emphasize how we depart from rationality, but don't really explain how it is that we do manage to cope in most challenging life situations. Particularly missing are sophisticated accounts of how reflective reason and reflexive emotion work in concert to help us navigate the world successfully. (Damasio's work, for instance, doesn't figure prominently in these accounts, and the large psychological literature on emotion and coping is almost completely absent). As a result, we seem to have gone from a model of investor rationality to one of investor irrationality. But markets *are* efficient, if not perfectly so, and a thorough account of investor and trader behavior needs to account for that fact.
2) Absence of Real-World Validation - For such a large literature, it is noteworthy that so few studies have been conducted with actual traders in actual trading situations. Either the studies create laboratory decision-making tasks or rely on animal models of choice under various conditions. Interestingly, I can't find any studies where the investigators have simply observed traders in the act of trading and interviewed them about their experience or measured their emotional/physiological response patterns. It's all a bit like studying creativity without observing and talking with artists. As a result, some of the conclusions of the research don't ring true to trading life. For instance, there is a presumption that emotions interfere with good decision-making and need, somehow, to be managed. That fails to account for the important ways in which successful traders and investors do manage to profit from their "feel" for markets.
3) Simplistic Portrayal of the Process of Decision Making - Just about every discussion I run into conflates physiological arousal and subjective emotional experience. The two are not the same, and the relationship between the two is an important mediator of coping and performance. At times intuition is described as a function of the body; at times it is equated with emotional feelings. Howard Gardner's important work on multiple intelligences makes room for "bodily-kinesthetic" knowing: the kind of expertise demonstrated by, say, a mime or a dancer. This is different both from reflective/analytic thought and from emotional awareness. That has yet to be integrated into the literatures of neuroeconomics and behavioral finance.
A little while ago, I announced a trader coaching project in which I offered a month of free coaching to a trader in return for the right to post the process to the blog. That work with the trader I called Trader C went well and leads me to consider extending the project. One way of doing so would be to offer free coaching to traders willing to participate in interviews and biofeedback measurement regarding their decision-making experience. Such a project extension would bring needed real-world perspective to a growing and promising literature.
More on what such a project might look like will be coming in October.
RELATED POSTS:
Neurofinance and the Assessment of Trader Performance
Handling Volatile Markets: Lessons From Neuroeconomics
Inside the Trader's Brain
Research From Dr. Andrew Lo
Is Trading Style Hard-Wired?
.
Saturday, September 22, 2007
Using the Twitter Trader App for Disaggregation
The Twitter application enables me to maintain a blog within a blog, with updates regarding markets and indicators. Many topics that might not merit their own separate blog post can be easily given their own Twitters of 140 characters or less. I've only been sending the Twitters out since July, but already there have been over 900 posts--almost as many as in a couple of years of TraderFeed.
The most recent five Twitters automatically appear on the TraderFeed blog home page under the section "Twitter Trader". To review prior posts, you can go to my Twitter page or sign up on that page for automatic updates.
I have mostly been using the Twitter app to summarize market indicators and review activity across various markets. The goal is to post information that will help traders prepare for the coming trading day. I will be expanding and refining these posts, particularly after my return to the U.S. in early October.
A second use of Twitter, however, is what I call disaggregation. If you have been around the blogosphere very much, you know that aggregation has been the rage. Sites attempt to cull material from across the Web, post it to their pages, and consolidate sufficient traffic to generate ad revenues.
The problem with aggregation--and the reason I choose to not participate in most aggregation efforts--is that it lumps everything into one pot. There are really good articles and writers represented, and there are some really poor ones. It's like taking designer merchandise, pooling it with discount wear, and hoping to get as many shoppers as possible.
It's also inefficient from the standpoint of the reader. How much time does the average trader have (or care to spend) scouring the Web for nuggets of information?
For this reason, I'll be using the Twitter app for disaggregation. I'll pull posts from the best of the portals and aggregators and link to those via Twitter. I will do my best to limit my links to those posts that offer distinct value and unique information. That will allow me to push the best information to you the reader, and will enable you to click on the links or ignore them as you see fit.
If I think a post is an absolute must read, I'll indicate that in my Twitter. And if you're a blog author yourself and put together a post that you feel is truly a must read, please email me (my address is in the "About Me" section of the TraderFeed home page) and pass along the URLs. No commercial material please; I have no commercial links to the sites I'll be linking via Twitter and accept no direct or indirect consideration for posting the work of others.
Why am I doing this? Disaggregation is a discipline that I need to maintain as a trader--culling out the important themes from the mass of news and writings out there. As long as I'm maintaining that discipline, I'm happy to share the fruits of that labor through a medium as convenient as Twitter and a posting mechanism as simple as Twitteroo.
