* Have we put in a durable bottom in stocks? - I've been writing for a while about the drying up of stocks making new lows as we tested the January lows in March. Since that time, we've bounced nicely and are hugging that major resistance area around 1400 in the S&P 500 Index. I've also noted of late that the recent market strength has been accompanied by waning participation to the upside and uneven sector performance. We need to see the broad range of stocks in gear to the upside to confirm that this is more than just a catch-up move of beaten down stocks, sectors, and asset classes at the expense of first-quarter winners. I'll be looking to see if the Fed announcement can generate the rising tide that lifts all boats. Conventional wisdom has stocks selling off at the prospect that the Fed may be finished with its easing; less conventional wisdom (which I prefer) suggests that such a shift in Fed policy might be seen as a vote of confidence in credit markets and the economy.
* Will deflation or inflation concerns rule the markets? - Watch the fixed income markets in the wake of the Fed announcement. Will we see the risk-averse flight to quality, with rising Treasury prices and falling yields? Or will we see money continue to move from safety toward riskier assets, as has occurred this past week, with Treasury rates rising and yield spreads narrowing vs. mortgage-backed and high yield debt? The Fed may well offer a balanced perspective in their statement to preserve flexibility at future meetings, but the bond markets will tip us off to the market's interpretation of Fed priorities. Conventional wisdom is still focused on weak housing, and even the taxi cab driver seems to know about LIBOR. Less conventional wisdom is focused on the breakout moves we've already seen in yield spreads.
* Will sector themes mirror confidence or lack of confidence in the economy? - I've mentioned at numerous points over the past few months the importance of the financial sector and especially the bank stocks. With Citi's recent move for further cash infusion, those stocks have seen a recent resumption of weakness. Keep an eye on them in the wake of the Fed announcement. It is very difficult for me to believe that we'll sustain a bull move without confidence in the banks. But I'm aware that conventional wisdom is also focused on financials; less conventional wisdom also sees the influx of funds into consumer discretionary stocks vs. staples at the same time that commodities have been falling and the U.S. dollar has shown a bit of strength. I'll be watching the latter trends carefully as a barometer of nascent economic confidence.
Themes and transitions among themes reflect the flows of funds within and across asset classes. Even short-term traders can benefit from standing back and seeing where capital is flowing and why. The upcoming Fed meeting should prove instructive in this regard.
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Wednesday, April 30, 2008
Tuesday, April 29, 2008
Thematic Shifts Among Stock Market Sectors
Going into tomorrow's Fed announcement, we've seen significant changes in sector themes. Many of the sectors that were most beaten down during the market's selloff are now performing well. Interestingly, this has occurred at the same time that Treasuries--which had been strong during the selloff with the flight to quality--have sold off. It appears that we have been making a gradual shift toward risk-taking among stocks. This has helped the consumer discretionary, financial, and technology stocks in particular.
Below are the eight S&P 500 sectors that I track closely, along with their Technical Strength reading (a measure of short-to-intermediate term trending) and the percentage of stocks within the sector trading above their 50-day moving averages:
Materials (XLB): -60 (54%)
Industrials (XLI): +140 (77%)
Consumer Discretionary (XLY): +360 (70%)
Consumer Staples (XLP): -120 (59%)
Energy (XLE): +240 (81%)
Health Care (XLV): -200 (51%)
Financial (XLF): +220 (65%)
Technology (XLK): +260 (70%)
Some of the sectors that had been strongest during the market weakness (Consumer Staples, Materials) have been weak of late. Consumer Discretionary shares, which had suffered with recession fears, have bounced back dramatically.
I will be watching to see how the Fed meeting affects these potentially important thematic shifts.
RELEVANT POST:
Sector Money Flows
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Below are the eight S&P 500 sectors that I track closely, along with their Technical Strength reading (a measure of short-to-intermediate term trending) and the percentage of stocks within the sector trading above their 50-day moving averages:
Materials (XLB): -60 (54%)
Industrials (XLI): +140 (77%)
Consumer Discretionary (XLY): +360 (70%)
Consumer Staples (XLP): -120 (59%)
Energy (XLE): +240 (81%)
Health Care (XLV): -200 (51%)
Financial (XLF): +220 (65%)
Technology (XLK): +260 (70%)
Some of the sectors that had been strongest during the market weakness (Consumer Staples, Materials) have been weak of late. Consumer Discretionary shares, which had suffered with recession fears, have bounced back dramatically.
I will be watching to see how the Fed meeting affects these potentially important thematic shifts.
RELEVANT POST:
Sector Money Flows
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The Perils of Achievement Motivation: When Traders Press Too Hard to Win
A deadly pattern among some of the best traders is to channel achievement motivation into trading *more*.
The best traders do have a strong achievement motivation and work quite hard at their craft. That achievement drive makes them hate losing. Their impulse is to go for the jugular; they want to not only achieve, but achieve *more*.
This drive can be a trader's greatest weakness, however. It can lead to stubborness in taking losses, leading to outsized losses. It can also lead to overtrading, as the driven trader attempts to *make* things happen. That is a particular recipe for disaster on slow, narrow days such as yesterday, when it's easy to get chopped up jumping aboard seeming trending moves.
The net result is that *pressing* to achieve can take the trader out of his or her game. It subverts risk management by leading the trader to trade too large, without careful attention to stop loss points. It also interferes with decision-making by leading the trader to take trades without an objective edge.
A good analogy is the fighter who goes for the knockout on every punch, leaving himself wide open to jabs and punches from the opponent. When the boxer is *too* aggressive, defensive skills go out the window. So it is with the trader.
Another analogy is the soldier in the battlefield. Too hyped up and too aggressive, he may charge out of his foxhole and make himself an easy target for the enemy. Sometimes the best strategy is to maintain control and pick off the enemy sniper-style.
How can you know if this is a problem for you? If you keep metrics of your trading results, you'll see that the average size of your losing trades exceeds the average size of the winners. You'll see that your biggest losing days are ones in which you trade most often and with largest size, particularly when the market was showing no special opportunity. You'll also know by your state of mind: traders who *press* to win typically experience high degrees of frustration when the profits don't come quickly.
If these are concerns for you, self-control strategies such as meditation and biofeedback can be tremendously helpful. How to use such strategies will be the focus of my next post.
RELATED POSTS:
The Most Important Skill Traders Need
Biofeedback for Performance
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The best traders do have a strong achievement motivation and work quite hard at their craft. That achievement drive makes them hate losing. Their impulse is to go for the jugular; they want to not only achieve, but achieve *more*.
This drive can be a trader's greatest weakness, however. It can lead to stubborness in taking losses, leading to outsized losses. It can also lead to overtrading, as the driven trader attempts to *make* things happen. That is a particular recipe for disaster on slow, narrow days such as yesterday, when it's easy to get chopped up jumping aboard seeming trending moves.
The net result is that *pressing* to achieve can take the trader out of his or her game. It subverts risk management by leading the trader to trade too large, without careful attention to stop loss points. It also interferes with decision-making by leading the trader to take trades without an objective edge.
A good analogy is the fighter who goes for the knockout on every punch, leaving himself wide open to jabs and punches from the opponent. When the boxer is *too* aggressive, defensive skills go out the window. So it is with the trader.
Another analogy is the soldier in the battlefield. Too hyped up and too aggressive, he may charge out of his foxhole and make himself an easy target for the enemy. Sometimes the best strategy is to maintain control and pick off the enemy sniper-style.
How can you know if this is a problem for you? If you keep metrics of your trading results, you'll see that the average size of your losing trades exceeds the average size of the winners. You'll see that your biggest losing days are ones in which you trade most often and with largest size, particularly when the market was showing no special opportunity. You'll also know by your state of mind: traders who *press* to win typically experience high degrees of frustration when the profits don't come quickly.
If these are concerns for you, self-control strategies such as meditation and biofeedback can be tremendously helpful. How to use such strategies will be the focus of my next post.
RELATED POSTS:
The Most Important Skill Traders Need
Biofeedback for Performance
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Monday, April 28, 2008
Musings for a Monday
* Lack of Follow Through - A number of traders have mentioned to me how difficult they've found the trading over the last several months. It's almost as if each day has its own theme and pattern, with little follow through from one day to the next. I took a look at the daily money flow figures for the 80 S&P stocks across the eight sectors, as posted earlier today. Just looking at the data since the beginning of November (N = 120 trading days), it turns out that when money flows have been positive on the day, the next day in SPY has averaged a loss of -.42% (12 up, 22 down). When money flows have been especially negative on the day, the next day in SPY has averaged a gain of .34% (16 up, 13 down). Moderately negative money flows on the day have led to very flat performance. When we get solid buying in stocks, it's tended to not follow through, but when we've had strong selling among stocks, it too has tended to reverse. Not an easy market for short-term trend followers.
* Advance-Decline Perspectives - The excellent chart above from Decision Point shows the advance-decline line specific to common stocks only within the NYSE universe. This is a great representation of the strength and weakness within the broad market. Note that the AD line has gone nowhere of late, even as price has ground higher. This fits with the observations from the recent indicator review, which noted diminished participation during recent market strength. I find Decision Point's coverage of indexes and sectors quite helpful, with indicators not found elsewhere.
