Saturday, January 31, 2009

Taking Heat on Your Trades

The odds of selling or buying a market at the precise top or bottom are pretty slim. What that means is that even the best trades will take some heat, i.e., some adverse price movement. Indeed, distinguishing between normal heat--random price movement around an entry--and just plain being wrong on the trade is an important component of trading expertise.

The recent post on emotionally intelligent trading is highly relevant to the issue of taking heat on trades. The emotionally intelligent trader uses the feelings generated by adverse movement to become more market focused, absorbed in the details of how and why the market is moving. If the heat on an S&P trade occurs on a modest TICK reading, for example, and is not confirmed by similar moves among small cap stocks and leading sectors, the trader may well conclude that it is merely noise. Conversely, if a leading sector moves opposite one's trade and the broad market follows, the heat may represent an important shift in short-term sentiment and warrant a quick exit. The emotionally intelligent trader neither ignores the heat nor overreacts to it. Instead, it becomes a prod to revisit one's trade and trade assumptions.

One of the common reactions I observe among traders is that they react to heat with frustration and a venting of emotion. This creates distraction and a lapse in concentration. Lacking emotional intelligence, the trader takes the heat personally rather than as fresh market information. When reactions are personalized in this manner, it is difficult to make decisions that are not impulsive.

A great way to deal with heat is to anticipate it. When traders react personally to adverse movement, it's often because they didn't expect to take heat. If you check out the posts on hot and cold emotional states and using imagery to accelerate behavior change, you'll see that mentally rehearsing expectable heat (and one's desired reactions to the heat) can very much instill sound trading behaviors. When we vividly imagine adverse movement and what we would do under various scenarios, the heat becomes familiar to us; it loses its threat value. Heat on a trade doesn't have to make us hot-headed. Once we expect adverse movement and have rehearsed how to handle it, we can channel our discomfort toward greater focus, awareness, and planning.

The Strengths of the Emotionally Intelligent Trader

A recent review highlighted different models and definitions of emotional intelligence. Among the features associated with emotional intelligence are:

* Ability to accurately read emotion in others and respond in empathic and appropriate ways;

* Ability to effectively assimilate emotion in thought and action for coping and problem solving;

* Ability to regulate emotion, channeling it into motivation, persistence, and effective relationships.

The traits assessed by questionnaires measuring emotional intelligence are wide ranging:

* Adaptability - Flexibility and willingness to adapt to new conditions;
* Emotional Regulation - Ability to control emotions and their expression;
* Low Impulsiveness - Ability to refrain from giving into urges;
* Self Motivation - Tendency to persist in the face of adversity;
* Social Awareness - Ability to effectively network with others;
* Stress Management - Ability to withstand pressure and perform effectively;
* Empathy - Ability to take the perspective of others;
* Optimism - Tendency to look on the bright side of life;
* Happiness - Tendency toward cheerfulness and satisfaction.

These qualities pretty much read as a collection of strengths that are present among most successful traders. To be sure, there are many cognitive strengths that are necessary to trading success, including pattern recognition, memory, and speed of processing. These will not yield consistent profitability, however, if not supplemented with emotional strengths.

In a social interaction, the emotionally intelligent person picks up on subtle cues--tone of voice, body language, changes of topic--to track others and respond effectively. If we think of traders as being in relationships with markets--and if we think of market movements as reflections of buying and selling sentiment--then it's easy to see that the emotionally intelligent trader is one who is highly attuned to the emotional meanings of market communications.

When people become caught up in their own emotions, they become emotionally unintelligent. They respond to others out of their own neediness, anger, or insecurities and fail to track what is really being communicated. Similarly, traders immersed in their own needs for profits or excitement no longer focus on market communications. They make emotionally unintelligent decisions, which are generally unprofitable ones.

The start of emotionally intelligent trading is recognizing that you are in an emotional relationship with markets. If you treat the market as a valued partner, rather than as an adversary to be conquered, you'll be surprised at the subtle communications you'll be able to hear.


