A Unique Approach to Emotional Self Regulation

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

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

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

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

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Implications of the Housing Crisis and More Market Readings

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

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

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

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

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

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

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

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

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

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

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

Seven (Questionable) Things I Hear From Traders

1) I missed the bottom (top); it’s too late to get in – More of those destructive perfectionistic standards. By that criterion, you’d only get into a trade if you were clairvoyant. And, of course, if you bought a seeming low or sold a seeming high and were wrong, you’d beat yourself up for fighting the trend. You can’t win with that kind of thinking: winners want to win; they don’t set unattainable goals for themselves.

2) I have a passion for trading – Passion is what traders talk about when they can’t show results. Please, save the passion speeches. Just show a phenomenal work ethic and the commitment will shine through. But if you don’t have concrete goals, concrete ways of working on goals, and specific routines to research markets and prepare for the day, you don’t have a passion for trading. You have a passion for making speeches about being passionate. Whatever.

3) Trading success is mostly mental – I’m now working with six different trading firms, each of whom has very successful traders who have made substantial sums over a period of years. All have finely honed skills, superior information, and unique strategies for exploiting markets. Once you have all of those, then psychology enters the picture to provide consistency and resilience in the face of challenge. But what happens if you have a good mindset, but don’t hone your skills, obtain superior information, or cultivate unique strategies? You’ll calmly and smilingly go up in flames.

4) I have a feel for the markets – And I have a feel for bullshit. Do you have a track record of success across a variety of market conditions? Can you document solid risk adjusted returns over time? Have you actually tested the setups that you “feel”? If the answer to these questions is no, your trading identity rests on an unproven premise. Don’t be surprised when you have trouble sustaining confidence during a drawdown. When the chips are down, what will you really have to feel confident about?

5) Others are trading the pattern; it must be successful – Yeah, right. Back in the day when I actually participated in those well-advertised trading seminars (i.e., before I learned that such participation completely discredits you with serious trading firms), I made an effort to talk shop with the presenters. The majority had no clue as to what markets were doing, how to read the participation of institutions in markets, how to see what market makers were doing, or how to gauge intermarket relationships. Completely, utterly clueless.

6) I can’t afford to lose more money – Fine, close your trading account and put your funds in a FDIC insured certificate of deposit. If you genuinely can’t afford to lose more, don’t risk more. But if what you mean is that you are having trouble emotionally tolerating the feelings of loss and failure, then step away from the screen, study your trades intensively to see what’s working and what isn’t, and focus all your efforts on what’s working with small, small size. You’ll keep risk down as you rebuild confidence. But cut the “poor me” self-talk. I’ve never met anyone who paved the path to winning with whining.

7) I left my job to start trading for a living – Mmmmk. So you have no prior experience or track record, you have a $20,000 account, you’ve read some books and attended some seminars, and you’re going to sustain triple digit annual gains against experienced market pros. That’s a great business plan. And to top it off, you get defensive with anyone (like your spouse who has to pay the bills) who questions your “dream”. And you wonder why I don’t take on wing-and-a-prayer traders for coaching. If I have to participate in a delusion to get paid, I’d rather do without the income.

You know, trading is a craft. It’s something you hone over time. It’s not a place to act out one’s wildest fantasies or basest fears. If you’re not taking a logical approach to trading success, perhaps your motivations for trading are psycho-logical. That, is the saying goes, is an expensive way to learn hard lessons about yourself.

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Turning Setbacks Into Goals

One of the most common mental errors I see traders make is that they equate movement with opportunity. If the market moves and they’re not on board, they berate themselves for “missing opportunity”.

Opportunity, however, is not defined solely by the market and its movement. It is also a function of your trading signals and the ability of those signals to detect a positive expectancy in future returns. If movement were opportunity, there could be no random movement.

The perfectionistic trader looks at market moves and expects to participate in each. This creates a perpetual experience of frustration and failure, because those expectations are never fully met--and *can* never be met.

The proper rejoinder to, “I should have been on board for that move,” is “By what standard?” The only standard that demands participation in all market moves is the standard of omniscience. Perfectionism fails because we will always fall short of omniscience. Perfectionism ensures the mindset of a loser.

A more reasonable set of standards would grade us on outcomes that are in our control: whether we size positions properly, whether we maintain a good risk/reward profile on each trade, whether we follow rules about stops and exits, and whether we trade when and only when there is genuine opportunity.

Steady improvement is a realistic goal that can lead to growing feelings of mastery. Perfectionism dictates unreachable goals that undercut our sense of mastery. No one has ever berated themselves into confidence and competence.

The secret to goal-setting is setting yourself up for success and steadily building the sense of mastery and competence. Every market mistake provides a learning experience when we turn setbacks into goals.

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Market Note for Wednesday

Interesting to see a strong up day (Tuesday) as an inside day. The bounce improved some of the indicator readings, but again it's the follow-through that we need to see. Note the important support formed over the last few days in the NQ futures. That's what's going to break if we get the capitulation scenario, and that's what needs to hold to initiate a bottoming process here. We're seeing 26% of S&P 500 stocks trading above their 50-day moving averages and 38% above their 200-day MAs. Those figures are weaker for the S&P 600 small caps (18% and 26%, respectively).

Some indicators weakened, however. Among NYSE common stocks, we had 15 new 52-week highs, against 193 new lows. Interestingly, that's an expansion of new lows relative to Tuesday. We saw a marginal expansion of new 20-day lows across the three exchanges: 220 new 20-day highs and 1793 new lows. Among the stocks in my basket, we had 4 that were technically strong at the close, 6 that were neutral, and 30 that were weak, a bit of improvement from Tuesday. Until we see a drying up of new lows and sharply stronger momentum figures (Demand/Supply was 59/41 on Tuesday), I will continue to keep powder dry.

Once again, a monitoring of interest rates and the Yen, as well as those critical bank and homebuilding stocks, will tell us much about the market's risk appetite.

A Schematic for Rule-Governed Trading

Suppose you’re establishing a long position in a stock market index because you think the market is strong and will move higher. Let’s unpack the meaning and implications of your position:

1) Because you are buying, you believe that the recent price low (L1) is a candidate swing low for the market;

2) Because you identify the market as strong, the market must be stronger at L1 than at the next previous swing low point L2;

3) Because you think the market is strong, your long position should, at the very least, test the swing high price prior to L1 (H1) and, in a strong market, should exceed H1;

4) The strength of the market should be quantifiable with such indicators as Cumulative NYSE TICK, AD Line, sector behavior, and new highs/lows, such that, if L1 is indeed a swing low for the market, we should not obtain weaker readings on these indicators going forward than the levels obtained at L1;

5) Similarly, if the market is indeed strong, we should see indicator levels exceed those registered at H1;

6) By quantifying strength and weakness of indicators at candidate swing highs and lows, we create natural stop loss criteria, such that we exit a long trade if indicators are weaker at present than at L1;

7) By using prior swing highs and lows as initial price targets, we can ensure that our entries are sufficiently close to L1 to ensure a favorable ratio of reward:risk;

8) By observing similar patterns of candidate highs and lows at higher time frames, we can obtain longer-term price targets;

9) The above rules limit trading to pullbacks in uptrends, bounces in downtrends, and retracements of moves within a range; you are always fading shorter-term moves and going with the longer-term patterns;

10) The above rules provide a set of yardsticks for assessing the quality of one’s trading, including maintenance of stops; holding winners to targets; entering with favorable reward:risk; and entering in direction of longer-term trend.