RELEVANT POSTS:
Twitter Trader Introduction
Indicators Tracked Via Twitter Trader
.
The most recent five Twitters automatically appear on the TraderFeed blog home page under the section "Twitter Trader". To review prior posts, you can go to my Twitter page or sign up on that page for automatic updates.
I have mostly been using the Twitter app to summarize market indicators and review activity across various markets. The goal is to post information that will help traders prepare for the coming trading day. I will be expanding and refining these posts, particularly after my return to the U.S. in early October.
A second use of Twitter, however, is what I call disaggregation. If you have been around the blogosphere very much, you know that aggregation has been the rage. Sites attempt to cull material from across the Web, post it to their pages, and consolidate sufficient traffic to generate ad revenues.
The problem with aggregation--and the reason I choose to not participate in most aggregation efforts--is that it lumps everything into one pot. There are really good articles and writers represented, and there are some really poor ones. It's like taking designer merchandise, pooling it with discount wear, and hoping to get as many shoppers as possible.
It's also inefficient from the standpoint of the reader. How much time does the average trader have (or care to spend) scouring the Web for nuggets of information?
For this reason, I'll be using the Twitter app for disaggregation. I'll pull posts from the best of the portals and aggregators and link to those via Twitter. I will do my best to limit my links to those posts that offer distinct value and unique information. That will allow me to push the best information to you the reader, and will enable you to click on the links or ignore them as you see fit.
If I think a post is an absolute must read, I'll indicate that in my Twitter. And if you're a blog author yourself and put together a post that you feel is truly a must read, please email me (my address is in the "About Me" section of the TraderFeed home page) and pass along the URLs. No commercial material please; I have no commercial links to the sites I'll be linking via Twitter and accept no direct or indirect consideration for posting the work of others.
Why am I doing this? Disaggregation is a discipline that I need to maintain as a trader--culling out the important themes from the mass of news and writings out there. As long as I'm maintaining that discipline, I'm happy to share the fruits of that labor through a medium as convenient as Twitter and a posting mechanism as simple as Twitteroo.
RELEVANT POSTS:
Twitter Trader Introduction
Indicators Tracked Via Twitter Trader
.
Keeping Tabs on Stock Market Sentiment
I observed a while back that the traffic statistics for this blog seem to be reflective of market sentiment. During the brief March plunge and especially during the August weakness, the traffic to this site expanded significantly. I found that these increases were not related to external sites linking to mine. Indeed, I could even track sensitivity to market conditions hour-by-hour: during very weak intraday periods, traffic for that hour expanded well above its norm.Conversely, during July--prior to the market decline--I noticed a distinct dropoff in visits to the site. On slow market days such as Friday, I also notice less blog traffic.
Since mentioning these patterns, other market bloggers have contacted me and mentioned that they've observed similar phenomena. It appears that, during periods of high market uncertainty and volatility, one way that traders and investors cope is to seek information. This manifests itself in increased Web surfing of blogs and other sites that post in a timely fashion.
The reason I bring this up is that, even apart from the slow day on Friday, I've noticed that my traffic statistics are looking more like early July and less like August. Traders don't seem to be reaching out for information in the frantic way that they had been doing during the market decline.
I decided to examine the five-day equity put-call ratio (see chart above) and plot it against the S&P 500 Index (SPY). Sure enough, the put/call ratio has also tailed off as the market has turned around. Option-related sentiment is not far off its early July levels. The put-call ratio has closely followed the traffic patterns on the blog.
Does this mean the market is headed for a sustained decline? Not necessarily. What I've found is that the combination of a weakening market (fewer stocks making fresh 20-day highs; fewer stocks trading above their 50 day moving averages; fewer stocks closing above their volatility envelopes; reduced levels of Cumulative Adjusted NYSE TICK) and bullish market sentiment is the setup for a meaningful correction.
Thus far, during the past week, we've seen solid strength in these indicators (which I track daily in my Twitter comments and summarize weekly in my Trading Psychology Weblog). It's when we see sustained divergences that we want to be lightening our exposure to stocks.
RELEVANT POSTS:
Sentiment and Short-Term Cycles
Cumulative TICK as Sentiment Measure
What Drives Investor Sentiment?
.
Friday, September 21, 2007
Biofeedback and More Weekend Readings
* Biofeedback and Performance - My recent post brought quite a few emails regarding the use of biofeedback as a performance tool. Here is my post on biofeedback as a best practice in trading. I will be extending my work with biofeedback in future posts and in work with traders.