Friday, January 30, 2009

A Life Lesson From Trading

One of the things I love about trading is how it teaches many worthwhile life lessons. For some of the lessons I've learned over the past, check out this post; this post and its links also highlight some lessons from family. It's those lessons that are the rewards of a lifetime, enduring long after the glow of a day's profits has dimmed.

Today's lesson was a bit of the market, a bit of family. I was short the S&P 500 Index in the afternoon, holding a moderate-sized profit in my position. The trade was choppy as we got down to the low 820 range in the ES contract, and I went back and forth in my head as to whether to take the profit and call it a week. I wasn't in a particular mood to turn a winning trade into a loser to finish the week, but my research told me that, given the weakness of the NYSE TICK and Dow TICK, we had a good shot at heading lower and hitting the S1 price target. So, back and forth the market traded, and back and forth I debated the position.

Then a phone call came. It was from our son Macrae's high school. Crae was pretty broken up emotionally because he found out that one of his high school friends had died just a little while before. I knew it had to have hit Crae hard; he's not the kind of guy to show his feelings. We talked over the phone and just shared the sadness of the moment. I misted up just thinking of what it must be like for his friend's family and how I would feel if I were to lose one of our children. I wanted to make Crae feel better, but there wasn't much of consolation I could say, other than, "I love you, and I'm sorry this happened."

Of course, the market didn't stop trading simply because I had a family crisis. But it was as if something snapped in me. I suddenly didn't care whether the position reversed or hit its target. I kept it in place and just let it go. There were more important things to think about. No sooner did I reach that point than the market continued its leg down, taking me out at my target. It didn't really matter. My mind was on other things.

The irony, of course, is that I traded well--followed my plan and escaped my uneasiness about the position--once I hit the emotional realization that there was something much more important happening than my trade. It wasn't caring about my trading that made me trade better; it was not caring too much. When trading is front and center in our lives, it is all to easy to slip from wanting to make money to needing to make money. At that point, the trade control us. It took an emotional crisis to detach my ego from the market and focus on the really important things in life.

It's a lesson I know well, but sometimes lose sight of: the best way to take the pressure off your trading is to stay focused on all the things in life that are more important than the day's profits. Trading success follows from the fullness of your life; it cannot fill life's voids.

Making the Most of TraderFeed Resources

Well, TraderFeed will hit its 2000th blog post this weekend and, coincidentally, the Twitter Trader feature of the blog is nearing its 2000th subscriber. Readers are no doubt aware that I have shifted the blog to more trading-centric themes--i.e., posts regarding the nuts and bolts of trading--in an effort to provide a helpful blend of trading psychology, market psychology, and trader psychology.

The reason for this shift is that, while there are good trading education services out there, most of them are priced beyond the level of a developing trader. When I began trading in the late 1970s with my $2500 stake as a graduate student, I couldn't have afforded trading coaches who charge hundreds of dollars per hour or seminars that cost hundreds if not thousands of dollars. No trader should be spending 5% or more of his or her trading stake on any single educational opportunity. Prudence dictates that a trading business, like any fledgling enterprise, keep its overhead reasonable.

That is why I've been developing a suite of resources that are designed to aid traders who are like me in my early years: full of interest and willingness to work and learn, but shy on capital. Here's a rundown on those resources and who might find them of use:

1) TraderFeed Blog - This blog has a twin focus: market psychology and trading psychology. Thus you'll find posts on market sentiment--the buying and selling interest among participants and market sectors--as well as posts on trader psychology and trading methods that make use of sentiment and psychology. Many of the posts generate enlightening comments from readers; the readership includes a large number of individual and institutional professional traders. Subscription to the blog via RSS is free, of course; links for subscription can be found below the "About Me" section of the blog page.