This is a beginning sketch of a rule-governed, discretionary approach to trading. If I were mentoring a trader, I would first have them follow such a rule-based approach religiously, so that they learn proper discipline and execution. Only after sustained experience managing winning and losing trades would I then allow the student trader to revise and extend the rules to develop his or her own trading style.

More important than the specific schematic is the ability to trade in a rule-governed manner that addresses the trading universals: limiting losses, letting winning trades run, not fighting market direction, etc. Necessary additions to the schematic are rules concerning the proportion of capital to be risked on any given trade (and during any given day) and other rules for money management, including when to add to positions, when to scale out of trades, and which markets/instruments to trade.

Can you really expect yourself to stay disciplined when you haven't made your rules explicit?

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Quick Update for Tuesday

* Indicator Update: Despite Monday's sharp drop at the end of the day, we saw fewer stocks make new lows than last week. Specifically, we had 280 new 20-day highs and 1738 new lows. New 20-day lows had exceeded 2700 early last week. Among NYSE common stocks, we had 21 new 52-week highs and 169 new lows, also not as weak as last week. Within my basket of 40 stocks across the eight S&P sectors, we have 4 stocks qualifying as technically strong, 2 as neutral, and 34 as weak--quite an extreme reading. The Technical Strength Index was a very weak -2160--a level that has been typical of short-term bottoms in the recent past. We have only 20% of SPX stocks trading above their 50-day MA and 33% trading above their 200-day MA. The latter is not yet at the level of recent bear market lows.

* Musings: One wonders, on the heels of the well-timed Abu Dhabi investment in C, if sovereign wealth funds and other overseas money will increasingly perform the role of the Fed in supporting troubled markets. One also wonders about the price of such cooperation and the equal potentials for economic harm when so much wealth is concentrated. From the market's side, as I noted earlier, sharp rallies have led to immediate selling of late, which has kept us in a downtrend. The measure of the current market will be to see if buying can engender further buying in a desire to pick up longer-term value. Until that happens, it's premature to call a bottom, despite very oversold readings and some divergences in the indicators.

After a Devastating Trading Loss

The year was 1982. I had been short most the year and was doing quite nicely in this, my fourth year as a trader of U.S. stocks. For the first time I allowed myself to think about trading as more than an avocation: as a potential source of ongoing income that could help free me to do the writing that I loved best.

Then we hit mid-August. A ferocious rally drove prices sharply higher and left me in the red. I decided to hold and wait for a pullback, but the pullback was mild. We moved sharply higher again in the fall and I was forced to take losses that consumed not only most my profits, but all my dreams of supplemental income.

I'd have to say it was the most depressing period of my life overall. I was questioning the work I was doing in community mental health--a great learning experience, but not a viable career path--and I was not happy in my personal relationships. The trading losses were the icing on a not so delectable cake. The bottom came in a bar in Homer, NY after too much to drink and a smoke that I discovered too late to be adulterated. It was not a happy time.

I'm convinced that the most successful people are not those who avoid those ruts in life, but the ones who use those to turn themselves around. I discontinued trading and embarked on research regarding market timing that, I vowed, would enable me to never make the same mistake. Out of that research came the work on new highs and lows and sector lead/lag relationships that I draw upon to this day.

I also turned it around socially. After consuming a full bottle of scotch at a New Year's party at the end of 1983, I found myself too inebriated to ask the pertinent questions of the woman I had met. Had I asked the questions, I would have found out that she was not yet divorced, had three children, and was nine years my senior--not at all what I was looking for. Today, after 24 years, she remains my wife and the best decision I ever made.

With the marriage in 1984, I inherited shared responsibility for three children. The steps I didn't take for myself I had to take for the new family. Gone were the drinking and partying. I parlayed my community mental health experience into a student counseling position at Cornell University, taking a 33% pay cut in the process. One year later, impressed by the Cornell experience, Upstate Medical University in Syracuse hired me and I joined a medical school faculty.

At Upstate, I realized that my counseling skills were not ideally suited for the medical school environment. I undertook a lengthy review of the research and practice literatures and taught myself the fundamentals of an emerging approach to helping called "brief therapy". Shortly thereafter, I began teaching brief therapy in the psychology and psychiatry programs. In 1990, I published my first review paper in the field, then another in 1992. I had found my niche: one that would lead to over 50 published papers and book chapters, two books in psychology and psychiatry, and two books combining my trading and psychology loves--and, of course, this daily blog.

I look back on that trading loss in 1982 and now see it as the beginning of a turnaround, not as the ending of a dream. But it took an unflinching and unforgiving look in the mirror to make that turnaround. It also took relationships with people I loved enough to want to make more of myself.

I've received several emails and blog comments from traders who have been through devastating trading losses. This post is for you. What doesn't kill you *can* make you stronger, if only you can sustain that hard look in the mirror.

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Inspirations for the New Week

* Large Cap Strength - Here is a daily advance-decline line of the 40 stocks in my basket. As mentioned in my recent post, these are the most highly weighted five stocks within eight S&P 500 sectors: materials, industrials, consumer discretionary, consumer staples, energy, health care, financials, and technology. The advance-decline line for these uber-caps remains bullish, while the advance-decline lines specific to the S&P 600 small caps and the S&P 400 midcaps are in clear downtrends. It's a bit reminiscent of 2000-2001, when a bear market started in NASDAQ and tech stocks, but Dow issues held their own. It seems to be financials and homebuilders playing the role of tech stocks in that drama, however.

* Reading to Start the New Week - Trader Mike updates his links, including a frightening look at bank write-offs and a Dow testing support. More excellent links from The Kirk Report, including a look at meltdown in the economy and a case for buying value funds when they're down. Abnormal Returns returns with more fine links, including a look at oil denominated in various currencies. Barry Ritholtz wraps up the week with a look at what was strong and weak, as well as prospects for the dollar and inflation.

* Ideas for the New Week - Adam takes a look at cyclical volatility. A Dash of Insight provides a look at their trades and at what's strong and weak among ETFs. Bespoke offers a sector snapshot and finds mixed performance. Ray Barros examines the anatomy of a bubble. StockPickr assembles a portfolio of short-squeeze candidates. Seeking Alpha examines ways of investing in water themes.

New Highs and Lows in the Stock Market: Mixed Signals

The basket of 40 stocks that I track daily consists of five of the most highly weighted stocks within eight S&P 500 sectors. In that sense, they are among the largest of the large cap issues. As you can see by clicking the chart above, we tend to see a drying up of new 10-day highs prior to intermediate-term market peaks and a drying up of new 10-day lows prior to market bottoms. (Blue line is SPY; pink line is 10-day new highs minus lows among the 40 stocks).

Prior to Friday's rally we saw new price lows in SPY, but new 10-day lows among my basket of stocks actually contracted relative to earlier in the month. That was not the case among stocks overall; rather, it appears to be limited to the large cap issues. For example, we had 1525 new 20-day lows across the three exchanges on November 8th, but 2739 new lows on November 20th.

On Friday we actually finished with more stocks in my basket making new 10-day highs than lows. The past three occasions in which this has happened, we have seen immediate selling take the market lower. Contrast this to what we saw at the August bottom (and in bottoms typically) in which an initial bounce in new highs is followed by further strength and a surge in new highs.