* Worth Reading - The Kirk Report links many interesting themes, including solar stocks that look good; quite a list of trading tips; and a useful ETF performance tracker. Also check out the links from Abnormal Returns, including an interesting study that shows how past positive experience (reinforcement) affects future investment decisions.
* Web 3.0? - Fascinating article on how information from blogs and other sources is being aggregated in real time to create a new kind of news.
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Indicator Review for April 28th
This is the 1500th post to the TraderFeed blog, going back to December, 2005. Three of the past four months have hit high water marks for numbers of visits to the site. Add those 1500 posts to nearly 2500 Twitter "tweets" and the information starts to add up! I want to thank readers for their continued interest and support.
Last week's indicator review noted signs of market strength, but also some concerns on the horizon with respect to money flows into Dow stocks and the cumulative NYSE TICK. This week features much of the same, but with a few more cautionary notes regarding the price strength.
The top chart requires some explaining. I recently posted money flows from the ten most highly weighted stocks within eight S&P sectors: financial, consumer discretionary, energy, consumer staples, technology, materials, industrials, and health care. I combined the money flows from those 80 stocks (the specific issues are identified in the sector posts) to arrive at an estimate of money flows into and out of the S&P 500 Index.
If you review those sector posts, you can see that there are wide variations of money flow from sector to sector. That tells us that we are not seeing money being put to work in the market in a broad-based fashion. Across the sectors, however, selling pressure (money outflow) has been waning, which you can see in the top chart from the rising lows in the five-day flow figures. Moreover, since the start of April, we have seen rather consistent flows into the S&P 500 stocks. To this point, flows are confirming the price highs that we've been seeing, but there are notable laggards among sectors--hardly a vigorous bull move.
This selective nature of the recent price strength can be observed in the new high/new low data (middle chart). Note that, during the recent move to price highs in SPY, new 20-day highs minus lows have been lagging. Moreover, this non-confirmation continues to show up in our cumulative NYSE TICK measure (bottom chart). Last week's indicator review highlighted the importance of the 1400 area as long-term resistance in the S&P 500 Index. If we are to sustain a break above that level, we need to see indications of expanding participation in the strength. While we *are* seeing expanded money flows across the sectors, the variability from sector to sector; the lagging number of stocks registering new highs; and the lagging cumulative TICK give this bull move something of a yellow caution light.
Here's a quick look at other indicators and what we might glean from them:
* Treasury interest rates have risen sharply in the past week, especially at the short end. There is growing speculation that the Fed may pause after one final interest rate cut this week. This is dollar supportive, but it also suggests that market participants are weighing the possibility that we're dealing with a normal recessionary economy, not a deflationary one requiring Japanese-style quantitative easing. It also indicates a much reduced need for the flight-to-safety trade, which frees capital for stocks.
* My Cumulative Demand/Supply measure, which has nicely tracked intermediate-term market peaks and valleys, is moderately overbought at a reading of +22. Readings of +30 and above have corresponded to 20-day periods of subnormal performance in the S&P 500 Index. We hit that +30 level back on April 18th. Interestingly, the recent price highs in SPY have occurred at lower levels in the Cumulative DSI, suggesting once again that fewer stocks have been displaying strong upside momentum as we've moved to the 1400 level in the June ES contract.
* We're seeing a continued expansion of stocks trading above their 200-day moving average. Among the S&P 500 issues, 46% are now above their 200-day averages, the highest level of 2008. That proportion is 39% for S&P 600 small cap issues, which have lagged a bit recently.
* Friday saw 51 new 52-week highs among NYSE common stocks and 23 new annual lows. That is significantly less than the over 100 new 52-week highs registered the prior week. I'm watching this closely; we need to see expanding new highs if the bull move is to be sustained.
* We continue to see technical strength within my basket of 40 stocks, with 27 issues trading in uptrends, 4 neutral, and 9 in downtrends. This is down from last week's peak, but still robust.
The bottom line is that we *are* seeing reduced selling in stocks and selective increased buying. How selective the buying remains--or how it can broaden out from here--will tell the story of whether we fall back into the multi-month trading range or sustain an intermediate-term move to new highs.
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Sunday, April 27, 2008
Money Flows Into the Materials, Industrials, and Health Care Sectors
My recent posts have examined money flows into the energy, technology, and consumer staples stocks as well as the consumer discretionary and financial sectors. (The latter post includes a detailed explanation of the money flow measure).
In this post, we take a look at five-day money flows plotted against the materials (XLB; top chart), industrials (XLI; middle chart), and health care (XLV; bottom chart) ETFs, which track the sector components of the S&P 500 large cap stock universe.
As with the earlier posts, I've taken the ten stocks most highly weighted within those ETFs to estimate sector money flows. Those stocks are as follows:
Materials: MON, DD, FCX, DOW, AA, PX, APD, NEM, NUE, X
Industrials: GE, UPS, UTX, BA, MMM, CAT, HON, EMR, DE, GD
Health Care: JNJ, PFE, MRK, ABT, WYE, MDT, LLY, GILD, AMGN, UNH
We can see from the top chart that, unlike the other sectors, funds have been consistently flowing into the materials sector, as the five-day average has spent much of its time above the zero line separating inflows from outflows. Note, however, that the most recent readings have been rather tepid. When XLB hit new price highs two weeks ago, money flows were lagging. When we had selling in the commodities last week, flows turned negative. This appears to be part of a shift out of the hot commodities stocks and into more beaten down areas, such as financials and consumer discretionaries.
Money flows for the industrials sector trace a pattern we've noted before: waning selling pressure since the January highs and net inflows since early April. As XLI has tested recent price highs this past week, money flow hit new highs before trailing off late in the week. The pattern of higher lows and higher highs in the five-day flow numbers suggests that investors have been putting money to work in this area.
Finally we have the weakest of the sectors: health care. Observe that, as the broad market has rallied of late, XLV has barely participated. Money flows have been rather consistently negative as well. We saw some inflows early this past week, but those have hardly been impressive. It is quite likely that investors, noting the health care reform ideas advanced by the Presidential candidates, are not aggressively dedicating capital to this sector.
Once again we can see how the flow of funds in and out of sectors captures important market themes. This is a promising measure of sentiment that I'll be covering in greater detail in the future.
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Money Flows Into the Energy, Consumer Staples, and Technology Sectors
My recent posts have tracked money flows to the consumer discretionary and financial sectors (see the latter post for an explanation of the money flow measure). Above we see five-day average money flow for the energy, consumer staples, and technology sectors plotted against their respective ETFs: XLE, XLP, and XLK.As with the earlier posts, I drew upon the ten most highly weighted stocks within each of those sector ETFs to estimate overall sector money flows. The stocks chosen were:
Energy: XON, CVX, COP, SLB, OXY, DVN, RIG, APA, XTO, HAL
Consumer Staples: PG, WMT, PM, KO, CVS, PEP, KFT, MO, CL, WAG
Technology: T, MSFT, CSCO, IBM, AAPL, INTC, HPQ, GOOG, VZ, ORCL
We can see from the top chart of the energy sector that the sector has been quite strong in terms of price action, following the strength of oil overall, but that money flows have been lagging. We've seen net inflows since the start of April--a pattern also noted among the financial and consumer discretionary shares--but those inflows have been modest. Indeed, with some selling in the energy markets this past week, flows actually turned negative among the energy issues of late. It's clear from the chart that selling pressure (outflows) has dried up since the January lows (another pattern we noticed in the prior two sectors reviewed), but we've yet to see investors devote funds aggressively to the sector.
The consumer staples sector (middle chart) gives us a different look altogether. Significant outflows from the sector have been seen even following the January lows--a possible result of a shift of priorities among investors from a more risk-averse stance to a more risk-seeking one (something we've seen of late in the Treasury market). Price of the sector ETF has lagged of late, and we are having trouble sustaining any kind of inflows to the sector.
The technology sector (bottom chart) shows particular strength, as outflows have been moderating since November, 2007 and inflows have recently hit new highs. Once again, this may reflect a shift in investor sentiment from a more defensive stance toward one that favors growth-oriented names, such as those found within the XLK universe. We're seeing multi-month price highs in XLK, and those are confirmed by money flow strength.
From this comparison, we can see how a sector-by-sector examination of money flows can provide us with insights into themes pursued by traders and investors. Because large transactions dominate the money flow figures, the sentiment of institutional traders is nicely tracked by the money flow measure.
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A Few Sites to Check Out
Video Reviews of Market Action - Those of you who enjoy Brian Shannon's work may have noticed that Blogger shut down his site as part of a review process concerning possible "spam blogs". This once happened to me and can take quite a few days to remedy. In the interim, you can find Brian's review of Friday action--and his other posts--at this blog URL.
Drinking From a Fire Hydrant - If you want to immerse yourself in market data and information--including much of the information most relevant to hedge fund portfolio managers--then check out the Between the Hedges site. Gary reviews his portfolio performance and gives his perspective on the markets. He also links a tremendous amount of news and market data. Fantastic site and resource.