2) Become Your Own Trading Coach Blog - This is my new blog site that emphasizes information that can help traders further their personal and trading development. It is a companion blog to the trading coach book that will be coming out shortly (see below), and it serves as an archive for some of the most practically useful trading psychology posts from TraderFeed. New material will be added to the Trading Coach book (see below) over time, and will be available through the Trading Coach blog. RSS subscription is also available via links on the blog at the top left.

3) Twitter Trader - This is the "blog within a blog" feature that sends traders short messages of timely relevance. Some of the "tweets" are links to mainstream media articles that highlight important big picture themes for markets; others are links to blog posts regarding markets and trading methods. Also included in the Twitter posts are pre-opening indicator readings; heads ups on economic reports coming out; and morning comments about market conditions, relative volume, and other important real time information. Free subscription is available via my Twitter page.

4) The Daily Trading Coach - This new book is in print as I write and should be out in the next month or so. To my knowledge, it is the first book specifically designed as a self-help book for traders, with 101 short chapters, each highlighting a practical method for improving trading and psychology. Chapter lessons include specific cognitive, behavioral, and dynamic techniques for working on the psychological side of trading, as well as sections devoted to improving your trading business (risk management, performance measurement) and perspectives from well-regarded trader/bloggers. New material will be added to the book electronically via the Trading Coach blog (see above), and readers will have a dedicated email address to communicate their questions and comments to me. One long-awaited reader-requested feature: A full chapter--10 lessons--devoted to identifying patterns with Excel.

Not all of these resources will appeal to all traders, of course, but my hope is that the mix of them can provide a deep and affordable base of information and skills for those riding their learning curves. Who knows? If the interest is there, over time I may add video and live resources to the mix: whatever will help traders coach themselves toward greater personal and trading development. Thanks as always for the interest and support.

Thursday, January 29, 2009

Two Key Questions to Ask When Emotions Affect Trading

Traders most often contact me when they feel that emotional factors are interfering with their trading performance. Their hope is that resolving these problems will help their bottom lines. But how can they begin to achieve such resolution? A good start is to address two key questions:

1) Do the problems that affect your trading also impact other areas of your life? - Let's say that you find yourself overtrading and taking too much risk relative to your planned exposure. You realize that these lapses of discipline are costing you money and creating significant frustration. The key question to ask is whether these lapses also occur in other spheres of life: in managing personal finances, in failing to follow through on personal responsibilities, or in impulsive decision-making regarding career, relationships, and the future. If so, then you know that this is a general problem that is spilling over into trading. Working with a psychologist or other licensed therapist or counselor could be the best way to go, as this is not uniquely a trading problem. Alternatively, if the problem truly is unique to trading, then it is probably triggered by situational factors related to how you are trading. Relying on a trading coach to review your trading practices and address these factors can be promising.

2) Do the problems primarily result from poor trading, or are the problems a primary cause of poor trading? - This can be tricky to sort out, because the direction of causality often goes both ways. Many times, poor trading practices--such as trading excessive risk--lead to emotional fallout, such as frustration, anxiety, or even depression. Working on changing emotions might be helpful, but the root cause--the faulty money management--needs to be addressed. Conversely, there are times when emotional problems, such as performance anxiety, get in the way of trading plans and trading results. It is very helpful to examine trading problems in a step-by-step fashion, to see where emotions are affecting trading and to see where trading is creating emotional pressures.

The most difficult emotional interference in trading occurs when longstanding emotional patterns and conflicts spill over into handling the risk and uncertainty of trading. A rebellious teen with unresolved control issues with parents can easily grow up into a trader who rebels against rules and plans, undercutting his own trading. A person who has been traumatized by losses of loved ones may find it difficult to handle financial losses. Someone who never learned to regulate anger and frustration as a child may now find these emotions derailing sound decision making in markets. When the past is intruding into the present, affecting emotional well being and trading performance, sound psychological assistance--even the short-term methods of brief therapies--can be very helpful.