Following the logic of my recent Weblog entry, if we are to see market bottoming from here, we will want to see small caps join the large caps in subsequent strength. Such strength would be reflected in the NYSE TICK and advance-decline statistics. Conversely, if we are to see further weakness and a market capitulation from here, we would want to see those large caps roll over and join the small caps to the downside. This would be reflected in weakening new high/low numbers for my basket of stocks.

At times like these, I like to track the strongest stock sectors (consumer staples, energy) and the weakest ones (financials, materials, consumer discretionary). Market bottoms begin with maximum downside momentum, pulling even the strongest sectors lower; market bottoms end with broad bargain hunting, pulling even the weakest sectors higher. Friday gave us a nice bounce, but it's the follow through that tells us whether we have further to run on the downside.

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Shedding Some Light on Seasonal Affective Disorder (SAD)

First you notice a loss of energy. You're not as chipper in the morning as you usually are. You find yourself snacking more often to try to jack yourself up, but you simply put on weight. You're not as enthusiastic as usual, and sometimes you're even feeling in the dumps. You don't have a history of depression--and you certainly don't have the signs of major depressive disorder--but it certainly feels as though you're down.

Interestingly, as many as two-thirds of all people who display signs of atypical depression evidence seasonality to their symptoms. This seasonal syndrome, known as SAD (seasonal affective disorder), affects roughly 10% of individuals in winter regions with reduced sunlight. My own experience with SAD began in Syracuse, NY, where I taught on the faculty of an academic department of psychiatry and ran a counseling program for medical and health science students. Quite a few of these students experienced symptoms of lowered energy and mood that were seasonally related.

To this day, even though I'm in sunnier suburban Chicago, I keep a phototherapy light in my office. This cranks out the light equivalent to a sunny day. Although I personally do not experience a full-blown SAD, I do experience the subclinical signs commonly known as winter blues. The daily dose of full sunlight has been helpful in starting my days--quite literally--on a bright note.

Studies in Finland find that the combination of exercise and light significantly improves seasonal mood declines. Interestingly, the authors found that even healthy individuals without winter blues benefit from the combination of light and exercise. Their work suggests that the light exposure has an even greater impact on mood than the exercise. My own experience is that light therapy is often sufficient for people who experience those winter blues; those who experience more profound depressive symptoms in winter can also benefit from a course of anti-depressant medication.

Mood affects decisions and can also impact concentration and other aspects of performance. Seasonal patterns of mood decline often go unnoticed. A careful investigation of your own mood patterns may help you take the steps to smooth your equity curve when the dark, dreary days of winter are upon us.

Stock Market Observations for a Saturday

* Lack of Confidence Remains - Yields on 3 month commercial paper are down since August, but the ratio of yields on 3 month commercial paper to 3 month Treasury bills continues at historic highs. That ratio recently weighed in at 1.43. Going back to 1960 (N = 2499 trading weeks) the median ratio has been 1.098 and the standard deviation has been .08. So we're about four standard deviations above the norm. That tells us that confidence in commercial paper, due to continued subprime concerns, remains weak. Difficult to see how we'll turn around these skittish markets as long as that is the case. Interestingly, the most recent peaks in the ratio occurred in October, 1998 (1.308) and October, 1987 (1.432)--both scary market times but ultimately solid buying opportunities.

* Technical Strength by Sector - My measure of Technical Strength is a quantification of trending over the short-intermediate term. Here are the Technical Strength Index scores by sector for the major S&P 500 sectors:

Materials: -340
Industrials: -240
Consumer Discretionary: -200
Consumer Staples: +300
Energy: -60
Health Care: -120
Financial: -380
Technology: -220

You can see that there has been some use of the consumer staples issues as a safe haven, while formerly strong sectors (materials, technology) have weakened. The financial sector remains on its back despite Friday's bounce.

* Bear Market Benchmark - While stocks are weak, they're not at levels normally associated with bottoms at major bear markets when we look at the percentage of NYSE issues trading above their 200-day moving averages. At important bottoms in 1987, 1990, 1994, 1998, and 2002, we saw 20% or fewer NYSE issues above their 200-day MA. At present, we have 37% of NYSE issues trading above their long-term moving averages.

* Heavy Buying Days - If we look only at common stocks traded on the NYSE (to eliminate funds, preferred issues, and the like), we find that, on Friday, the ratio of up volume to down volume was over 13:1. That's the fifth highest reading in 2007. When we had a higher reading earlier in November, there was rapid follow through to the downside. At market bottoms in March and August, the heavy buying days were followed by further price strength--and more strong buying days. It's the follow through to heavy buying days that tells us whether we were seeing mere short covering or the start of longer-term buying by value-oriented market participants.

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Getting a Handle on Anxiety and Trading

In the last post, we took a look at anxiety and its effect upon decision making. Anxiety affects trading in many ways, including:

* Inhibition - Failing to take trades indicated by one's research or setups;

* Freezing Up - Failing to exit positions that have hit or exceeded one's stop loss level;

* Cutting Winning Trades Short - Exiting trades before targets are hit;

* Chasing Markets - Entering markets late in a move out of a fear of missing the move.

Notice that these include some of the most common "discipline" problems faced by traders. They are eloquent testaments to the ways in which anxiety can alter our processing of information and skew our actions.

The first step in dealing with anxiety effectively is to assess its causes. There is no "one size fits all" solution for anxiety; an assessment by an experienced, trained professional is important. Here are a few of the assessment questions I ask when working with a trader who has been wrestling with anxiety:

1) Is the anxiety a response to objective danger? - Anxiety is not necessarily maladaptive. Sometimes the dangers we face are very real and anxiety is a useful signal of mind and body telling us to trim our risk. If one's ideas aren't working and market volatility has greatly increased, anxiety may be helpful in holding back, preserving capital, and waiting until conditions (our own and the market's) right themselves. Anxiety is also adaptive in situations in which traders start trading before they've received proper training and experience: their minds are telling them that danger lies ahead!

2) Is the anxiety chronic? - Do anxiety problems predate our trading? Do they show up in areas of life outside of trading? If so, we might be dealing with an anxiety disorder, which affects an amazing 18% of all Americans during any given year. There are structured cognitive-behavioral methods and effective, non-addictive medications (not tranquillizers!) for dealing with anxiety disorders. Getting help from a professional experienced in these modalities is key to lasting progress.

3) Is the anxiety a reaction to trauma? - Very painful, emotional events can leave their imprint as traumatic stresses. Sometimes these events are trading-related; other times they reflect difficult past life events. If the trauma has been recent, the anxiety may not be chronic, but may still require the assistance of a professional who is trained in dealing with traumatic stresses. Behavioral, exposure-based methods are very effective in overcoming traumatic responses.

4) Is the anxiety part of a dysfunctional thought process? - This is a tricky one to tease apart. Anxious feelings can stoke anxious thoughts, but negative thinking can also generate anxiety. Sometimes we see traders engaging in constant worry and catastrophic thinking, especially after a period of loss. This thinking maintains the body's state of preparation for danger, which we experience as anxiety. Cognitive restructuring methods are proven modalities for changing these thought patterns and interrupting periods of anxiety.

5) Could the anxiety be part of a larger medical problem? - To complicate the picture further, a number of endocrine imbalances can manifest themselves as anxiety and mood disorders. If the anxiety is not fitting a typical pattern of situational response or identifiable disorder, getting a thorough medical evaluation can be crucial.