Understanding Volatility - The VIX and More site does contain valuable trading information regarding the VIX (the topic of my next post), but there is More indeed. Bill has been covering the topic of implied volatility, including sector-specific implied volatility. Using options markets to understand sentiment in the broad stock market is quite helpful, and there are some gems in this site.
Mentorship Blog - Ray Barros is one of the very few trading coaches/mentors who actively trades and follows markets--and who freely shares his perspectives on markets and trading. His Trading Success blog contains a number of worthwhile lessons, including this one on trading and new experiences.
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Drinking From a Fire Hydrant - If you want to immerse yourself in market data and information--including much of the information most relevant to hedge fund portfolio managers--then check out the Between the Hedges site. Gary reviews his portfolio performance and gives his perspective on the markets. He also links a tremendous amount of news and market data. Fantastic site and resource.
Understanding Volatility - The VIX and More site does contain valuable trading information regarding the VIX (the topic of my next post), but there is More indeed. Bill has been covering the topic of implied volatility, including sector-specific implied volatility. Using options markets to understand sentiment in the broad stock market is quite helpful, and there are some gems in this site.
Mentorship Blog - Ray Barros is one of the very few trading coaches/mentors who actively trades and follows markets--and who freely shares his perspectives on markets and trading. His Trading Success blog contains a number of worthwhile lessons, including this one on trading and new experiences.
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Saturday, April 26, 2008
Money Flow Into the Consumer Discretionary Sector
My last post took a look at money flows within the financial sector of the S&P 500 large cap stock universe. (See that post for an explanation of money flow and how it is calculated).
The financial sector is especially important to market sentiment, given the concerns we've had over bank losses and credit quality.
A second sector I'm following closely is the consumer discretionary stocks, which are sensitive to consumer behavior--and hence the impact of recession. If the stock market is looking past recession to a recovery, we should see inflows of capital to the consumer discretionary area. If the market is anticipating deepening and more prolonged recession, however, we should see outflows from these shares.
The chart above depicts five-day money flows vs. the XLY (consumer discretionary) sector ETF. The flows are based upon the ten most highly weighted stocks within XLY. These are: MCD, DIS, CMCSK, TWX, HD, NWS, TGT, LOW, NKE, and VIA.B.
We can see a pattern in the money flows for consumer discretionary issues that is similar to the one we observed with financials and with the Dow Industrials stocks overall. Going into the January lows, we saw consistent outflows from the consumer discretionary sector and then sustained buying during late January and February. Outflows diminished with the March lows and, since early April, we've seen resumed inflows to the sector.
This pattern of waning selling sentiment since the January lows is confirmed by new high-new low data for the stock market overall and by my work on the Cumulative NYSE TICK. It is fair to say that the various measures taken to assist the economy, from rate cuts to infusions of capital into banks and fiscal stimulus, have stemmed selling pressure in the market.
It is also clear, however, that these measures have not generated significant inflows into stocks. While we've seen net inflows to the consumer discretionary area since the start of April, the most recent price strength in the sector has not been accompanied by meaningful dollar flows. The February rally in XLY failed when price highs late in the month came on diminished capital inflows. A similar pattern may be showing up during April's market. XLY has moved to new price highs, but money flows to the sector are lagging.
It is one thing to see a drying up of selling; it's another to sustain buying. So far we've seen a notable decrease in selling manifested across several sentiment measures. Buying sentiment, on the other hand, remains muted of late--something we will need to track as we trade at an important area of long-term price resistance in the broad market.
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Money Flow Into the Financial Sector
Money flow is a measure of the dollar volume that is moving into or out of individual equities. When a stock trades on an uptick, the price of the trade times the volume of that trade (i.e., the dollar volume) is added to a cumulative total. When the stock trades on a downtick, the dollar volume is subtracted from the total. By the end of the day, if the total (i.e., daily money flow) is positive, it means that dollars have been flowing into the stock--there has been net buying interest. If the total is negative, then money has been flowing out of the stock, suggesting net selling interest.
If we aggregate the daily money flow figures for individual stocks, we can make inferences as to the money flowing into and out of particular sectors and even the broad market. This is why I track money flows for the 30 Dow Industrial stocks. By examining flows from sector to sector, we can gain a more refined perspective on how funds are flowing *within* the stock market. This is invaluable information for stock pickers.
Note that we can view money flow as a sentiment measure, not unlike the NYSE TICK and Market Delta measures emphasized in the recent webinar. We're using activity at the market bid to indicate an aggressiveness among sellers and activity at the market offer to indicate initiating interest among buyers. By aggregating this behavior over the course of a day and then examining the flow of funds across days, we can detect shifts in sentiment toward stocks and sectors.
With that in mind, we can see from the above chart the financial sector of the S&P 500 Index (XLF) plotted against a five-day moving average of money flows for the ten stocks most highly weighted in XLF. Those stocks are: BAC, C, JPM, AIG, WFC, GS, WB, USB, AXP, and MS. The chart is constructed in Excel from data derived from Townsend's Real Tick platform.
As with the earlier post on money flow with the Dow stocks, we can draw two conclusions with respect to the financial sector:
1) Outflows have been waning since the January market low;
2) We have not seen massive dollar inflows into the sector.
To be sure, we *have* seen net dollar inflows into the financial shares since the start of April. These inflows, however, are not as great as those we saw at sector bounces in November, 2007 and late January, 2008. The good news is that steps taken by central banks and recapitalization efforts by banks have stemmed selling within the financial sector. The bad news is that those developments have not, as yet, led to broad-based buying of financial shares.
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Friday, April 25, 2008
Archived Webinar on Reading Market Psychology
Thanks to Bill and Trevor for quickly posting links to Thursday's Webinar on the IOAMT site and the Market Delta site. There are a few skips in the audio and you can tell that I'm not entirely past my laryngitis, but otherwise the archived session should be pretty intelligible.
I noticed that the detail in the charts that I displayed is a bit fuzzy in the archived playback, so I've posted the charts above. If you click on those, you'll see plenty of detail.
If you have any questions about the Webinar content, feel free to post them as comments to this blog post and I'll answer to the best of my ability.
I appreciate the interest--
Brett
Anticipating Reversals by Tracking Participation in Stock Index Moves
I want to thank everyone who attended the Webinar after the close yesterday. We had over 200 traders in the room; I hope they found the review of short-term sentiment measures and trading setups helpful. When the link for the archived Webinar is posted, I will point readers to it. Thanks to Bill of IOAMT and Trevor of Market Delta for hosting the program and making the archive available.
The Webinar focused on short-term sentiment measures: NYSE TICK and Market Delta. Another element that I find important in trading is participation. Participation refers to the proportion of stocks within a sector or index that are participating in a move when we reach new price highs or lows in that sector or index.
Many times an index will make new highs or lows simply because a relative handful of highly weighted issues are dominating the move. When a significant portion of issues are not participating in a rise or fall, that move is more likely to reverse. This is a principle that I find helpful across multiple time frames. That is why I monitor 20-day new highs and lows in my Twitter comments and in my weekly indicator reviews; it's also why I like to keep tabs on individual stocks and sectors intraday.
Very often, market reversals of direction are preceded by waning participation in moves.
Above we can see that principle illustrated in yesterday's market action in the Dow Jones Industrial Average (DIA) and the 30 Dow stocks. The chart tracks the number of Dow issues making fresh two-hour price highs minus those making two-hour lows; that number is updated every five minutes. Only closing five-minute prices are used for the calculation.
Early in the morning, the Dow moved lower, bounced a bit, and then moved to a new price low for the day. That price low did not show an expansion in the number of component stocks registering fresh new lows. That was a warning that the decline was running out of steam.
As the market reversed, new highs steadily expanded, which kept traders in the trending move. Note, however, that the fresh price highs around 2 PM ET were not confirmed by the new highs. This deterioration was a nice tell for the selloff late in the day: the rise was running out of steam. Waning participation preceded reversal.
It is not necessary to monitor all stocks within an index to track participation. Tracking individual sector ETFs can be a useful strategy as well. In general, if I see multiple S&P 500 sectors not participating in a move to new highs or lows in the ES contract, I will be likely to take profits if I'm riding that move, and I'll be likely to look for spots to fade the move. Combining assessments of participation (new highs/lows) with readings of shifts in sentiment (TICK, Market Delta) can be very effective in identifying directional changes in the indexes.
RELEVANT POSTS:
Detecting Participation in Breakout Moves
Participation: A Key Market Variable
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Thursday, April 24, 2008
Money Flows Into the Stock Market and What They're Telling Us
Quick review: dollar volume flows take every trade in every stock (in this case in the Dow Industrials) and multiply the price of the trade times the volume of the trade. If the trade occurred on an uptick, the dollar volume is added to a cumulative sum. If the trade occurred on a downtick, the dollar volume is subtracted from the sum. I then add the figures for all 30 Dow stocks to arrive at an estimate of dollar inflows and outflows for the broad large cap market. A positive figure for this money flow indicates capital being put to work in stocks. A negative figure suggests capital being withdrawn from stocks.
In the chart above, we see dollar volume flows into the Dow Jones Industrial stocks (pink line) plotted against the Dow Jones Industrial Average (DIA). Two immediate findings stand out from the chart:
1) Since the January lows, outflows from the Dow stocks have moderated;
2) Since the March lows, we have not been able to sustain significant inflows.