* Great Weekend Reading - Trader Mike updates his links, including a perspective on a continuing bull market. Excellent reading from Abnormal Returns, including what makes hedge funds successful and views from Robert Shiller. See also Kirk's extensive links, including a look at a possible foreclosure frenzy.
* Factoring Risk Into Decision Making - Henry Carstens' views are not simple, but they are very important. Here he explains why it is important to gauge the risk associated with trading historical patterns--and how adding elements to those patterns helps gauge their stability.
* How Economic Growth Affects Perceptions in China and India - A Gallup poll finds interesting differences between the two countries. Compare both of those to the perceptions of the countries formerly part of the Soviet Union.
* How Volatility Affects Returns - Interesting study from Larry Connors finds that historical volatility matters in stock selection.
* The Consumer Crunch - Is already upon us, according to this Gallup survey.
* Great Weekend Reading - Trader Mike updates his links, including a perspective on a continuing bull market. Excellent reading from Abnormal Returns, including what makes hedge funds successful and views from Robert Shiller. See also Kirk's extensive links, including a look at a possible foreclosure frenzy.
* Factoring Risk Into Decision Making - Henry Carstens' views are not simple, but they are very important. Here he explains why it is important to gauge the risk associated with trading historical patterns--and how adding elements to those patterns helps gauge their stability.
* How Economic Growth Affects Perceptions in China and India - A Gallup poll finds interesting differences between the two countries. Compare both of those to the perceptions of the countries formerly part of the Soviet Union.
* How Volatility Affects Returns - Interesting study from Larry Connors finds that historical volatility matters in stock selection.
* The Consumer Crunch - Is already upon us, according to this Gallup survey.
Repressive Coping and Somatic Markers of Experience During Trading
One of the most basic measures of physiological arousal is heart rate. Our heart rate increases with physical exertion, of course, but also rises in response to excitement and stress. In the case of the latter, elevated heart rate is part of the flight-or-fight response pattern that prepares us for action in the face of situations that we experience as threatening.
A very simple way to measure heart rate in real time is with the kind of monitor worn by joggers and runners. The unit I use, manufactured by Polar, has an elastic strap worn below the breastbone that sends signals from sensors to a display worn as a wrist watch. The advantage of such a unit is that, worn regularly, it becomes a natural part of the trader. It does not interfere with trading, and indeed fades from awareness once one is absorbed in the markets.
My base heart rate, when I'm sitting or lying down and reading a book, is in the mid 70s. If I make particular efforts to calm myself, I can get the rate into the upper 60s. My base rate when I'm following the markets during trading hours (but not with a trade on) is in the low to mid 80s. During such a period, I feel very focused and ready for action, but not at all excited or anxious. It is a different subjective experience than simply lying down and reading a book: I feel more alert.
In this post, I will trace my heart rate behavior during an episode of trading from yesterday's market (click on chart above for detail). At the time, the market was slow and range bound; I was looking for a break out of the range between the recent market high (around 9:15 AM) and the market low (around 9:45 AM).
I bought the market around 10:15 AM (see blue arrow). I was noticing a waning of selling in the NYSE TICK and decided to go long the S&P 500 Index with a small position as a feeler. I was skeptical of the long side, however, because of dollar weakness/Yen strength and relative weakness among financial and housing stocks. For that reason, I was prepared to reverse my position if the market could not go higher.
At the time of placing my order, my heart rate was averaging 85. I experienced no particular stress; it was a routine short-term trade. The market very promptly moved my way, and I briefly had a thought of taking a quick one-point profit. That wasn't the plan for the trade, however, so I stayed in the trade. It just as quickly reversed on me, with the negative TICK expanding.
With the expansion of selling, I stopped and reversed my position (SAR on chart), targeting a move below the lows below the 9:45 AM area.
During the market's reversal--and the reversal of my own position--my heart rate did not elevate. This is important: a carefully planned trade--even one that goes against you--does not seem to generate a stress response. Indeed, it felt like a mechanical trade to me. The thoughts at the time were, "OK, we're not going higher; I'll sell here, stop it out if we break 40 and cover when we break below the recent range." I saw the initial (long) trade as information, not as a loss or disappointment.
The market once again quickly moved my way, and I again had a thought of exiting for a quick profit. As before, however, I decided to see the trade through. My heart rate through this time was very consistent, in the low to mid 80s.
Volume really slowed down from there, and the market bounced higher. At one point (marked on the chart as "reaction"), I shifted in my seat and had the distinct thought, "This trade is taking too long to work out." I wondered to myself if I should pull out of the position. I looked at my monitor, and it showed my heart rate in the high 90s.