My book on trader performance concludes with chapters outlining behavioral and cognitive methods that can be useful in overcoming anxiety. When self-help methods are insufficient, however, seeking more formal, professional assistance is essential. I have no reason to believe that traders are exempt from the emotional problems that affect the general population. If 18% of the population experiences anxiety disorders in a given year, it means that nearly one in five traders probably are seeing their results hampered by this problem.

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Brief Therapy for the Mentally Well

Dr. Brett's Brief Therapy Text
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Trading and Anxiety: Navigating Danger and Opportunity

Anxiety is the response of mind and body to perceived danger. At times of heightened market volatility, anxiety can be a useful warning signal and an impediment to decision-making.

Research suggests that people tend to become highly risk averse when they are anxious. In one way, this is quite adaptive. If we are accurate in our perceptions of danger, we can avoid taking potentially catastrophic risks at those times and preserve our safety. Some of the very best traders I know have greatly scaled back their risk during the recent market action, holding onto their capital and waiting for greater clarity and opportunity in the markets.

If we are not accurate in our perceptions of danger, then anxiety can inhibit normal risk taking during periods of opportunity. We can also be diverted from focusing on tasks at hand by our preoccupations with danger. This is one possible reason why anxiety appears to hinder decision-making among health care professionals. It is difficult to process clinical information effectively and come up with diagnostic formulations when we are attending to perceived threats in the environment.

The challenge of dealing with anxiety in trading is that, very often, the times of heightened threat are also times of enhanced opportunity. Becoming the deer in the headlights can destroy us if we're trapped in a losing position, and it can also prevent us from acting upon those enhanced opportunities. How can we use anxiety as an informative signal of mind and body and still reduce its ability to dominate decisions and actions?

We'll tackle that topic in the next post in this series. In the interim, you may find the related posts below to be helpful, especially during these turbulent market times.

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Market Themes for a Wednesday

* Tale of Two Sectors - We continue to see a major divergence between Consumer Staples stocks within the S&P 500 universe (XLP) and Consumer Discretionary issues (XLY). With the threat of economic slowdown, investors are gravitating to issues that are likely to hold their earnings during difficult times.

* New Lows Continue to Expand - Tuesday saw an expansion of new 20-day lows to 2739, against 237 new highs. New 65-day lows jumped to 1944, against 154 new highs. It is proving difficult to sustain an upmove while investors continue to dump those housing, banking, semiconductor, and consumer discretionary shares.

* Concern for the Bulls - Perhaps most worrisome for the bulls is that we saw new 52-week lows among NYSE common stocks rise to 324, against 31 new highs. This is an expansion of new lows beyond the level registered in August, setting up a situation of weaker highs but also weaker lows. My primary scenario has been one of market correction, rather than outright bear market, but I do follow my indicators and don't buy markets when we see expanding new lows. Interestingly, new 52-week lows among S&P 500 stocks soared to 102 on Tuesday (against 12 new highs), also well beyond the August readings. That tells us that broadening weakness is not limited to small cap issues. Weakness is expanding, not contracting, ever since late last week and that has to be concern for the bulls.

* Sentiment Measure - The Treasuries have become excellent sentiment measures, reflecting the flight to safety both with respect to risky credit and to stocks. The yield on the 10-year Treasury note fell to 4.054% on Tuesday, a multi-month low and also well below the August lows. Similarly, banking stocks have become sentiment measures for the health of the financial system. Note the new lows in such stocks as FNM, C, BSC, and JPM, as well as the new low in the $BKX banking index. We'll need to see some confidence from these measures to put the brakes on the bear.

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A Note About Integrity

A good trader's loyalty is not to the bull side or to the bear side, but to the data. Conducting analyses with an open mind and faithfully following one's independent judgment is a form of integrity--one demanded by shifting markets.

In practice this means that I must remain true to the market data that I track each day, whether I like what the data are saying or not.

Right now, at the moment I'm writing this, the data are not supporting the bull case. We're seeing an expansion in the number of stocks making new lows, not a contraction. We're seeing weak sectors get weaker, not attracting longer-term value-oriented buyers. Advance-decline lines are making new lows, not sustaining divergences.

Tomorrow AM, I will summarize some of the data and some of these concerns. There's an old saying about the importance of knowing when to be concerned about the return on your capital and when to be concerned with the return *of* your capital. When weak markets don't attract sustained buying--and continue to weaken--my foremost concern is capital preservation.

Above all else, do no harm. It's an oath that works for physicians and traders alike.

Expanding Stock Market Weakness and a Look Ahead

As I mentioned in the Weblog, one of the things that concerned me about Friday's market action was the expansion of stocks making fresh 65 day lows. Of course, those expanded further with Monday's weakness. Across the major exchanges, we had 138 new 65 day highs against 1742 new lows. Going back to September, 2002, which is when I first began collecting the data on 65-day new highs and lows, we've had only 22 occasions in which those new lows have exceeded 1500. Forty days later, the S&P 500 Index (SPY) was up every single time, by an average of 5.33%. That is much stronger than the average 40-day gain of 1.83% (845 up, 398 down) for the remainder of the sample. The bear case is that this time is different, owing to dynamics of housing, credit, etc. If that's the case, we should see new lows expand from here and beyond the levels registered in August of this year. The bull case rests on a drying up of new lows and then an expansion of new highs going forward. I'll be tracking that measure closely.

All in all, we had 27 NYSE common stocks make annual new highs on Monday and 265 new lows. Interestingly, the new lows are below the level registered two weeks ago and below the 300 registered in August. Whether or not this divergence holds is, I believe, important to the bull case. We're also seeing 24% of S&P 500 stocks trading above their 50-day moving averages, another divergence with respect to earlier this month and with August. One divergence that hasn't held is the Advance/Decline Line for the NYSE common stocks: it is now below its August level. The line for SPX stocks remains above its August reading. There's no question that small caps have been underperforming large caps across both the NYSE and NASDAQ. How they behave from here will play a major role in determining whether or not those new lows expand further or live up to their 2002 - present performance.

RELEVANT POST:

When New Lows Expand

Subscribe to TraderFeed
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TraderFeed FAQ: Ten Common Questions and Replies

Some questions so commonly appear in my email inbox that I thought I'd write an all-purpose FAQ post. Here are ten common questions that most often get a "no, but" answer:

1) Do you exchange links? (No, but if you have something free and educational of special interest to TraderFeed readers, send me the URL and I'll link in a future post.)

2) Do you coach traders? (No, my work is limited to trading firms, including hedge funds, investment banks, and proprietary shops, but I'll be happy to make a referral if you let me know what you want to work on.)

3) Can I publish your posts on my site? (No, I'm not looking for wider exposure, but if you have something free and educational of special interest to TraderFeed readers, send me the URL and I'll link in a future post).

4) What are your advertising rates? (None, this is not a commercial site, but I can recommend fine blogs that do take advertising).

5) Would you mention my (book, software, services, etc.) on your site? (No, I'm swamped with these requests, but if you have an informative Website that describes your offerings, I'd be happy to link in an upcoming post).

6) Could you help me find a job at a trading firm? (No, but I can point you in some general directions if you tell me the kind of firm you're looking for).

7) We have a new service that can get you more exposure... (No, I'm not looking for publicity or exposure, but if you have a free, informative site about your service, I'd be happy to link in an upcoming post).

8) Could you tell me how to compute (chart, interpret, etc.) your market indicator? (No, some of my research is proprietary, but I'll be happy to explain its logic and direct you to posts on the topic).