As we can see from the light blue line representing zero inflow/outflow, the five-day average of money flows is only slightly positive at present--and that was due to one solid day of inflows. After some sharp inflows following the January lows, we simply have not been able to keep money coming into the Dow issues.
The result of this has been a stalling of the market rise that began with the March lows. That stalling is visible in a number of the current market indicators. On Wednesday, for instance, we had 780 NYSE, NASDAQ, and ASE issues make fresh 20-day highs, but 723 register new lows. My measure of technical strength across the 40 stocks in my basket, drawn equally from eight S&P 500 sectors, shows 22 stocks in uptrends, 8 neutral, and 10 in downtrends. Three of the ten stocks in downtrends are from the banking sector, which continues to generate credit-related concerns.
Where does this leave us? Selling appears to be drying up, but we are also not seeing buyers flock into the current market. This dynamic is also apparent in the Cumulative NYSE TICK indicator, which has been weak of late. Given this indecision, the market may just remain in its longer-term range bound mode until it receives guidance next week from the Fed meeting.
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Wednesday, April 23, 2008
Webinar Update and a Few Wednesday Notes
* Tomorrow's Webinar - Here's the link for registering for tomorrow's Webinar, held after the market close and sponsored by the Institute for Auction Market Theory. Quite a few people have written to me, asking if the Webinar would be archived for those who aren't able to attend the event live. This is always my preference, especially in deference to those in Europe and Asia who are likely to find the time inconvenient. I just received word that the session *will* be archived; I'll post details once the link is up.
* A Portfolio of Blogs - Thanks to the Currency Trading site for this rundown of top trading blogs in various categories. There are quite a few I'm not familiar with and will check out as a result.
* Many Thanks to Readers - Who have forwarded links to interesting articles to me recently. I try my best to scour the Web (though Kirk leaves me in the dust!), but can't possibly get to everything. If you happen across an article about trading psychology or markets that is unique and informative, do send me the link at the email address posted in the "About Me" section of the blog. Also, if you know of unique trading websites and blogs, trading software, or other tools of value to traders, do pass those along to me. I keep the blog non-commercial, but always enjoy passing along resources to traders.
* Lots of Talk - About how interbank loan rate problems may impact the Fed. See also the LIBOR woes entry in the WSJ's Real Time Economics blog. Meanwhile, downgrades of subprime debt continue...and continue to weigh on markets. Hat tip to Barry Ritholtz for highlighting this informative piece on how the subprime situation developed.
* More Consumer Woes and Impact - Mish tracks soaring credit card losses and Calculated Risk updates estimates of housing losses.
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* A Portfolio of Blogs - Thanks to the Currency Trading site for this rundown of top trading blogs in various categories. There are quite a few I'm not familiar with and will check out as a result.
* Many Thanks to Readers - Who have forwarded links to interesting articles to me recently. I try my best to scour the Web (though Kirk leaves me in the dust!), but can't possibly get to everything. If you happen across an article about trading psychology or markets that is unique and informative, do send me the link at the email address posted in the "About Me" section of the blog. Also, if you know of unique trading websites and blogs, trading software, or other tools of value to traders, do pass those along to me. I keep the blog non-commercial, but always enjoy passing along resources to traders.
* Lots of Talk - About how interbank loan rate problems may impact the Fed. See also the LIBOR woes entry in the WSJ's Real Time Economics blog. Meanwhile, downgrades of subprime debt continue...and continue to weigh on markets. Hat tip to Barry Ritholtz for highlighting this informative piece on how the subprime situation developed.
* More Consumer Woes and Impact - Mish tracks soaring credit card losses and Calculated Risk updates estimates of housing losses.
.
Reading Stock Market Psychology
If you click the chart above, you'll see my annotations of the pre-opening Market Delta chart for the June ES contract. The point I want to emphasize is that reading the psychology of the market *before* the open is excellent preparation for the trading day.
First, a little orientation about the chart. We see price on the left and right vertical (Y) axes. At the left is the "Delta" at that price: the number of contracts that have been transacted at the market offer minus those transacted at the bid. When the color is green and the number beside price is more positive, it means that we have greater buying interest at that price. When the color is red and the number next to price at the left is more negative, it means that we have greater selling interest at that price.
So, along that left-hand Y-axis, we're seeing demand and supply at each market price. As the annotation at left indicates, we're seeing supply swamp demand as prices move lower: the numbers become *more* negative. Selling is not drying up as we move lower. Lower prices are attracting more sellers. This is what drives short-term market trends.
Along the X-axis, we have two sets of numbers. The top is total volume for the bar period (in this case 30 minutes). The bottom number is the Delta at that *time*. This shows us the net number of contracts transacted at the market offer minus bid over each half-hour period.
If we want to see how demand and supply are distributed *within* the bar period, we look to the numbers within the bar. The first is the volume transacted at that time and price at the market bid. The second is the volume transacted at that time and price at the market offer. When volume at bid exceeds volume at offer, that portion of the bar becomes red. When volume at offer exceeds that at bid, that portion of the bar becomes green. The mix of red and green within the bar--and from bar to bar--shows how market psychology, the shift of sentiment among buyers and sellers, evolves over time.
This view of changing market psychology within time periods and from one period to the next is especially powerful when correlated with total market volume. We can see this from the way the market topped out early in the morning. Note that during the period from 2:30 to 4:30 AM CT, the market was moving higher, but then stalled out in total volume (X axis, top number) and stalled out in the proportion of volume within each period dominated by buyers vs. sellers (less green than red). This stalling out of a market rise brought out the sellers, who then piled into the market during the 6:00 AM bar.
Once volume picked up dramatically during the selling, the bounce in the next bar was feeble, both in terms of price (amount of retracement of the recent decline) and in terms of volume transacted at offer vs. bid (very little green). This set us up for continuation of the downside move and a resumption of control by the bears.
During my Thursday Webinar, I'll have much more to say about reading market psychology. Every day in the market is an auction, and the price and volume figures reveal to us the relative interest of buyers and sellers in this auction. By understanding the dynamics of the auction prior to the market open, we can formulate hypotheses about the coming morning trade and become alert to any shifts that might occur in market sentiment.
RELEVANT POSTS:
Stock Market Reversals
Tracking Market Transitions
Breakout Trades
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Tuesday, April 22, 2008
Free Webinar This Thursday
Dear Readers,
I'm pleased to announce that, after the stock market close this Thursday (3:30 PM CT), I will be offering a free Webinar on the topic of "Reading the Psychology of the Market" hosted by Bill Duryea and the Institute of Auction Market Theory (IOAMT). I'll be delivering the session from the Chicago Board of Trade offices of Trevor Harnett, the developer of Market Delta, who will assist with the program. Access to the Webinar will be available to those who sign up for a free five-day trial membership to Bill's real-time trading room. It's a great opportunity to experience trading education in real time. During the trial period, as part of the trading room, Trevor will be conducting free educational programming regarding the use of Market Delta. Please note that he is also offering a free 30-day subscription to Market Delta--an excellent opportunity to kick the tires and see how the program works across different market conditions.
Before I launch into a description of the session, just a few disclaimers: I have no commercial ties to IOAMT or Market Delta and have insisted on receiving no compensation for the Webinar. Bill and Trevor offer services that I feel are of value to traders, so I'm happy to support their efforts. I've been a Market Delta subscriber for years and have found it to be a useful tool in reading volume/sentiment patterns in the market. A number of traders have reported positive things to me about the real-time trading room run by Bill--particularly his integration of Market Profile, Market Delta, and intraday trading principles. From my end, the Webinar is a vehicle for offering quality education to traders; I don't use it to solicit business personally, and I don't receive any compensation or consideration from IOAMT or Market Delta for my participation.
It's a shame I have to offer such disclaimers, but it's in response to the crass commercialism that dominates offerings in "trader education". So many programs are little more than infomercials. The Thursday Webinar will not be an infomercial!
The Webinar will run 1 hour in length, with time for questions/answers at the end. The focus will be on the psychology of the market--reading supply and demand as they unfold during the trading day--not so much on the psychology of traders themselves. Among the topics I'll touch upon are reading patterns across indexes and patterns in the NYSE TICK and Market Delta.
I have found--personally and in my work with developing traders--that Market Profile is an excellent conceptual framework for understanding what markets are doing and why. It's also a practical framework for thinking about price and volume relationships and when market moves are likely to extend vs. retrace. The integration of very short-term supply/demand analysis from Market Delta alongside the longer-term analysis of value from Market Profile yields many sound trading ideas and plans. The idea is to know *what* to do, but also *why* to do it. That yields mastery.
Look forward to seeing you on Thursday! As always, thanks for your interest--
Brett
.
I'm pleased to announce that, after the stock market close this Thursday (3:30 PM CT), I will be offering a free Webinar on the topic of "Reading the Psychology of the Market" hosted by Bill Duryea and the Institute of Auction Market Theory (IOAMT). I'll be delivering the session from the Chicago Board of Trade offices of Trevor Harnett, the developer of Market Delta, who will assist with the program. Access to the Webinar will be available to those who sign up for a free five-day trial membership to Bill's real-time trading room. It's a great opportunity to experience trading education in real time. During the trial period, as part of the trading room, Trevor will be conducting free educational programming regarding the use of Market Delta. Please note that he is also offering a free 30-day subscription to Market Delta--an excellent opportunity to kick the tires and see how the program works across different market conditions.