When, however, skills haven't been learned and a trader lacks a true edge, then trading may be causing emotional frustration and anxiety. Many traders try to front run their learning curves, putting capital to work before they're ready, creating stress and distress in the process. Psychology is vital to good trading, but you need to trade well to sustain a sound psyche.


Reversal and Momentum Effects Following Surges in Stocks Making New Highs

One pattern that I've seen play out on multiple timeframes is that price breakouts that lead to a surge in the number of stocks making new highs tend to be followed by consolidation/reversal in the short run, but continuation thereafter. This sets up useful trades in which initial pullbacks following these surges can make nice entry points for subsequent upside moves.

Going back to late 2002, when I first began collecting these data (N = 1572), I looked at what happened in the S&P 500 Index (SPY) following days in which the number of stocks making new 20-day highs across the NYSE, NASDAQ, and ASE exceeded 1500 (N = 213). Interestingly, ten days after the surge in new highs, SPY averaged a gain of only .05% (122 up, 91 down), compared with an average gain of .08% (787 up, 572 down) for the remainder of the sample.

When we go out 30 days, however, we find that the surge in new highs leads to an average gain of .85% (143 up, 70 down), compared with an average rise of only .13% for the rest of the sample (801 up, 598 down). The surge in strength does not necessarily result in significant near-term gains, but it is common to see momentum carry the market higher in the longer run. In a future post, I will illustrate this pattern at intraday time frames. The links below illustrate the importance of understanding momentum dynamics in markets.

Wednesday, January 28, 2009

The Dow TICK ($TICKI): Identifying Pullbacks in a Market Trend

Long time blog readers are familiar with my use of the NYSE TICK as a trading tool. As I noted in today's Twitter posts, today's market was a nice example of strong underlying buying interest among NYSE issues, as measured by the Cumulative TICK. As a rule, it pays to trade in the direction of the Cumulative TICK, as that reveals buying vs. selling sentiment across the broad range of NYSE issues.

In e-Signal, the NYSE TICK goes by the symbol $TICK. Closely related is the TICK measurement that is specific to the Dow Industrial stocks, $TICKI. Here we're tracking how many Dow stocks are trading on upticks vs. downticks at any given moment (the figure is updated about 6 times per minute). Because the Dow stocks trade very actively, TICKI moves much more quickly than TICK. Most traders don't understand TICKI, and few utilize the indicator because it seems so noisy.

As I noted in an earlier post, the Dow TICK is sensitive to program trading, because the Dow stocks are frequent constituents of baskets of stocks. This creates an interesting dynamic between $TICKI and $TICK. We can have situations in which there is program selling of large cap issues, for example, but strong underlying demand for stocks overall. That was indeed the case in today's market. As the chart above depicts, the Cumulative TICKI (a cumulative line of the one minute H+L+C values) danced above and below the zero line during the first part of the day's trade, even as the Cumulative TICK was in a strong uptrend.

What that tells us, as a rule, is that program trading is limited and cannot drag down the broad range of stocks. In such an environment, pullbacks in Cumulative TICKI that occur at successively higher Cumulative TICK levels (and successively higher ES prices) often are great entries to follow the trend. You're letting the temporary program selling move the market lower to give you a better entry on the long side. The reverse is true during market declines: bounces in TICKI in a weak Cumulative TICK and price market often provide excellent entries for shorting and riding the downtrend.

I find that plotting a short-term moving average of TICKI (10 periods on a 1-minute chart) helps filter out the noise and helps traders identify whether TICKI is staying mostly above or below the zero line. It's the pullbacks and bounces in this moving average line--in the context of overall price and TICK strength and weakness--that can create short-term opportunities for nimble intraday traders.

Trading With Patience: Using Trading Metrics to Aid Trading Psychology

One of the themes from the trader performance book that is also a major focus of the new book on learning to coach yourself is the importance of keeping statistics on your trading. Recall that a cornerstone of the solution-focused approach is that working on weaknesses will at best take deficient performance and turn it to average. That can be helpful, but in itself will not make you a stellar performer. To get to that proverbial next level, you need to build on your strengths and become more consistent in drawing upon them.