9) Could you speak to our group of traders? (No, my road schedule has become onerous, but I'd consider doing a Webinar free of charge if you can set it up and publicize).

10) Could I call you (or get together with you)? (No, the number of times in a year that I socialize with people other than my wife and kids fits on one hand; time just doesn't permit. But if you have questions, I'll do my best to answer them electronically).

I do welcome questions about blog posts and trading topics; posting those in the comments section of the blog is the best way to draw upon the expertise of readers. Thanks for your understanding (as I look at my email inbox hit 941).

Brett

Explosions of New 52-Week Lows

In August of this year, we had a situation in which over a third of all NYSE issues traded during the week made 52-week lows. Two weeks ago, we saw nearly a quarter of all NYSE issues make fresh annual price lows. With Monday's weakness, we've started a new week on a footing that just might give us more than 25% of issues making new 52-week lows.

It turns out that explosions of new lows of this type have had favorable returns going forward. If we go back to 1981 (N = 1382 trading weeks), we find only 16 occasions in which more than 25% of traded stocks in a week made 52-week lows. Twenty weeks later, the Dow Jones Industrial Average ($DJI) was up by an average of 7.58% (13 up, 3 down), stronger than the average 20-week change for the remainder of the sample (4.28%; 954 up, 392 down).

It's not unknown for us to see clusters of explosions of 52-week lows. This occurred in September and October of 1981; August, September, and October, 1990; August, September, and October, 1998; and July and October, 2002. If you check your market history, these were not bad occasions to be buying stocks for a multi-year period.

RELEVANT POSTS:

When New Lows Swell

Falling Markets and New Lows
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Market Views for a Monday

* Getting a Market View - I summarize my indicators and market view in the latest Weblog entry. The expansion of stocks making fresh 65-day lows and failure of the market to build on bounces on Friday were negatives for the bulls. Some of that weakness is carrying through in the preopening market on Monday as I write. Note from the Weblog that we're seeing a bit of strength in the Cumulative NYSE TICK--the first in a while. I'll be watching that very closely during Monday's trade. I'll want to see a drying up of 20-day lows and an expansion of 20-day highs before carrying any meaningful long exposure. Meanwhile, I'm trying to stay grounded in best practices.

* Worth Reading - Abnormal Returns has quite a few interesting articles among its Sunday links, including ETFs of ETFs (the ability to buy and sell portfolios in a single stock), seasonal patterns in the stock market, and a fresh reading of Fed policy.

* Fascinating Research - CXO Advisory summarizes a thought-provoking study of the sectors that behave best when the Fed is easing vs. tightening. See also the eye-opening findings about our misperceptions of volatility.

* Trading ETFs - For those trading ETFs, here's an excellent, practical series of posts from A Dash of Insight.

* Prospects for Recession - The Big Picture looks to retail and takes a look at the week ahead, including a very thoughtful analysis of four scenarios for markets and the economy from Gavekal.

* Inflation on the Horizon? - Econbrowser takes a hard look at the data: the rise in gold and oil and whether that portends inflation.

From Solution Patterns to Best Practice Rules: Learning From Success

A theme I hear from many traders is the tendency to get complacent after a winning period in the markets. After all, when we’re doing well, there really aren’t that many problems to work on!

The fallacy, of course, is that self-development is limited to “working on problems”. It is equally important to drill down, identify strengths, and build upon these. In that sense, we can work just as hard after winning periods as after losing ones.

One way I work on my trading after a winning streak is to crystallize what has contributed to that success. As I’ve described in past posts, this is the essence of the solution-focused approach. The idea is to turn those solution patterns—the things we're doing right—into trading rules that represent best practices.

Here are a few of those best practice rules that I’m focusing on this week:

1) Keeping on top of the market’s larger picture – The indicators that I’ve been updating daily on this site and in the Trading Psychology Weblog have been exceedingly useful in detecting underlying strength and weakness in the market. This has helped me enter the market short-term in the direction of the larger market picture. Even when my timing has been less than perfect, the market has been forgiving, because I’m catching that larger picture. In practice this means that, before starting my trading day, I’m creating a framework that identifies whether we’re trending up, down, or range bound and using that to guide shorter-term trading decisions.

2) Adjusting position sizes for market volatility – I’m estimating the day’s volatility and, as volatility rises, I take my position size down. What that means in practice is that each trade from day to day is risking a similar dollar amount and seeking a similar reward. The smaller size has enabled me to sit through market noise that would otherwise take me out of trades, and it has brought a consistency to my P/L that helps promote consistency in my trading.

3) Sticking to the knitting – I have core patterns that I trade and core times of day when those trades have been most successful. During the winning period, I have not moved away from that base. It is easy to get caught up in success and increase trading as profits roll in. In the past, that has led me to move outside my areas of greatest competence. Recently, my approach has been workmanlike: trade my patterns, make my money, and move on. By not getting too excited about the winning, I avoid overtrading and the inevitable disappointment caused by overtrading.

Too often we get back to basics and trade well only after suffering a drawdown. By requiring ourselves to generate rules for best practices, we can ensure that we are doing the right things before those drawdowns occur. That can make a dramatic difference in trading results—and in our frame of mind.

RELEVANT POSTS:

Best Practices in Trading

A Solution Focused Linkfest
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Herding Sentiment in the Stock Market and Prospective Index Returns

In my last post, I took a look at herding as a form of sentiment and found a characteristic pattern at market bottoms. That post used a measure of volume concentration to detect when traders were leaning significantly to one side of the market (advancing stocks, buying) or the other (declining stocks, selling). This post will take the same volume concentration measure and cutoff points to detect herding to see what has happened historically following days of significant herding. (Please consult the previous post for details on the Volume Concentration Index and its cutoff points).

Going back to 1965 (10,715 trading days), we find 159 days of significant herding into rising stocks. Three days later, the S&P 500 Index (SPY) averaged a gain of .62% (105 up, 54 down), much stronger than the average three-day gain for the remainder of the sample (.09%; 5699 up, 4857 down). Indeed, when we go out twenty days, we find that the average gain in SPY following a single upside herding day has been 1.86% (109 up, 50 down), far stronger than the average 20-day gain of .61% for the rest of the sample (6222 up, 4334 down).

In short, a single day in which investors significantly herd into rising stocks has tended to bring bullish follow through in the near term. That pattern has held during the period of 2004-present, particularly at that 20 day horizon. Of the 20 days of bullish herding since 2004, 16 have shown positive returns over the next 20 days, averaging a healthy gain of 1.55% in SPY.

Now let's turn to herding days in which volume is concentrated in the shares of declining issues. Going back to 1965, we find 220 days of such bearish herding. The following day, the S&P 500 Index (SPY) averages a loss of -.19% (93 up, 127 down), weaker than the average single-day gain of .04% (5500 up, 4995 down) for the remainder of the sample. Interestingly, as we go to a 20-day horizon, we find no significant bullish or bearish implications of downside herding days. The bearish follow through to a single day of concentrated volume to the downside has been limited to the very short term.

Even this conclusion must be qualified, however. Since 2004, single downside herding days (N = 28) have had significant bullish prospects going forward, including the very short term. Twenty days after a downside herding day, SPY has averaged a gain of 1.60% (22 up, 6 down), much stronger than the average 20 day gain for the remainder of the sample.