Before I launch into a description of the session, just a few disclaimers: I have no commercial ties to IOAMT or Market Delta and have insisted on receiving no compensation for the Webinar. Bill and Trevor offer services that I feel are of value to traders, so I'm happy to support their efforts. I've been a Market Delta subscriber for years and have found it to be a useful tool in reading volume/sentiment patterns in the market. A number of traders have reported positive things to me about the real-time trading room run by Bill--particularly his integration of Market Profile, Market Delta, and intraday trading principles. From my end, the Webinar is a vehicle for offering quality education to traders; I don't use it to solicit business personally, and I don't receive any compensation or consideration from IOAMT or Market Delta for my participation.
It's a shame I have to offer such disclaimers, but it's in response to the crass commercialism that dominates offerings in "trader education". So many programs are little more than infomercials. The Thursday Webinar will not be an infomercial!
The Webinar will run 1 hour in length, with time for questions/answers at the end. The focus will be on the psychology of the market--reading supply and demand as they unfold during the trading day--not so much on the psychology of traders themselves. Among the topics I'll touch upon are reading patterns across indexes and patterns in the NYSE TICK and Market Delta.
I have found--personally and in my work with developing traders--that Market Profile is an excellent conceptual framework for understanding what markets are doing and why. It's also a practical framework for thinking about price and volume relationships and when market moves are likely to extend vs. retrace. The integration of very short-term supply/demand analysis from Market Delta alongside the longer-term analysis of value from Market Profile yields many sound trading ideas and plans. The idea is to know *what* to do, but also *why* to do it. That yields mastery.
Look forward to seeing you on Thursday! As always, thanks for your interest--
Brett
.
Perspectives and Themes for Tuesday Morning
* Banks Continue to Struggle - While we recently hit multi-month highs in the number of stocks trading at fresh 65-day highs, banking stocks ($BKX) remain solidly lodged within their February-March trading range. As I noted in recent Twitter posts, both the Bank of England and the ECB have expressed continued concerns over banks and the credit crisis. I'm not sure the banks need to lead any market rally, but their failure to participate is concerning.
* The Virtues of System Trading - Bill Rempel offers some valuable elaborations to my recent trading psychology post by pointing to the strengths of developing and trading systems. Readers know that I am a discretionary trader, but I can vouch for the successes of those who develop and tweak systems that adapt to changing market conditions. Bill's point regarding the value of trading multiple systems that perform under varying regimes is excellent.
* It's Not Just Markets That Follow Seasonal Patterns - Thanks also to a reader for pointing me to the research of Dr. Richard Wiseman and this very interesting study of how personality patterns--including the perception of being lucky!--are related to the seasons of one's birth. Given the relationship between seasonality and mood, including the phenomenon of seasonal affective disorder, the findings aren't so far-fetched.
* Scenario Planning as a Guide to Action - Ray Barros continues to offer excellent guidance for traders, including this perspective on scenario planning. See also his scenario creation for discretionary traders.
* Valuable Perspectives - Trader Mike's recent links highlight discussions of stop-losses and algorithmic trading. From Abnormal Returns, we get some very interesting views, including a look at commodities and bond yields and how seasons affect the VIX.
* Can Positive Thinking Be Irresponsible? - Thanks to a reader for bringing this research report to my attention, highlighting how people edit their memories of past outcomes to justify continued gambling. It's much harder to engage in such distortion when you're tracking your trades and P/L in a journal (which may be one reason traders don't maintain journals).
* Comprehensive Psychiatry Textbook - Just received my copy of the mammoth fifth edition of the Textbook of Psychiatry from American Psychiatric Publishing, the publishing arm of the American Psychiatric Association. With over 1700 pages, the volume features chapters from recognized experts on topics ranging from psychiatric disorders to treatments and the needs of special populations. My chapter deals with brief therapies, including the approaches to short-term work that I utilize with traders.
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Monday, April 21, 2008
Why Every Trader Should Be An Investor
I find two things striking about a large number of active traders:
1) They're not prepared for failure - If trading doesn't work out for them, they don't have clear backup plans (and trading doesn't naturally lead to other careers);
2) They're not prepared for success - If trading does work out for them, how will they accumulate wealth over time and ensure their financial future?
In some ways, the latter problem is just as acute as the first. Making money, holding onto money, and accumulating wealth are very different things. Just because traders make money doesn't mean they know how to deploy that money wisely to build wealth. Indeed, I've seen many sad outcomes among those who have retained a trading mindset with respect to financial planning.
If traders are going to build a financial future, they need to think like investors. And that's not easy to do, when all your financial decision-making has been on the short term.
Fortunately, there are some valuable resources available to help traders make the transition to becoming personal money managers. Here are a few that have come to my attention of late:
1) The Disciplined Investor by Andrew Horowitz - This very accessible book is excellent for those needing an investment primer. Horowitz doesn't cover the full gamut of financial planning (insurance, estate planning, wills), but rather focuses on the range of wealth enhancement and wealth preservation opportunities via stock market investing, mutual funds, and annuities. He begins with "creating a discipline", offers background on quantitative, technical, and fundamental investment strategies, and launches into important material on risk management. It's clearly written and not at all intimidating for investment newbies. Andrew also maintains a blog and conducts frequent podcasts on investment themes.
2) Create Your Own ETF Hedge Fund by David Fry - This is a valuable introduction to the world of exchange-traded funds (ETFs), which are rapidly putting a variety of investment options--from bonds to stocks to currencies and commodities--in the hands of traders. Fry is the founder of the ETF Digest site, which tracks various ETF portfolios and includes weekly podcasts related to investment in ETFs. Fry's central thesis is that individual investors can replicate common and successful hedge fund strategies, from long/short equities to profiting from global macro themes. At the end of the book, he offers sample portfolios designed to meet a variety of investor needs. The book is very practical and quite clearly written.
3) The ETF Book by Richard A. Ferri - Ferri's book is a detailed look at the exchange-traded fund universe, covering various styles and choices among ETFs and then examining portfolio management options for ETF investors. A particularly worthwhile segment of the text applies different ETF strategies to investors in various phases of their life cycle. Ferri covers both passive and active portfolio strategies and offers clear, illustrative sample portfolios. If you're ever wondering which ETFs are available for particular kinds of investment, this book pretty well covers the gamut in a way that is not overly technical. Ferri has also written on asset allocation--an extremely important theme among investors.
What are some general lessons from these books that traders can draw upon in becoming more astute investors? These come to mind:
* You can't invest what you don't save - An investment plan starts with a cogent savings plan.
* Know your objectives - It's important to get a return on your capital, and it's important to ensure the return *of* your capital. Your investment strategy should be tailored to your risk tolerance, and that should reflect where you're at with respect to child bearing, retirement, etc.
* Know your alternatives - With a vast array of mutual funds, annuities, and exchange-traded funds, there are many ways of investing nationally, internationally, in stocks, and in other asset classes.
* Diversify, diversify, diversify - Even the greatest investments (think residential real estate of the last decade, or equities in China) can lose money quickly. Placing eggs in many baskets and ensuring that those baskets are not highly correlated in returns produces superior risk-adjusted returns over time.
You work for your profits; it's important to ensure that they work for you. The average savings rate in the U.S. has recently become negative; people are spending more than they earn. They have assumed that the rising values of their homes would fund their retirements. With the recent housing decline, that assumption will be called into question for quite a few of those folks. For them, retirement is a potential train wreck on the horizon.
That doesn't have to be you. Saving money and making it work for you in a carefully planned manner can ensure that earnings today become tomorrow's wealth of a lifetime.
.
1) They're not prepared for failure - If trading doesn't work out for them, they don't have clear backup plans (and trading doesn't naturally lead to other careers);
2) They're not prepared for success - If trading does work out for them, how will they accumulate wealth over time and ensure their financial future?
In some ways, the latter problem is just as acute as the first. Making money, holding onto money, and accumulating wealth are very different things. Just because traders make money doesn't mean they know how to deploy that money wisely to build wealth. Indeed, I've seen many sad outcomes among those who have retained a trading mindset with respect to financial planning.
If traders are going to build a financial future, they need to think like investors. And that's not easy to do, when all your financial decision-making has been on the short term.
Fortunately, there are some valuable resources available to help traders make the transition to becoming personal money managers. Here are a few that have come to my attention of late:
1) The Disciplined Investor by Andrew Horowitz - This very accessible book is excellent for those needing an investment primer. Horowitz doesn't cover the full gamut of financial planning (insurance, estate planning, wills), but rather focuses on the range of wealth enhancement and wealth preservation opportunities via stock market investing, mutual funds, and annuities. He begins with "creating a discipline", offers background on quantitative, technical, and fundamental investment strategies, and launches into important material on risk management. It's clearly written and not at all intimidating for investment newbies. Andrew also maintains a blog and conducts frequent podcasts on investment themes.