What was interesting was that I shifted position and my heart rate elevated *before* I was consciously aware of any concern with the trade. Indeed, it would be more accurate to say that my body registered threat first and only then did I interpret that threat explicitly, consciously.
I looked over at the NQ and ER2 futures contracts and saw absolutely no sign of enhanced buying in stocks. I concluded that there was nothing in the slow action or recent bounce that invalidated the basic trade idea. I decided to stick with the position. Shortly afterward, my heart rate returned to the mid 80s, where it stayed for the duration of the trade--including the point at which I covered the position and went flat for a while.
Recent research suggests that repressive coping--the ability to keep physiological arousal from becoming explicit emotional distress--has many adaptive benefits. This research review is particularly informative. During the trade, I experienced heightened physiological arousal, and the marker for this was the shift in my seating position in the chair. I did not, however, experience any unusual anxiety about the position. Indeed, I would describe my state as somewhat bored and a little antsy--a clear response to the slow pace of trading.
In a market with decent volume and volatility, such as we've had recently, the position would have gone my way promptly. My elevated heart rate and shift of position were the first clues that something did not feel right about the trade. It wasn't moving my way as quickly as I expected. That arousal did not manifest itself as distress; rather, it became a cue to examine the trade more closely. When I saw that nothing had really changed in the supply/demand equation, I stuck with the position and my heart rate steadily dropped.
The term "repressive coping" is not quite accurate for my trading episode, though it fits the definition in the research review. In acknowledging and accepting my body's signals, I was able to use them to activate a well-worn behavior pattern of checking price and volume patterns in correlated indexes. Something didn't feel right about the trade, but it turns out that all was OK.
At other times, however, I have taken my flight or fight response to be an action cue to exit the position, with worried thoughts--"Oh no, it's going against me!"--mediating an anxious emotional response. Very, very often those exits turn out to be bad decisions.
What appears to be key, at least in my case, is making myself very aware of somatic markers--shifts in my state--and then using those as information, not as automatic guides to action. Not surprisingly, this is easier to do when trades are planned and when position sizes are reasonable.
Losses need not be stressful if they are preplanned (i.e., if there is a conscious strategy for stopping out of the trade and utilizing the stop-out as market information). Conversely, we can register physiological stress without being consciously aware of any problems with our positions. It's the ability of the mind to register threats subconsciously that provides us with useful alerts--and potential sabotages to decision-making.
RELEVANT POSTS:
Heart Rate Variability and Self Control
Getting Into "The Zone" With Biofeedback
.
Thursday, September 20, 2007
Tracking Themes in a Post-Fed Market
It's been a day of dollar weakness against both the Euro (middle chart) and Yen (bottom chart). Interestingly, it's also a day in which 30 yr bond yields (top chart) are up smartly and approaching the 5% level. The Fed rate cut makes the dollar less attractive relative to higher yielding currencies, but now we're seeing a situation in which the dollar has quite likely peaked vs. the Yen. If so, that makes the carry trade--the borrowing of cheap Yen to finance trades in (among other things) equities--less appealing.
Dollar weakness also raises the likelihood that investors will demand greater return (higher yields) for holding dollars and dollar-denominated assets. That puts pressure on bond prices (and raises yields).
How would rising long-term rates affect the economy, financial issues and housing in particular? I note that, today, banking stocks ($BKX) were down nearly 2%-- far weaker than the S&P 500 Index ($SPX). And housing? The homebuilders index ($HGX) has sharply reversed its strength from earlier this week and closed down over 4% on the day. It's now hovering near its bear lows. Rising long-term rates can't be good for housing.
I submit that the Fed action has accelerated a number of investment themes that will affect returns in the foreseeable future. Financial assets are losers in a stagflationary environment; the tangible assets mentioned in my recent post become the clear winners.
RELEVANT POST:
Interest Rates and Stocks
.
Investment and Trading Philosophy: Who Needs It?
A little over 30 years ago, in an address to West Point graduates, Ayn Rand asked the question: "Philosophy: Who Needs It?". Her basic point was that philosophy, while abstract, is the most practical of disciplines. It provides us with the principles that will guide our lives. The issue is not whether or not we follow a philosophy; rather, it is whether we are conscious of the philosophy we are following.
For the same reason, albeit in a more limited context, market participants need an investment or trading philosophy. Mike Goodson, writing in his blog for the VesTopia site, recently made this excellent point:
I think this is a very important distinction. You cannot stray from a discipline you never defined in the first place. Someone who begins a business starts with a well-researched business plan: it defines opportunities, competitive threats, core strengths, and the like. Behind every business plan is an implicit or explicit business philosophy: a set of principles that lays out one's role in the marketplace, criteria of success, and overriding priorities.