One implication of the above finding that bears further investigation is that bull markets treat downside herding days differently than bear markets. Indeed, that might help to make bull markets bull markets (panic selling leads to buying among value-oriented, longer time frame participants) and bear markets bear markets (panic selling feeds on itself). Examining the trajectory of market outcomes following herding days might thus yield insights into the longer-term trend and sentiment of the market. This is particularly the case when we examine sequences of upside and downside herding days (i.e., upside herding day following a downside herding day and vice versa; successive upside or downside herding days).

This is a fruitful area for research, as I'll be elaborating in my next Trader Performance post. In my next blog entry, we'll look at volume concentration as a kind of "overbought-oversold" indicator to see if it yields any historical insights about prospective market moves.

RELATED POSTS:

Making Decisions From Current Stock Market Data - Relevant to real-time monitoring of volume concentration.

Trading With Sentiment Bars - Relevant to very short-term market patterns involving volume concentration.
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Herding Behavior in the Stock Market: A Look at Volume Concentration

Some of the best thinking occurs when we approach old topics in fresh ways. Consider the topic of sentiment. Through our normal lenses, we parse the world into bulls and bears. Suppose, however, we look at sentiment differently and measure it as the degree to which traders behave in more vs. less differentiated ways. If traders respond to markets in a non-differentiated way, they move as a herd, and we would expect transacted volume to be lopsided toward advancing or declining stocks. In a differentiated mode, market participants discriminate between better and worse investments and apportion volume to advancing and declining issues accordingly.

My measure of Volume Concentration takes the difference between advancing and declining volume on the NYSE and divides that by the sum of advancing and declining volume. This gives us an index that ranges from +100 (all directional volume is concentrated in advancing stocks) to -100 (all directional volume is concentrated in declining stocks), with the zero level denoting a market in which directional volume is evenly divided between advancing and declining issues.

I went back to 1965 and found that the average level of daily Volume Concentration is just a bit above zero, with a standard deviation of 38. For practical purposes, I set a two standard deviation threshold to represent herding behavior. Whenever the Volume Concentration Index (VCI) exceeds +75 or falls below -75, we'll call that herding sentiment.

What we find historically is that, since 1965 (N = 10,754 trading days), there have been relatively few days of herding sentiment. Specifically, we've had 160 days of herding in which volume has been highly concentrated in advancing issues and 223 days of herding in which volume has been highly concentrated in declining issues. Thus, a bit under 4% of all trading days meet our strict criterion of herding.

A look at the distribution of herding sentiment finds that it tends to occur in clusters. I examined the number of herding days over a moving 250 day period. The average for the entire sample was 8.6. We saw repeated readings over 15 during the market bottom and recovery around October, 1966; May, 1970; December, 1974; October, 1978; March, 1980; August, 1982; October, 1987; October, 1990; and March, 2003. The pattern is that we see herding behavior as traders panic on market declines toward the end of bear markets and then herding behavior as investors pour into markets to grab value at the start of bull markets. Indeed, one might say that it is precisely this transition of herding to the downside and herding to the upside--short-term panicky participants disgorging falling stocks and longer-term participants grabbing them as they rise--that makes for major market bottoms.

Interestingly, we're seeing just such a clustering of herding days presently in the market. Out of the past 250 trading sessions, fully 28 have qualified as herding days--far more than the average of 8.6. Indeed, going back to 1965, the only times we've had more than 20 days of herding in a 250-day period have been late 1974 into 1975 and late 1987 into 1988. Those were very important market lows.

One possible implication of the data is that the current market weakness, which has extended episodically from March through the present but is clearest in the housing and financial sectors, represents a decline of historic proportions despite its mildness when measured by price action in the large cap indexes. If the historical pattern holds in the present case, we should see an explosion of buying (herding to the upside) once investors perceive it's safe to return to the water. To be sure, this could occur at lower price levels. Nonetheless, the dates of high herding noted above--late 1966, mid 1970, late 1974, late 1978, early 1980, late 1982, late 1987, late 1990, and early 2003--were times to be thinking about owning stocks for the long run, not disgorging them with the crowd.

At periods of comparable extreme herding--late 1974 and late 1987--there were precious few reasons to think about owning shares. The current period offers similarly gloomy prospects. History has favored contrarian bulls at such times.

There is one other possible implication of the data that we will only know in the fullness of time. We have had readings continuously above 20 since August of this year. It may well be that, owing to the concentration of capital among hedge funds, pension funds, sovereign wealth funds, and the like--combined with the competitive need to contain risk and manage it daily--that we are seeing a secular rise in herding behavior. If this is true--and it is only a hypothesis--it has important implications for volatility and money management challenges for daytraders and portfolio managers alike.

Herding-as-sentiment in general, and the VCI as a specific measure of herding, provide us with an interesting framework for analyzing historical price patterns in the stock market. In a future post, I will take a more granular look at what happens historically after days of extreme herding.

RELATED POST:

What Drives Investor Sentiment?
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Stock Market Sentiment and Other Ideas to Wrap Up the Week

* Sentiment Spikes - Above we see the 10-day equity put/call ratio (pink) plotted against the S&P 500 Index (SPY) from 2004 to the present. You can see how spikes in the ratio have tended to accompany intermediate-term market lows. We're currently experiencing such a spike.

* A Bevy of Links - Charles Kirk covers most the bases, including a look at what the top market timers are thinking about this market.

* Oldie But Goodie - This is a timeless and insightful post written a while back by Trader Mike on the topic of expectancy.

* Intuition and the Brain - Very interesting overview from Dr. Janice Dorn on the role of intuition in trading and information processing.

* Trading Tools to Use - Ray Barros, with an insightful commentary on finding the trading tools that match your ways of processing information.

* Regulations and Volatility - Adam takes a skeptical look at whether eliminating the uptick rule has affected volatility.

* Pain, Torture, and Abuse - Todd Chalem's blog post to the VesTopia site nicely captures some of the frustration portfolio managers are feeling in the current market.

Trying to Test Recent Lows

It was a great visit to the UK; very impressive to meet with traders there. There's a heightened international awareness among UK traders, I find, which is helpful to big picture thinking. Still, nothing beats the old routine of getting up at 4 AM, settling into the office chair, listening to some stimulating music, and figuring out the themes for the coming trading day.

I've resumed the regular Twitter postings; the last five will appear on the TraderFeed blog, and the entire list is on my Twitter page. There are a number of occasions when I'll see something interesting that may not merit a separate blog post; those are the items I'll pass along via Twitter.

Notice that we've had absolutely no follow through to the Tuesday rally, which supports the notion that the rally was largely short covering feeding on itself. As I noted yesterday, that places us in a range bound situation defined by the Wednesday highs and the Monday lows. How we trade on any test of those lows--the degree of participation among the various sectors, the behavior of those indicators of risk aversion (rates, Yen, financial stocks)--will play a large role in the market's near-term prospects. In the larger picture, nothing so far has altered my primary scenario of a multi-month range bound market defined by the bull highs and the August lows.

Normal expectations would be for some downside follow through to yesterday's weakness and negative momentum. My Demand indicator closed at 28; Supply finished at 116. What that means is that we had about 4 times as many stocks closing below the volatility envelopes surrounding their intermediate-term moving averages. Broad weakness of that kind frequently leads to further weakness in the short run.