2) Create Your Own ETF Hedge Fund by David Fry - This is a valuable introduction to the world of exchange-traded funds (ETFs), which are rapidly putting a variety of investment options--from bonds to stocks to currencies and commodities--in the hands of traders. Fry is the founder of the ETF Digest site, which tracks various ETF portfolios and includes weekly podcasts related to investment in ETFs. Fry's central thesis is that individual investors can replicate common and successful hedge fund strategies, from long/short equities to profiting from global macro themes. At the end of the book, he offers sample portfolios designed to meet a variety of investor needs. The book is very practical and quite clearly written.
3) The ETF Book by Richard A. Ferri - Ferri's book is a detailed look at the exchange-traded fund universe, covering various styles and choices among ETFs and then examining portfolio management options for ETF investors. A particularly worthwhile segment of the text applies different ETF strategies to investors in various phases of their life cycle. Ferri covers both passive and active portfolio strategies and offers clear, illustrative sample portfolios. If you're ever wondering which ETFs are available for particular kinds of investment, this book pretty well covers the gamut in a way that is not overly technical. Ferri has also written on asset allocation--an extremely important theme among investors.
What are some general lessons from these books that traders can draw upon in becoming more astute investors? These come to mind:
* You can't invest what you don't save - An investment plan starts with a cogent savings plan.
* Know your objectives - It's important to get a return on your capital, and it's important to ensure the return *of* your capital. Your investment strategy should be tailored to your risk tolerance, and that should reflect where you're at with respect to child bearing, retirement, etc.
* Know your alternatives - With a vast array of mutual funds, annuities, and exchange-traded funds, there are many ways of investing nationally, internationally, in stocks, and in other asset classes.
* Diversify, diversify, diversify - Even the greatest investments (think residential real estate of the last decade, or equities in China) can lose money quickly. Placing eggs in many baskets and ensuring that those baskets are not highly correlated in returns produces superior risk-adjusted returns over time.
You work for your profits; it's important to ensure that they work for you. The average savings rate in the U.S. has recently become negative; people are spending more than they earn. They have assumed that the rising values of their homes would fund their retirements. With the recent housing decline, that assumption will be called into question for quite a few of those folks. For them, retirement is a potential train wreck on the horizon.
That doesn't have to be you. Saving money and making it work for you in a carefully planned manner can ensure that earnings today become tomorrow's wealth of a lifetime.
.
Indicator Review for April 21st
Last week's indicator review noted short-term weakness, but a longer-term pattern of market strength. With the drying up of selling early in the week, we saw buyers return to the market and push the major averages above long-term resistance. The number of stocks registering fresh 20-day highs moved higher, but did not expand above levels from early this month (middle chart), but we did see a significant expansion of stocks making fresh 65-day highs. The reduced number of new lows during market weakness and the expansion of new highs suggests that the market has been gaining strength.
That having been said, I can't say the picture is entirely rosy for the bulls. The Cumulative Demand/Supply Index (top chart) has touched an overbought level (+30), which has corresponded to subnormal price gains 20 days out. In a market gaining strength, that doesn't necessarily mean we'll see a major price reversal, but it does often lead to a period of consolidation and choppiness.
A little more concerning is the relative weakness of the Cumulative NYSE TICK line, which is not confirming its early April highs to this point (bottom chart). A similar picture is painted by my work on money flows into Dow Jones Industrial stocks. While Friday gave us the highest dollar inflows of 2008, the five-day flows are only barely positive. I will be watching the TICK line and dollar flows very carefully. A retreat from current levels and a price move of the major stock indexes back into their long-term trading range would call this past week's bull move into question and, indeed, target a return to the midpoint of that range.
Other indicators generally confirm the bullish action from the past week. As I mentioned in a recent Twitter post, we're now seeing 68% of SPX stocks trading above their 50-day moving averages, up from a little over 40% last week and 10% at the March bottom. We have to go back to October, 2007 to find a stronger reading. Similar readings are found among the broad list of NYSE stocks.
Furthermore, the advance-decline lines specific to the NYSE common stocks and the SPX stocks held their March lows last week and now have moved to multi-week highs. Also hitting multi-week highs is my measure of technical strength, with 3/4 of all stocks in my basket now trading in uptrends.
The all-important trading issue is whether the break above long-term resistance was genuine or whether it will turn out to be a false breakout trapping the bulls. While a good deal of evidence suggests that the move is for real, those on the sidelines may want to look for continued strength in the NYSE TICK and the money flow numbers before chasing price highs in a market that's becoming overbought.
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Sunday, April 20, 2008
Becoming Your Own Trading Coach: A Case Study
Yo, check it out, as Randy Jackson would say:
A young, developing trader emails me about his performance on Friday. The market gapped open strongly to the upside and he immediately found lagging stocks to short. I can only guess that his reasoning was based on the supposition that "gaps tend to fill", so that he'd benefit when the weakest of the stocks retreat with the broad market.
Lost, of course, was the fact that this was a very large upside gap, very broadly distributed across a range of sectors and issues. If our young trader had actually made a historical study of such very strong opens, he might have been less inclined to swim against the tide. And that 's not even taking into consideration that the market was breaking out of a long-term zone of price resistance.
So, OK, the young trader begins his day on a boneheaded note, at least in my book. His shorts start out profitable and then give back their gains, presumably as the broad market is roaring ahead. What happens now?
This is where our young, developing trader shows that he will someday be an old, experienced trader. He describes a rule he had set for himself, "If a position immediately went against me, if after one hour it was still a loser and not yet at my loss goal, then I would get out and move to the next trade." In other words, he doesn't wait for the position to put him deeply under water and he doesn't fight the market and add to his position out of frustration. He just moves on to the next trade.
But, as Randy would say, this is where our trader is hot: His "next trade" involved buying calls. Our young, developing trader flipped his position and aligned himself with the market direction. He took the time to reassess and then found opportunity based on what the market was doing, not based on what he thought the market *should* do. By 9 AM, he had turned his head around, setting up a profitable and successful trading day.
Compare our young trader with others who wrote to me after fading the market all day Friday. Their refrain was that the market *shouldn't* be rallying because economic fundamentals are so bad, earnings are so weak, etc. They were so locked into their opinions and scenarios that they couldn't see the lopsided nature of the day's trade.
Hey, we're all going to lose forest for trees and make some boneheaded calls. I could regale you with dozens of my own. What sets apart the traders with longevity is the ability to quickly recognize these mistakes and make mid-course corrections.
To have a strong enough ego to aggressively take on risk when you feel conviction about an idea, but also to have enough lack of ego to let go of those ideas when they're not working: that's a huge part of success and the mindset of an expert trader.
Oh, and by the way, our young trader concluded the email by emphasizing other mistakes he had made and wanted to work on next week. He's only been a trader for a few months and already he's coaching himself and preparing to put me out of a job.
I love that kind of unemployment. It keeps me well employed.
RELATED POSTS:
Becoming Your Own Trading Coach
Letting Profits Run by Coaching Yourself
Programming Your Experience as a Trader
.
A young, developing trader emails me about his performance on Friday. The market gapped open strongly to the upside and he immediately found lagging stocks to short. I can only guess that his reasoning was based on the supposition that "gaps tend to fill", so that he'd benefit when the weakest of the stocks retreat with the broad market.
Lost, of course, was the fact that this was a very large upside gap, very broadly distributed across a range of sectors and issues. If our young trader had actually made a historical study of such very strong opens, he might have been less inclined to swim against the tide. And that 's not even taking into consideration that the market was breaking out of a long-term zone of price resistance.
So, OK, the young trader begins his day on a boneheaded note, at least in my book. His shorts start out profitable and then give back their gains, presumably as the broad market is roaring ahead. What happens now?
This is where our young, developing trader shows that he will someday be an old, experienced trader. He describes a rule he had set for himself, "If a position immediately went against me, if after one hour it was still a loser and not yet at my loss goal, then I would get out and move to the next trade." In other words, he doesn't wait for the position to put him deeply under water and he doesn't fight the market and add to his position out of frustration. He just moves on to the next trade.
But, as Randy would say, this is where our trader is hot: His "next trade" involved buying calls. Our young, developing trader flipped his position and aligned himself with the market direction. He took the time to reassess and then found opportunity based on what the market was doing, not based on what he thought the market *should* do. By 9 AM, he had turned his head around, setting up a profitable and successful trading day.
Compare our young trader with others who wrote to me after fading the market all day Friday. Their refrain was that the market *shouldn't* be rallying because economic fundamentals are so bad, earnings are so weak, etc. They were so locked into their opinions and scenarios that they couldn't see the lopsided nature of the day's trade.
Hey, we're all going to lose forest for trees and make some boneheaded calls. I could regale you with dozens of my own. What sets apart the traders with longevity is the ability to quickly recognize these mistakes and make mid-course corrections.
To have a strong enough ego to aggressively take on risk when you feel conviction about an idea, but also to have enough lack of ego to let go of those ideas when they're not working: that's a huge part of success and the mindset of an expert trader.
Oh, and by the way, our young trader concluded the email by emphasizing other mistakes he had made and wanted to work on next week. He's only been a trader for a few months and already he's coaching himself and preparing to put me out of a job.