But how can you build on strengths if you're not fully aware of what they are, and if you're not targeting them with positive goals that you work on daily? Keeping score of your trading helps you better understand what you do when you're at your best. It also helps you track your progress in living up to your performance ideals.

The notion of psychometrics is that trading statistics reveal trading psychology. How you trade is a reflection of how you think and feel. There is no better way of getting into your head than by getting into your trading account and examining what you're doing, what is working for you, and what isn't.

A great example of this occurred in my recent trading. I sliced and diced my recent P/L trade by trade and found one factor that reliably predicted my daily profitability: the time of entry of my first trade. If I traded very early in the morning session for my first trade, I was more likely to be unprofitable on the day than if my first trade occurred later. Indeed, by reviewing my results, I was able to determine that entries within the first ten minutes of trading drastically reduced my daily P/L performance.

Here is where psychometrics reveal psychology. The very early entries reflected a lack of patience on my part. I became wedded to a particular market scenario, and I was afraid of missing out on that move. Instead of waiting for market action to confirm my scenario, I tried to front-run the trend. As a psychologist, I know full well that in any dance with the market, you want the market to lead. My job is to follow market direction; not gratify my ego by predicting market action. But once my ego became attached to the anticipated move, all my fancy education and training went out the window.

So how do psychometrics help? Once I realized that my very early trading was hurting me, I created a hard and fast rule that I could not enter the market within the first 10-15 minutes of trading. I also created a psychological exercise for myself in which I could simply calm myself before the market open and visualize myself trading with extreme patience. During those exercises, I reminded myself that my opportunity was not limited to the opening moments of the day; that I was operating in an environment of plenty, not scarcity.

As a result, my batting average of winning to losing trades has improved and my equity curve, which took a dip, returned to a nice, positive slope. Equally important, I'm trading more in control, more at peace with myself. But it took a hard look at the metrics to bang sense into my head. I'm 54 years old, been trading since the late 1970s, have an advanced degree in psychology, and I'm still working on myself and working on my trading.

But that's what I love about the business: I'm working on myself by working on my trading.


Tuesday, January 27, 2009

Relative Volume and Movement in the Stock Market

If you take a look at my Twitter comments during today's trade, you'll see that I referred to the session as a "shit show" for intraday traders, as volume and movement tailed off ahead of tomorrow's FOMC announcement. That Twitter post was around 10 AM CT and was designed to help traders avoid making grand assumptions about the market movement to come. As you can see from a two-day chart of the ES futures (top chart above), today's market was narrow indeed, an inside market that offered opportunity only on moves from the edges of the ranges back toward the midpoint.

I've seen many traders lose a bundle of money on days like this, playing for breakout moves and getting chopped up. A great way to avoid overtrading markets such as these is to track relative volume: today's volume as a function of recent, average volume. In the bottom chart above, I plotted the recent median volume in blue (those numbers came from my Monday AM indicator post) and today's volume in pink. Notice how the pink line increasingly falls short of the blue one, as volume today tailed off relative to expected, median volume. We know that volume correlates well with volatility, so recognizing the slowing market was key to scaling back price movement expectations during the day.

Plotting today's volume during the day versus the "expected" volume is a great indicator, as you can see crossovers--points at which today's volume accelerates or decelerates relative to usual--and divergences, where today's volume either meaningfully exceeds or falls short of average. These patterns tell us how much movement to expect in the market, which in turn can help us in placing stops and setting price targets for trades. In my case, the relative volume told me to stay out of the market late in the day; it wasn't my kind of trade. Sometimes good trading is simply holding onto your capital.

I will be updating weekly relative volume benchmarks each Monday before the open and, when I'm not tied up with traders, will post real time relative volume observations via Twitter (subscription via RSS is free).