So many of the success stories in business, from Ford to GE to Toyota to Berkshire Hathaway to Ben & Jerry's to Starbucks to Google, are examples of business plans that yoke superior products and services to distinctive business philosophies.
It's common to assert that "trading is a business". If so, do you have a business philosophy that explicitly defines your values and priorities? Do you have a concrete plan that explicitly defines opportunity and threat, that guides your interactions in the marketplace?
Warren Buffett has a philosophy regarding value and a set of methods for defining and investing in such value. Victor Niederhoffer draws inspiration from Galton to define a scientific worldview and a set of methods for identifying and acting upon market patterns. The trend following of the Turtles lies upon a philosophical foundation regarding human nature, as well as specific techniques for defining and exploiting directional movement.
When I've been in a hiring role at trading firms, candidates have been keen to convince me of their passion for trading. Rarely, however, do they display a passion for truly thinking about their trading. Ask a trader about the abstractions of philosophy and you're likely to hear, "Who needs it?" It's during those volatile market storms, such as we've had recently, however, that we find the answer to that question.
Philosophy is our compass when we're lost; it provides a road map to success and a path to personal fulfillment.
RELEVANT POSTS:
Greatness and the Devotion to Development
Reflections on Life and Markets
.
For the same reason, albeit in a more limited context, market participants need an investment or trading philosophy. Mike Goodson, writing in his blog for the VesTopia site, recently made this excellent point:
I am tempted to say that the hardest part of investing for the non-professional is not straying from one's core investment philosophy, but I am afraid that the real answer is the lack of a core investment philosophy.
I think this is a very important distinction. You cannot stray from a discipline you never defined in the first place. Someone who begins a business starts with a well-researched business plan: it defines opportunities, competitive threats, core strengths, and the like. Behind every business plan is an implicit or explicit business philosophy: a set of principles that lays out one's role in the marketplace, criteria of success, and overriding priorities.
So many of the success stories in business, from Ford to GE to Toyota to Berkshire Hathaway to Ben & Jerry's to Starbucks to Google, are examples of business plans that yoke superior products and services to distinctive business philosophies.
It's common to assert that "trading is a business". If so, do you have a business philosophy that explicitly defines your values and priorities? Do you have a concrete plan that explicitly defines opportunity and threat, that guides your interactions in the marketplace?
Warren Buffett has a philosophy regarding value and a set of methods for defining and investing in such value. Victor Niederhoffer draws inspiration from Galton to define a scientific worldview and a set of methods for identifying and acting upon market patterns. The trend following of the Turtles lies upon a philosophical foundation regarding human nature, as well as specific techniques for defining and exploiting directional movement.
When I've been in a hiring role at trading firms, candidates have been keen to convince me of their passion for trading. Rarely, however, do they display a passion for truly thinking about their trading. Ask a trader about the abstractions of philosophy and you're likely to hear, "Who needs it?" It's during those volatile market storms, such as we've had recently, however, that we find the answer to that question.
Philosophy is our compass when we're lost; it provides a road map to success and a path to personal fulfillment.
RELEVANT POSTS:
Greatness and the Devotion to Development
Reflections on Life and Markets
.
Wednesday, September 19, 2007
What Happens After A Strong Stock Market Rise?
Tuesday's market was quite strong, with advancing stocks trouncing losers on the heels of the Fed news. We saw some follow through buying today, but how do stocks fare in the intermediate term following a strong rise?
One measure I track is the number of stocks closing above and below the volatility envelopes surrounding their 20-day moving averages. All stocks trading on the NYSE, NASDAQ, and ASE are included in the calculation; my data go back to September, 2002 (N = 1244 trading days).
On Tuesday, the number of stocks closing above their volatility envelopes outnumbered those closing below their envelopes by a whopping 15:1. During the time I've collected these data, we've only had three higher readings: 6/29/06; 5/25/04; and 7/19/06.
In all, we've had 25 occasions in which the ratio has been 8:1 or greater in favor of stocks closing above their volatility envelopes. Of those, the S&P 500 Index was higher on 20 occasions over a three-week period for an average gain of .90%. That is moderately stronger than the average three-week gain for the remainder of the sample (.70%; 799 up, 434 down).
It's thus a mistake to assume that a strong rise is "due for a correction". 80% of the time, the market has been higher over a three-week horizon. As a rule, a market that lifts off with great strength tends to follow through in the same direction before undergoing a meaningful retracement.