I love that kind of unemployment. It keeps me well employed.
RELATED POSTS:
Becoming Your Own Trading Coach
Letting Profits Run by Coaching Yourself
Programming Your Experience as a Trader
.
Saturday, April 19, 2008
A Few Trading Psychology Observations
* From working with developing traders, I'd say that 90% don't/can't sustain the process of keeping a substantive journal. Among the group that does journal, well over 90% of the entries are about themselves and their P/L. I almost never see journal entries devoted to figuring out markets.
* A sizable proportion of traders who have been having problems are trading methods and patterns that used to work, but are no longer operative. The inability to change with changing markets affects traders intraday (when volume/volatility/trend patterns shift) and over longer time frames (when intermarket patterns shift).
* It's a common observation that traders fail because they don't stick to their plans. My experience is different. Traders develop plans and trade patterns that simply don't work; they're based on randomness. When the patterns don't work, traders become frustrated and abandon their plans. So it looks like lack of discipline causes trading failure. But planning doesn't create success; sound planning does. Sticking to plans based on randomness is no virtue.
* I mentioned in my book an important law of performance: In every performance field of note--from Olympic athletics to Broadway--performers spend more time in practice than in formal performance. That is how expertise develops. The ratio of "practice" time (time spent on markets outside of trading) to trading time is a worthwhile indicator of a trader's prospective success.
* Among the predictors of trading success, a "passion for trading" is grossly overrated. The successful traders have a passion for markets, which is very different from a passion for trading. Indeed, a passion for trading in the absence of passion for markets is a fair definition of addiction.
* Some traders habitually look for tops in a rising market and bottoms in a falling one. There's much to be said for countertrend methods, but not when the need to be right exceeds the need to make money.
* An underrated element in trading success is mental flexibility: the ability to shift views and perceptions as new data enter the marketplace. It takes a certain lack of ego to form a strong view and then modify it in the face of new evidence.
* A trader I spoke with recently told me he was going to trade more aggressively by putting on more trades. Trading more frequently is not necessarily trading more aggressively, and it certainly isn't necessarily trading prudently. Trading more aggressively means allocating more risk capital to particular (sound) trade ideas. A considerable portion of traders would benefit from trading less frequently *and* more aggressively.
* Nice litmus test for any website devoted to trading education, coaching, and the like: If the site spends more time promoting the person than promoting ideas, you have a good sense for the site's priorities. Caveat emptor.
* Many traders fail because they're focused on what the market *should* be doing, rather than on what it *is* doing. The stock market leads, not follows, economic fundamentals. Some of the best investment opportunities occur when markets are looking past news, positive or negative.
* Success in trading requires the capacity for personal investment. Too many traders close out their efforts, along with their positions, at the end of the day.
RELEVANT POSTS:
What Trading Teaches Us About Life
Three Steps Toward Trading Improvement
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* A sizable proportion of traders who have been having problems are trading methods and patterns that used to work, but are no longer operative. The inability to change with changing markets affects traders intraday (when volume/volatility/trend patterns shift) and over longer time frames (when intermarket patterns shift).
* It's a common observation that traders fail because they don't stick to their plans. My experience is different. Traders develop plans and trade patterns that simply don't work; they're based on randomness. When the patterns don't work, traders become frustrated and abandon their plans. So it looks like lack of discipline causes trading failure. But planning doesn't create success; sound planning does. Sticking to plans based on randomness is no virtue.
* I mentioned in my book an important law of performance: In every performance field of note--from Olympic athletics to Broadway--performers spend more time in practice than in formal performance. That is how expertise develops. The ratio of "practice" time (time spent on markets outside of trading) to trading time is a worthwhile indicator of a trader's prospective success.
* Among the predictors of trading success, a "passion for trading" is grossly overrated. The successful traders have a passion for markets, which is very different from a passion for trading. Indeed, a passion for trading in the absence of passion for markets is a fair definition of addiction.
* Some traders habitually look for tops in a rising market and bottoms in a falling one. There's much to be said for countertrend methods, but not when the need to be right exceeds the need to make money.
* An underrated element in trading success is mental flexibility: the ability to shift views and perceptions as new data enter the marketplace. It takes a certain lack of ego to form a strong view and then modify it in the face of new evidence.
* A trader I spoke with recently told me he was going to trade more aggressively by putting on more trades. Trading more frequently is not necessarily trading more aggressively, and it certainly isn't necessarily trading prudently. Trading more aggressively means allocating more risk capital to particular (sound) trade ideas. A considerable portion of traders would benefit from trading less frequently *and* more aggressively.
* Nice litmus test for any website devoted to trading education, coaching, and the like: If the site spends more time promoting the person than promoting ideas, you have a good sense for the site's priorities. Caveat emptor.
* Many traders fail because they're focused on what the market *should* be doing, rather than on what it *is* doing. The stock market leads, not follows, economic fundamentals. Some of the best investment opportunities occur when markets are looking past news, positive or negative.
* Success in trading requires the capacity for personal investment. Too many traders close out their efforts, along with their positions, at the end of the day.
RELEVANT POSTS:
What Trading Teaches Us About Life
Three Steps Toward Trading Improvement
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Friday, April 18, 2008
Using a Basket of Stocks to Track the Stock Market
A few traders have emailed me, asking me to republish the names of the 40 stocks in my basket that I follow for technical strength. The 40 issues are evenly divided among eight S&P 500 sectors: Materials (XLB), Industrials (XLI), Consumer Discretionary (XLY), Consumer Staples (XLP), Energy (XLE), Health Care (XLV), Financials (XLF), and Technology (XLK). I chose the five stocks from each of the eight sectors, because they were among the most highly weighted issues within the sector ETFs.
I have found this basket of stocks to be invaluable. They tell me when sectors are moving in unison vs. traveling their own way--an issue relevant to the type of market we're in. The basket also helps me identify market themes: which sectors are leading and lagging. On an intraday basis, I use the 40 stocks to identify which stocks are making new short-term highs and lows as the broad market is making fresh price highs or lows. This is quite helpful in handicapping the odds of the move continuing vs. reversing.
Here are the stock symbols for the basket, arranged by sector:
In terms of technical strength, to wrap up the week, we find that 30 stocks in the basket are now trading in uptrends, 5 are neutral, and 5 are in downtrends. The rally has been broadening out to more stocks and sectors, which has been a very useful tell for trend followers. Not all trends are your friend, but the ones that gain strength as they progress are worth riding! The basket of stocks helps identify when trends are gaining and losing strength.
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I have found this basket of stocks to be invaluable. They tell me when sectors are moving in unison vs. traveling their own way--an issue relevant to the type of market we're in. The basket also helps me identify market themes: which sectors are leading and lagging. On an intraday basis, I use the 40 stocks to identify which stocks are making new short-term highs and lows as the broad market is making fresh price highs or lows. This is quite helpful in handicapping the odds of the move continuing vs. reversing.
Here are the stock symbols for the basket, arranged by sector:
Materials - DD, DOW, AA, IP, WY
Industrials - GE, UPS, BA, UTX, MMM
Consumer Discretionary - CMCSK, TWX, HD, DIS, MCD
Consumer Staples - PG, MO, WMT, KO, WAG
Energy - XOM, CVX, COP, SLB, OXY
Health Care - PFE, JNJ, MRK, LLY, AMGN
Financials - C, AIG, BAC, WFC, JPM
Technology - MSFT, INTC, IBM, CSCO, VZ
Industrials - GE, UPS, BA, UTX, MMM
Consumer Discretionary - CMCSK, TWX, HD, DIS, MCD
Consumer Staples - PG, MO, WMT, KO, WAG
Energy - XOM, CVX, COP, SLB, OXY
Health Care - PFE, JNJ, MRK, LLY, AMGN
Financials - C, AIG, BAC, WFC, JPM
Technology - MSFT, INTC, IBM, CSCO, VZ
In terms of technical strength, to wrap up the week, we find that 30 stocks in the basket are now trading in uptrends, 5 are neutral, and 5 are in downtrends. The rally has been broadening out to more stocks and sectors, which has been a very useful tell for trend followers. Not all trends are your friend, but the ones that gain strength as they progress are worth riding! The basket of stocks helps identify when trends are gaining and losing strength.
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Bandwagon Effects in the Stock Market
A little while back I posted about the increasing number of one-sided days in the stock market and how those are affecting traders. Yesterday I noticed another kind of one-sidedness: seven of the last nine trading sessions in the S&P 500 Index ($SPX) have closed either in the top or bottom quarter of their day's range.
This led me to examine more broadly the issue of how often stock indexes close near their day's highs or lows. If we divide each day's range into quartiles, then we would assume, over time, that a chance distribution would put 50% of market closes in the top or bottom quarter of the day's range and 50% in the middle two quarters.
That is not what we see in the data, however. Since July, 2007, two-thirds of all trading days closed either in the day's top or bottom quarter: 132 out of 200 days, to be precise. From January, 2000 through June, 2007, that ratio was 61% (385 out of 627 days).