Still, even as we approach the recent lows, there are indications of relative strength. On Thursday we had 122 fresh 20-day highs and 794 new lows across the three major US exchanges. That is far fewer new lows that we saw either earlier this week or especially last week. If we just look at NYSE common stocks, we find that Thursday brought 14 new annual highs and 110 52-week lows. That is less than half the level of new lows registered last week. I will be watching these new lows very carefully, as they will tell us a great deal as to whether this market is poised for a more sustained bullish turnaround or is undergoing a fresh round of deterioration.

My measure of Technical Strength, which I highlighted yesterday, deteriorated on Thursday. Among the 40 stocks across the S&P sectors that I track, we have 6 qualifying as technically strong, 5 as neutral, and 29 as weak. So what we're seeing is those neutral stocks fall into the weak category. Before a market gives strong readings from a weak situation, we see an expansion in the number of neutral stocks, so I'll be watching to see how well these neutral issues hold up in today's trading and will pass along any salient observations via Twitter.

I also notice that we had only 27% of S&P 500 issues and 29% of NYSE stocks close above their 50-day moving averages. That's not far from the low figures registered just prior to the Tuesday rally. A move in this indicator to new lows would suggest continued broad weakness. Notice above the excellent chart from Decision Point. We're actually seeing a positive divergence in the number of financial stocks closing above their 50-day moving averages, as the sector index (XLF) has made price lows with fewer component stocks trading below their moving averages. I would be much more bullish on the market turnaround scenario if we can see financial issues holding their recent lows on any tests of index lows.

So, all in all, we're seeing near-term weakness and it wouldn't be at all surprising to see near-term follow through to the downside. If we make fresh lows across the indicators after that Tuesday rally, we have to upgrade the odds of a larger bear market move. If we continue to see a reduction in stocks making new lows, stocks trading below their moving averages, etc., I'd expect a more durable rally to proceed from any tests of recent index lows.

One other thing for the radar: Notice how the jawboning about the dollar seems much more coordinated of late. Same theme out of Europe, Japan, and even the U.S. from Treasury Secretary Paulson. The U.S. doesn't want massive capital outflows (TIC data due to come out in a few hours) and other countries don't want a volatile, weak dollar. I don't know if coordinated jawboning could lead to coordinated intervention in the markets, but my ears are perked when I hear similar messages from different places.

Back to the music. Have a great weekend. I'll update with some links later today.

Scripts and Authenticity: Why We Make Bad Trades

I decided to lie down for a few minutes in the airline lounge at Heathrow prior to my flight back to Chicago. A couple took the couch behind me and began talking louder than I would have liked. The gist of the conversation was that the husband needed something from an airport store, the wife got it for him, but he was not happy with her selection. His tone was whiny, complaining, and not a little irritating. Her tone was clearly frustrated and curt.

A few moments passed and neither of them talked. Spontaneously, he resumed his complaint. As he went on, she became more hostile and the tiff picked up where it had left off. The whole affair sounded quite scripted: he had his role (nothing is good enough) and she had hers (it’s fine and if you don’t like it, go get yourself something else). The more he whined, the more she viewed him as unappreciative and responded with resentment. The more she addressed him in a tone of dismissal and contempt, the more he felt she was not listening to him. It seemed so well rehearsed that I easily could have believed that they had memorized their lines.

As I walked away—rest was clearly not going to happen in that section of the lounge—the thought struck me that the most important part of their interaction was the silence between their episodes of bickering. They had nothing positive to talk about. In the absence of any authentic conversation, they resorted to this scripted interaction. Perhaps any communication felt better than none.

Authentic communication is not scripted. It emerges spontaneously, based upon fresh perceptions, thoughts, and feelings. When a basis for authenticity is missing—when there is nothing fresh to bond the parties in interaction—the only alternatives are silence and the inauthentic. Interestingly, most of us choose to avoid silence. Keep kids inside on a rainy day, and they’ll cart out the old scripts: haggling with each other, trotting out old complaints. Anything is better than boredom.

There’s a scripted quality to much bad trading. One of the curious statements I hear from traders is that they often know they are making a bad trade as they are doing it. That’s a sign at some level that they are aware of an underlying script. Just like the couple’s argument, the trader is well practiced at the scenario of miss a move, get frustrated, and chase a trade. It’s happened so often that it seems staged.

The trader feels as though he’s sabotaging himself, and perhaps the couple feels the same way. The reality, however, is that they are probably taking the better of two unpleasant alternatives. It may feel better to make a bad trade than to not trade at all. In the absence of an authentic framework for decision-making, perhaps all that’s left to market participants are scripted behaviors.

It’s not the bad trade that’s the problem for the trader, just as it’s not the argument that’s the problem for my couple. Both behaviors are responses to the real problem: the absence of any authentic basis for constructive engagement. Without clearly defined and validated ideas, what is there to trade except for our emotional scripts?

RELATED POST:

Enacting Your Ideals
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Reflections on the Market's Technical Strength

We moved higher on Wednesday in expected follow through to the big Tuesday rally, but participation in the strength waned through most the day and we finished weak. The important thing to assess is whether we can test those Wednesday highs in the near term and whether the market attracts participation on any such tests. If not, we then look to the Wednesday highs and Monday lows as a broad trading range and a test of the Monday lows is not out of the question.

A solid move above the Wednesday highs with broad participation would increase the odds of this being a longer-term bottoming process. Again, my main concern is whether Tuesday was mere short-covering or the beginning of sustained buying, as longer-term participants identify value after the decline. I am looking to financial stocks, semiconductors, consumer discretionary issues, and small caps to see evidence of this value-based buying.

There's no question that the recent rally took most sectors higher. Recall that my Technical Strength measure is a quantification of trend. Of the 40 stocks across the S&P universe (evenly spread across eight sectors) that I follow, 8 qualify as technically strong, 11 as neutral, and 21 as weak. The Technical Index score of -920 shows that most stocks continue in downtrends, but that the weakness is far less broad than a couple days ago. WMT, KO, MRK, and JNJ stand out as strong stocks at present.

Here are the Technical Strength scores broken down by sector:

Materials: -120
Industrials: -260
Consumer Discretionary: -360
Consumer Staples: +280
Energy: -280
Health Care: +60
Financials: -80
Technology: -160

The pattern here is noteworthy in three respects:

1) Financials have moved smartly off their lows and are no longer the weakest sector;

2) The gap between Consumer Discretionary and Consumer Staples issues has widened.

3) Energy shares continue to underperform the oil market itself.

The second reflects recessionary themes--a preference of shares that are likely to hold up during times of economic slowdown. The third may also be consistent with economic slowdown. It is the Financial sector, however, that I'm watching most carefully (along with pricings in the credit markets) to assess evidence of increasing confidence in the banks.

I believe it's important to differentiate the theme of slowdown due to housing weakness and consumer retrenchment and the theme of credit crunch and possible expanded bank turmoil. If we see evidence of reduced concern about the latter, I expect the market to weather those other concerns quite nicely.

RELATED POSTS:

Measuring Technical Strength

My Previous Look at Technical Strength and Market Weakening
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The Trader as Trading Coach: Cultivating Self Awareness

The new book I’m writing is designed, in part, to help traders coach themselves to improved performance. The idea is to periodically stand apart from our trading to evaluate what we’re doing, learn from our experience, add to strengths, and minimize the impact of weaknesses. The self-coaching of most traders, I find, is limited at best to the keeping of a journal. Too often those journal entries are simple summaries of the last trading day, combined with statements of “what I should be doing”. Rarely do the journals identify and focus on strengths, and rarely do they set very specific goals that are systematically reviewed and refined.