RELEVANT POST:
When Demand Swamps Supply
One measure I track is the number of stocks closing above and below the volatility envelopes surrounding their 20-day moving averages. All stocks trading on the NYSE, NASDAQ, and ASE are included in the calculation; my data go back to September, 2002 (N = 1244 trading days).
On Tuesday, the number of stocks closing above their volatility envelopes outnumbered those closing below their envelopes by a whopping 15:1. During the time I've collected these data, we've only had three higher readings: 6/29/06; 5/25/04; and 7/19/06.
In all, we've had 25 occasions in which the ratio has been 8:1 or greater in favor of stocks closing above their volatility envelopes. Of those, the S&P 500 Index was higher on 20 occasions over a three-week period for an average gain of .90%. That is moderately stronger than the average three-week gain for the remainder of the sample (.70%; 799 up, 434 down).
It's thus a mistake to assume that a strong rise is "due for a correction". 80% of the time, the market has been higher over a three-week horizon. As a rule, a market that lifts off with great strength tends to follow through in the same direction before undergoing a meaningful retracement.
RELEVANT POST:
When Demand Swamps Supply
Commodity Price Inflation: 2000 - Present
If you click on the chart above, you'll see cash index prices for energy, grains, metals, and the U.S. dollar from 2000 to the present.
This is the backdrop against which we've seen a Fed cut in interest rates. (See Barry Ritholtz's blunt assessment).
Since 2000, energy has risen 233.97%; grains have risen 130.69%; metals have risen 162.95%; and the U.S. dollar has fallen 21.86%.
Just since 2006, energy has risen 18.57%; grains have risen 81.66%; metals have risen 36.23%; and the U.S. dollar has fallen 11.73%.
Jim Rogers believes the commodity boom has further to go. He also notes that periods of hot commodities tend to be ones that are not favorable for stocks.
Cutting interest rates when the dollar is weak and commodities are hot? Rogers expects a dollar rout and rising yields from the Fed actions.
It's the latter, history tells us, that would sound the alarm for stocks.
RELEVANT POSTS:
Interest Rates and the Stock Market
What We Can Learn From Market History
.
Tuesday, September 18, 2007
Worthwhile Online Trading Resources
I'm continually scouring the Web for promising trading resources. Here are a few that are on the current radar:
* Tracking Equity and Credit Research and More - I very much like the new Research Recap site developed by Alacra. Here, for example, is Economic Research; here is Market Research. There's even a section of Academic Research. It's free (paid research is available via the site as well), and it's well organized in blog format, with RSS for automatic reader updates.
* Neuroscience Interviews - Here are 11 interviews conducted by Sharp Brains, the latest with Judith Beck, Ph.D., who has been a pioneer in extending the cognitive therapy frameworks developed by her father, Aaron Beck, MD.
* Wealth of ETF Information - The Seeking Alpha site has a page devoted specially to new ETFs. It's amazing what's out there, including muni bond ETFs and an international private equity ETF. See also this page on specialty ETFs that track specific market themes.
* A Thought Provoking Blog - I like the market perspectives offered by Aleph Blog (even if they, like me, were surprised by the 50 bp hike!). Here are some big picture views from Aleph. And, by the way, if you're looking for financial blogs, the best blogroll is on the Instant Bull site, which also does a fine job of aggregating news and trader posts.
* Tracking the Polls - Gallup conducts polls that are very relevant to trading, investing, and the economy. Here we see that people are concerned about the effect of the housing crisis on the economy, but aren't concerned about how the housing situation will affect their personal finances. Here's how Americans view the economy.
RELEVANT POSTS:
Trading 2.0: Resources re: Trading Expertise
More Tools for Traders
* Tracking Equity and Credit Research and More - I very much like the new Research Recap site developed by Alacra. Here, for example, is Economic Research; here is Market Research. There's even a section of Academic Research. It's free (paid research is available via the site as well), and it's well organized in blog format, with RSS for automatic reader updates.
* Neuroscience Interviews - Here are 11 interviews conducted by Sharp Brains, the latest with Judith Beck, Ph.D., who has been a pioneer in extending the cognitive therapy frameworks developed by her father, Aaron Beck, MD.
* Wealth of ETF Information - The Seeking Alpha site has a page devoted specially to new ETFs. It's amazing what's out there, including muni bond ETFs and an international private equity ETF. See also this page on specialty ETFs that track specific market themes.
* A Thought Provoking Blog - I like the market perspectives offered by Aleph Blog (even if they, like me, were surprised by the 50 bp hike!). Here are some big picture views from Aleph. And, by the way, if you're looking for financial blogs, the best blogroll is on the Instant Bull site, which also does a fine job of aggregating news and trader posts.