If we tighten the criteria and divide each day's range into deciles, we can observe how often the market closes in the top or bottom 10% of its daily range. One would expect, by chance, that this would occur 20% of the time. Since July, 2007, however, it has occurred 77 out of 200 days: 38% of all occasions. From 2000 through June, 2006, we closed in either the top or bottom 10% of the daily range in $SPX 209 out of 627 days, or 33% of the time.
What we are seeing is that markets are closing near their day's highs or lows more frequently than we would expect by chance. This may reflect a bandwagon effect, in which traders and investors observe market movements during the day and don't want to miss out on them. This would lead them to buy rising markets and sell falling ones, creating late day strength or weakness. Regret and the fear of missing out on a market move would lead to increased trending behavior as the day progresses, creating a kind of one-sidedness to the trade.
This bandwagon effect, exaggerating market movements late in the day, tends to be unwound the next day. Going back to 2000 (N = 2082 trading days), we find the following average next day changes in $SPX as a function of the location of the prior day's close:
What this suggests is that, once a bandwagon starts during the day, it tends to persist into the close. Fading one-sided days, particularly of late, has not been a fruitful endeavor for traders. Expecting bandwagons to persist into the next day's trade, however, has also not been profitable. It appears that traders segment their performance day by day, perhaps jumping aboard trends in an effort to finish their days on winning notes. By the close of the next day, however, any such bandwagon effect has been erased.
RELATED POSTS:
Why It's Difficult to be a Trend Follower
Markets and Trending
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This led me to examine more broadly the issue of how often stock indexes close near their day's highs or lows. If we divide each day's range into quartiles, then we would assume, over time, that a chance distribution would put 50% of market closes in the top or bottom quarter of the day's range and 50% in the middle two quarters.
That is not what we see in the data, however. Since July, 2007, two-thirds of all trading days closed either in the day's top or bottom quarter: 132 out of 200 days, to be precise. From January, 2000 through June, 2007, that ratio was 61% (385 out of 627 days).
If we tighten the criteria and divide each day's range into deciles, we can observe how often the market closes in the top or bottom 10% of its daily range. One would expect, by chance, that this would occur 20% of the time. Since July, 2007, however, it has occurred 77 out of 200 days: 38% of all occasions. From 2000 through June, 2006, we closed in either the top or bottom 10% of the daily range in $SPX 209 out of 627 days, or 33% of the time.
What we are seeing is that markets are closing near their day's highs or lows more frequently than we would expect by chance. This may reflect a bandwagon effect, in which traders and investors observe market movements during the day and don't want to miss out on them. This would lead them to buy rising markets and sell falling ones, creating late day strength or weakness. Regret and the fear of missing out on a market move would lead to increased trending behavior as the day progresses, creating a kind of one-sidedness to the trade.
This bandwagon effect, exaggerating market movements late in the day, tends to be unwound the next day. Going back to 2000 (N = 2082 trading days), we find the following average next day changes in $SPX as a function of the location of the prior day's close:
Prior Day Closes in Top Quarter of Range (N = 727): -.06% (343 up, 384 down)
Prior Day Closes in Middle Two Quarters of Range (N = 743): -.02% (381 up, 362 down)
Prior Day Closes in Bottom Quarter of Range (N = 612): .11% (357 up, 255 down)
Prior Day Closes in Middle Two Quarters of Range (N = 743): -.02% (381 up, 362 down)
Prior Day Closes in Bottom Quarter of Range (N = 612): .11% (357 up, 255 down)
What this suggests is that, once a bandwagon starts during the day, it tends to persist into the close. Fading one-sided days, particularly of late, has not been a fruitful endeavor for traders. Expecting bandwagons to persist into the next day's trade, however, has also not been profitable. It appears that traders segment their performance day by day, perhaps jumping aboard trends in an effort to finish their days on winning notes. By the close of the next day, however, any such bandwagon effect has been erased.
RELATED POSTS:
Why It's Difficult to be a Trend Follower
Markets and Trending
.
Thursday, April 17, 2008
Catching Up on a Thursday
* After a Strong Momentum Day - Wednesday was a particularly strong momentum day, as my measure of Demand (reflecting the number of issues closing above the volatility envelopes surrounding their short-term moving averages) exceeded Supply (those closing below their envelopes) by more than 8:1. I went back to September, 2002 (when I first began collecting these data; N = 1384 trading days) and found only 28 occasions when Demand exceeded Supply by more than 8:1. Interestingly, there was no directional edge the next trading day, but ten days later, the S&P 500 Index (SPY) averaged a gain of 1.01% (22 up, 6 down), much stronger than the average ten-day gain of .33% (805 up, 551 down) for the remainder of the sample.
* After Hours Volatility - Brian Shannon tracks the action in GOOG and its impact on the NASDAQ 100 Index. I just received an advance copy of Brian's new book and will provide an overview shortly. It deals with using technical analysis across multiple time frames, something Brian illustrates well in the videos on his site.
* Great New Site - While we're on the topic of GOOG, here's the stock's page in the iStockAnalyst site. There's a wealth of information in one place, including rankings on technical, fundamental, performance, and sector criteria; latest news; analyst ratings; and much more. Very promising research tool.
* A Portfolio of Blogs - Financial Philosopher identifies his favorite sites, including self-improvement and philosophy blogs I wasn't familiar with.
* Agricultural Boom - Research Recap examines evidence that high agricultural prices are likely to persist, given structural changes in population growth among emerging economies and the use of food crops for biofuels.
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* After Hours Volatility - Brian Shannon tracks the action in GOOG and its impact on the NASDAQ 100 Index. I just received an advance copy of Brian's new book and will provide an overview shortly. It deals with using technical analysis across multiple time frames, something Brian illustrates well in the videos on his site.
* Great New Site - While we're on the topic of GOOG, here's the stock's page in the iStockAnalyst site. There's a wealth of information in one place, including rankings on technical, fundamental, performance, and sector criteria; latest news; analyst ratings; and much more. Very promising research tool.
* A Portfolio of Blogs - Financial Philosopher identifies his favorite sites, including self-improvement and philosophy blogs I wasn't familiar with.
* Agricultural Boom - Research Recap examines evidence that high agricultural prices are likely to persist, given structural changes in population growth among emerging economies and the use of food crops for biofuels.
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Volume in the Stock Index Futures Market - Part Two
In my recent post, I suggested that a key to understanding the character of a market day was tracking the volume patterns within that day. Specifically, if volume is running significantly above normal, it means that institutional participants are active in the marketplace. This tends to bring greater price volatility and increased likelihood of breakout and trending moves--especially when we see similar moves in related markets (interest rates, currencies, commodities, etc.).
The chart above is quite informative. It goes back 24 trading days (to the first day when the June ES futures contract became the front month) and identifies the median volume and high-low price range (in percentage change) for each 15-minute period through the day. We can clearly see the smile pattern in the data: the tendency for early morning and late afternoon periods to trade with greater volume and price movements than periods midday. Indeed, price movement early and late in the day is easily 50-70% greater than midday. This suggests that uniform rules for placement of stops and price targets are bound to fail: the market is not uniform intraday.
Nor is the market uniform from day to day. These are median values, but the values for each individual day vary widely. Wednesday's trade was a great example: some 15-minute periods during the day traded at near-median volume and even lower than median price movement. Other periods were greatly expanded from the norms charted. Those were the periods contributing to the day's trending movement. Institutional traders are not necessarily active in every time period--they're not daytraders. But when we see that they are active at key junctures (during price breakouts, in response to movements in rates or currencies), it underscores the significance of moves that occur as a result.
Below are the data for the chart. Note that the time periods are U.S. Eastern time; fifteen-minute segments starting at the time noted. I use these data to tell me when volume is running above and below average and, hence, when I can expect more or less price movement. As mentioned earlier, this is invaluable in deciding when to take profits aggressively vs. (as Wednesday) let profits run.
| Time | Volume | Range |
| 9:30 | 107300 | 0.388 |
| 9:45 | 85008 | 0.342 |
| 10:00 | 91522 | 0.348 |
| 10:15 | 71411 | 0.314 |
| 10:30 | 81151 | 0.34 |
| 10:45 | 73599 | 0.315 |
| 11:00 | 60560 | 0.263 |
| 11:15 | 50261 | 0.296 |
| 11:30 | 53194 | 0.277 |
| 11:45 | 46481 | 0.242 |
| 12:00 | 35930 | 0.232 |
| 12:15 | 40276 | 0.235 |
| 12:30 | 39703 | 0.233 |
| 12:45 | 36437 | 0.24 |
| 13:00 | 38134 | 0.224 |
| 13:15 | 31076 | 0.193 |
| 13:30 | 39797 | 0.247 |
| 13:45 | 35313 | 0.19 |
| 14:00 | 47716 | 0.29 |
| 14:15 | 50910 | 0.248 |
| 14:30 | 50096 | 0.297 |
| 14:45 | 56285 | 0.344 |
| 15:00 | 57959 | 0.32 |
| 15:15 | 53862 | 0.33 |
| 15:30 | 68613 | 0.365 |
| 15:45 | 93226 | 0.311 |
| 16:00 | 71828 | 0.284 |
RELATED POSTS:
What Every Short-Term Trader Should Know
Finding Opportunity in the Stock Market
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