Perhaps the hardest part of self-coaching is sustaining the stance of self-observation. To perform well, we need to be immersed in the doing; we can’t be observing and criticizing ourselves while we engage in performance. If we fail at such immersion and become overly self-aware, the result is an interference with performance. This is what creates writers’ block and a freezing up during public speaking engagements. In a very real sense, the master trader must minimize the coach inside his or her head during trading. The goal is to be completely market focused, not self-focused—and certainly not focused on P/L.

The natural tendency after a lengthy day of focused attention is to want to relax. As a result, little attention is paid to performance and reviewing the past day. That is the time when the coach inside the head needs to be maximized, with attention directed toward oneself. What did I learn about the market today? What did I do right? What do I need to correct? What is my game plan for tomorrow? All of these questions require a degree of reflection and self-directed attention.

Research in psychology initiated by Duval and Wicklund in 1972 suggests that self-directed attention can be an aversive state for many people. In a self-focused mode, we become more aware of the discrepancies between our real self—how we are currently performing—and our ideal. Not surprisingly as a result, people tend to avoid prolonged states of self-awareness.

My own research at Duke University found that self-awareness is particularly aversive when people feel that they are not capable of bridging their gaps between real and ideal in areas of life that matter to them. Ironically, then, we are most likely to avoid focusing and working on ourselves at those times when we most need it: times when we are self-doubting and feel furthest from our goals.

If, however, we are going to mentor ourselves and accelerate our development toward expertise, it means that we have to make friends with self-focused attention. We have to learn to love the look inside, even when the view is uncomfortable. By identifying with our learning processes rather than our day-to-day outcomes, we place the inward look into a different context: one in which self-focused attention is in the service of a higher ideal: shaping our selves.

RELEVANT POSTS:

Three Steps Toward Self-Coaching

Therapy for the Mentally Well
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Gauging the Extent of Market Moves and an Indicator Update

It was quite a nice rally, but the indicators were tracking strength even as we were declining in the two prior days, as the recent post noted. Whenever I see persistent selling pressure (weak NYSE TICK) in a market that's not weakening or persistent buying pressure (strong TICK) in a market that's displaying fewer new highs, lower momentum, etc., I generally look for those late to the move to get wiped out on the reversal. That's pretty much what happened on Tuesday. All those late to the selling had to cover their shorts and the rally fed on itself during the day, with very strong TICK readings.

One mechanism I've found helpful for gauging the extent of market moves after a reversal is to count the net number of contracts transacted at the bid vs. offer and then assume that at least that many will need to be covered before the reversal is complete. Market Delta is helpful for those calculations. So instead of a price target, you have a target based on volume. If a net 150,000 contracts were transacted at the bid during the market weakness while the indicators were strengthening, the reversal will last for at least 150,000 contracts transacted at the offer. Having a heuristic like that can help you stay in a trending move.

We finished Tuesday with 174 new 20-day highs and 638 new lows. What we'd want to see from the bulls here is an ability to continue to reduce those new lows. One day doesn't make a bull market; it's the follow through that counts. If we digest these gains and then see another rally on top of this past one, that would be the pattern we'd look for to signal a more durable market bottoming taking place. If this market is going to tank, I suspect it will be because of either a meltdown in China or a meltdown in our own financial sector. So I'll be watching those segments carefully. As I mentioned in my Trading Psychology Weblog, an outright bear market is not my primary scenario, but I'm open to the possibility as an alternative.

My Demand indicator was 117; Supply was 20. That means that we had more than 5 times as many stocks close with significant upside short-term momentum as downside momentum. When we see momentum jump like that, usually there's some price follow through to the upside over the next few days.

The number of S&P 500 stocks trading above their 50-day moving averages jumped to 37% on Tuesday. That same percentage holds for S&P 600 small caps, which of late have resisted selling. In a bottoming process we see rising bottoms in this indicator, so I'll be looking to see how we fare on any pullbacks.

Among NYSE common stocks, we had 22 annual new highs and 37 new lows--a significant contraction of new lows. Again, we want to see if that continues.

In short, we had a significant rally no doubt fueled by short covering following a couple of days in which lower prices in the major indexes were not confirmed by indicator weakness. Now we're seeing significant upside momentum. I will need to see weakness in the indicators before trading from the short side as a primary strategy.

RELEVANT POST:

The Structure of Stock Market Reversals
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Psychological Burnout and Trading: Five Signs

When I first began working with traders professionally, I noticed a curious phenomenon: Many of the traders who were in the most objective trouble in their careers (i.e., at risk of getting fired from their firms) actually worked less hard at their trading than when they were making money. They insisted that they wanted to succeed as traders, but their actions spoke otherwise. They watched markets without putting on trades; they left the office early; they stopped doing their research and keeping their journals.

What I realized was that these traders were burned out psychologically. They were physically and emotionally overloaded and simply could not sustain the efforts required to come back from their deficits. It wasn't a matter of motivation. Quite literally, they didn't have enough psychological fuel left in their tanks.

Research finds that burnout has very real--and dangerous--health consequences for people. These physiological effects affect brain function and contribute to further exhaustion, creating a vicious cycle. My experience has been that, once traders in trouble hit a burnout stage, it is very rare for them to come back. This suggests that early identification of burnout symptoms and preventive measures may be instrumental in prolonging the health and wealth of traders.

So what are some of the early warning signs of burnout among traders? These come immediately to mind:

1) Loss of Motivation - This is experienced as just not caring as much as they used to. It's also expressed as avoidance of work tasks.

2) Cynicism - The trader in burnout feels that nothing will work out right; the market is out to get him. There is a palpable sense of hopelessness in later stages.

3) Exhaustion - This is experienced both physically and emotionally. Traders know they should work on their situation, but just can't muster the energy.

4) Sleep Disruptions - The trader who is burning out may oversleep or display insomnia and chronic tiredness.

5) Substance Abuse - Traders in early burnout stage may try to self-medicate to feel better and to escape their situations. Food may also serve as a refuge.

I recommend a several step program for traders who are burning out:

1) Take a Break - The worst thing a trader can do is feel guilty and try to force themselves to work harder. Burnout is not laziness, and it will not go away with willpower. Getting away from work stress and attending to good sleeping and eating patterns can help provide the energy for a comeback.

2) Get Help - Sometimes what looks like burnout can be a different problem: depression or an endocrine imbalance. Getting a medical workup is important to rule out physical causes of fatigue. If the problem indeed turns out to be burnout, short-term counseling/therapy can be very helpful in getting a handle on situations that feel overwhelming.

3) Regain Control - A common denominator in much burnout is a perceived loss of control over one's situation. Setting reasonable work goals, managing time effectively and reasonably, and finding elements in the situation that can be controlled all can be very helpful. By keeping goals modest and building small success experiences, traders can regain optimism and energy.

Burnout is common within high stress, high demand, fast paced fields, such as ambulance/EMT work; nursing; military combat; and medical residencies. By recognizing that burnout is a potential occupational hazard, traders can take a preventive stance by keeping expectations realistic and getting plenty of time away from work, in activities they enjoy and can control.

If you are no longer enjoying your trading; if you respond to losses but get little enjoyment from gains; if you stop caring about your work; or if you are just too overloaded to get the work done, consider the possibility of burnout. Renewing yourself early in the process can save a career.

RELEVANT POST:

The Most Common Problem Faced by Traders
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