* Tracking the Polls - Gallup conducts polls that are very relevant to trading, investing, and the economy. Here we see that people are concerned about the effect of the housing crisis on the economy, but aren't concerned about how the housing situation will affect their personal finances. Here's how Americans view the economy.
RELEVANT POSTS:
Trading 2.0: Resources re: Trading Expertise
More Tools for Traders
Climbing Our Own Walls Of Worry
Every trader knows what it's like to be paralyzed by worry.
Sometimes it takes the form of catastrophizing "what-ifs": What if the market moves against me? What if I've lost my ability to trade?
Other times, worry manifests itself as perfectionism, as we become so concerned about getting all indicators to line up, so invested in catching exact tops and bottoms, that we miss out on opportunities.
On yet other occasions, worry can become so intrusive that we will exit positions at the worst times just to achieve some degree of relief.
Many people equate worry and anxiety, but the psychological research suggests otherwise. Worry is a ruminative cognitive process, whereas anxiety is the physiological experience of fear. In a very informative research review, Thomas Borkovec, Ph.D. of Penn State University and colleagues find that worry actually decreases the experience of anxiety in the short run.
In other words, worry is what people do to avoid anxiety; it is a defense against more fundamental fears. Worrying over catching an exact top or bottom, for example, may bind the much greater anxiety over losing money--or losing a trading career.
The problem with worry as a coping strategy is that it does not permit resolution of that more fundamental fear. By turning our attention to the negative aspect of details in our environment, worry does not allow us to engage in the facing of fears that is needed for anxiety reduction. In that sense, worry is the opposite of disclosure: openly acknowledging and talking/writing about one's concerns.
This is because we rarely worry over what we most find anxiety-provoking.
Interestingly, one of Borkovec's techniques for reducing worry is to establish a 30 minute period each day in which a person does nothing but worry! His research finds that shorter periods of worry serve an avoidant function, keeping us away from what we're really anxious about. When people engage in purposeful, extended worry, however, they cannot avoid and end up facing what's really on their minds.
Another technique helpful for worry is desensitization: using imagery to evoke underlying anxieties and normalizing our responses to those. In one variant, called flooding, extended exposure to images and actual experiences of anxiety-provoking situations lead to anxiety reduction.
Worry perpetuates anxiety by deflecting attention from what we find threatening. By getting at the root of our fears and facing them squarely--Pennebaker's research finds that writing openly about them for an extended time leads to emotional relief--we allow ourselves to move beyond them--and we reducing worrying.
So often, when we're worried about the next trade, the real source of our anxiety is Our Trading. It's an important distinction.
RELEVANT POSTS:
Stress, Coping, and Trading
Self-Confidence and Self Talk
.
Sometimes it takes the form of catastrophizing "what-ifs": What if the market moves against me? What if I've lost my ability to trade?
Other times, worry manifests itself as perfectionism, as we become so concerned about getting all indicators to line up, so invested in catching exact tops and bottoms, that we miss out on opportunities.
On yet other occasions, worry can become so intrusive that we will exit positions at the worst times just to achieve some degree of relief.
Many people equate worry and anxiety, but the psychological research suggests otherwise. Worry is a ruminative cognitive process, whereas anxiety is the physiological experience of fear. In a very informative research review, Thomas Borkovec, Ph.D. of Penn State University and colleagues find that worry actually decreases the experience of anxiety in the short run.
In other words, worry is what people do to avoid anxiety; it is a defense against more fundamental fears. Worrying over catching an exact top or bottom, for example, may bind the much greater anxiety over losing money--or losing a trading career.
The problem with worry as a coping strategy is that it does not permit resolution of that more fundamental fear. By turning our attention to the negative aspect of details in our environment, worry does not allow us to engage in the facing of fears that is needed for anxiety reduction. In that sense, worry is the opposite of disclosure: openly acknowledging and talking/writing about one's concerns.
This is because we rarely worry over what we most find anxiety-provoking.
Interestingly, one of Borkovec's techniques for reducing worry is to establish a 30 minute period each day in which a person does nothing but worry! His research finds that shorter periods of worry serve an avoidant function, keeping us away from what we're really anxious about. When people engage in purposeful, extended worry, however, they cannot avoid and end up facing what's really on their minds.
Another technique helpful for worry is desensitization: using imagery to evoke underlying anxieties and normalizing our responses to those. In one variant, called flooding, extended exposure to images and actual experiences of anxiety-provoking situations lead to anxiety reduction.
Worry perpetuates anxiety by deflecting attention from what we find threatening. By getting at the root of our fears and facing them squarely--Pennebaker's research finds that writing openly about them for an extended time leads to emotional relief--we allow ourselves to move beyond them--and we reducing worrying.
So often, when we're worried about the next trade, the real source of our anxiety is Our Trading. It's an important distinction.
RELEVANT POSTS:
Stress, Coping, and Trading
Self-Confidence and Self Talk
.
Monday, September 17, 2007
Are Stock Sectors Pointing to Stagflation?
The chart above is pretty busy, but if you click on the image, you'll be able to tease apart the 2007 performance of the S&P 500 Index (SPY) and eight sectors within that index: Materials (XLB); Industrials (XLI); Consumer Discretionary (XLY); Consumer Staples (XLP); Energy (XLE); Health Care (XLV); Financial (XLF); and Technology (XLK).
As you can see, Energy has been far and away the strongest sector for the year. This reflects the rising price of oil, which in turn reflects the inflationary impact of a weak dollar. Financials have been the weakest sector, thanks, in part, to mortgage crisis concerns. Interestingly, Consumer Discretionary issues have been weak as well, revealing worries over a slowing economy.
When we look at returns since the July market peak, other interesting patterns emerge. Here are how the sectors have fared over that period:
SPY: -4.98%
XLB: -9.61%
XLI: -5.72%
XLY: -8.76%
XLP: -1.65%
XLE: -3.49%
XLV: -3.17%
XLF: -6.82%
XLK: -4.83%
Notice that the Materials stocks have been the laggard since mid-July, falling over 9%. This likely reflects the impact of the falling dollar, which makes raw materials more expensive. We also see continued weakness in the Consumer Discretionary issues, again speaking to concerns over a weakening economy. Interestingly, the strongest sector has been Consumer Staples, as investors have favored shares perceived as recession-resistant.
Now let's take a different look. My Technical Strength Indicator (TSI) is an attempt to quantify trending behavior over short and intermediate-term time frames. A number near zero indicates a trendless market; a number that is solidly positive or negative reflects an uptrend or downtrend. Here are my TSI numbers by sector, based on the five most highly weighted stocks within each group:
SPX Overall: +620
Materials (XLB): -120
Industrials (XLI): +180
Consumer Discretionary (XLY): -120
Consumer Staples (XLP): +180
Energy (XLE): +240
Health Care (XLV): +180
Financial (XLF): -20
Technology (XLK): +100
The TSI numbers provide a somewhat shorter term picture of sector performance. Again, we see Consumer Staples and Energy strong (recession concerns, oil price inflation). We also see weakness among Consumer Discretionary and Materials stocks (weak economy, falling dollar).
So what do we have? A falling dollar, inflationary pressures, and fears of a weakening economy. Going into the Fed meeting, stagflation is on the radar.
RELEVANT POSTS:
Measuring Technical Strength
Technical Strength and Weakness
Readings to Start a Fed Week
* Weakening Stocks - My cumulative line for the Adjusted NYSE TICK has been showing weakness. That has shown up in the stats for new 20-day lows, which hit a multi-week extreme on Friday, with 736 new 20-day highs and 784 new lows.
* Readings on the Fed Decision - Trader Mike updates his links, including why this may be the mother of all trading weeks. See also excellent Fed-related reads from Charles Kirk, including why the Fed can't stop recession.
* Best Blogs - Dave Johnson offers his list and wisely warns against obvious trades.
* Recession Ahead? - Paul Kedrosky, writing for Seeking Alpha, reports very high odds. See also Paul's traffic stats for the major financial portals.
* More Volatility for Stocks? - That's what Adam Warner sees priced into those fat options. But see this perspective on volatility and Fed meetings from VIX and More.
* What Lies Ahead? - A great linkfest once again from Barry Ritholtz, including a perspective on the winners and losers over the next 5 years from Rich Bernstein.
* Readings on the Fed Decision - Trader Mike updates his links, including why this may be the mother of all trading weeks. See also excellent Fed-related reads from Charles Kirk, including why the Fed can't stop recession.
* Best Blogs - Dave Johnson offers his list and wisely warns against obvious trades.
* Recession Ahead? - Paul Kedrosky, writing for Seeking Alpha, reports very high odds. See also Paul's traffic stats for the major financial portals.
* More Volatility for Stocks? - That's what Adam Warner sees priced into those fat options. But see this perspective on volatility and Fed meetings from VIX and More.
* What Lies Ahead? - A great linkfest once again from Barry Ritholtz, including a perspective on the winners and losers over the next 5 years from Rich Bernstein.