Three Basic Trade Setups

So much of trading success is a function of pattern recognition, and so many trading patterns boil down to three basic setups:

1) Reversal Trades - The market moves to or just beyond the edges of a trading range (a consolidation area, the value area from the prior day), cannot sustain buying/selling interest, and falls back into that range. The initial target for such a trade will generally be the midpoint of that range (which may also be the pivot level from the previous day or week); a reversal on good volume and very weak/strong NYSE TICK will frequently test the opposite end of that range, as the breakout traders bail out of their positions. I like to be particularly on the lookout for reversal trades in environments in which relative volume is weak, as these tend to be markets that will be pushed around by market makers, not longer time frame participants. (Relative volume parameters can now be found in my Monday AM indicator updates).

2) Breakout Trades - Here we have a situation in which the market is range bound (note the current multi-day trading range in SPX) and surges out of the range, generally on enhanced volume and very high/low NYSE TICK levels. Very often, there will be a catalyst for the breakout (economic news; earnings) and the move will be reflected by other trading instruments and/or asset classes. For instance, if an economic report leads to repricing of other markets (interest rates; currencies), the chances are good that a simultaneous breakout in stock prices is real. The initial targets for breakout moves will be the daily price targets (R1, R2, R3; S1, S2, S3) that I distribute each AM prior to the market open via Twitter (free subscription) and the weekly price targets that appear in my Monday AM indicator reviews.

3) Continuation Trades - Here we have a trend already in place; the idea is to wait for a pull back to enter the trend. A good continuation trade can be thought of as a trade that has already broken above or below its recent pivot level, hit its R1 or S1 level relatively quickly, and now is positioned for possible moves to R2/R3 or S2/S3. We can also think of a continuation trade as a strong daily move that is moving toward a weekly price target as a profitable swing trade. A good continuation trade will show volume expanding in the direction of the trend and contracting on pullbacks. There will also be a trending cumulative NYSE TICK and Market Delta; pullbacks in TICK and Delta will serve as potential entry points. For instance, if we hit R1 and then pull back on light volume and only modestly negative NYSE TICK and Delta, we could reload on the long side for a continuation move to R2.

I hope to illustrate each of these three basic setups in future posts and, as yesterday, alert readers to their appearance via Twitter updates early in trading sessions. The most recent five Twitter posts appear on the blog page under "Twitter Trader"; the complete list of posts appears on my Twitter page. Links for subscription to the TraderFeed blog via RSS can be found below the "About Me" section of the blog page.

Monday, January 26, 2009

Resources for Traders

Making Better Charts - Recall that I posted a request for comments to the blog regarding improvements traders wanted to see in their charting software. The response was most gratifying, with dozens of excellent suggestions (they follow the blog post linked above). Well, the software firm that I met with, Market Delta, took the comments to heart and has illustrated in their own blog post how many of the ideas that were suggested can be tracked in real time. They are adding new features to the Market Delta program that will make it possible to follow such indicators as money flow, cumulative TICK, cumulative Delta, pivot-based price targets, and Market Profile-based value areas--all on a single screen. I look forward to the new release and hope to use screenshots and Twitter "tweets" as free blog-based tools for trader development.

A Day in the Life - Here is a really well produced video that provides a peek at the life of a prop trader at SMB Capital. I especially like the midday review and the focus on trading as a team, with traders learning from each other. Great stuff.

Common Trading Patterns - Certain patterns repeat in markets across different price and time scales. One common pattern is that a market will move above or below a clear area of support/resistance (often defined by prior day's lows/highs), but the breakout move will fail to attract significant fresh selling/buying. The reversal back into the range traps the traders who were playing the breakout and, as they disgorge their positions, the market moves back into its prior trading range, often with the day's or week's pivot level as a price target. If you review my Twitter comments on the day (free subscription), you'll see where I pointed this out. In the future, I'll be using Twitter for market comments as well as indicator updates and links; many of these comments will be designed to help traders recognize these common trading patterns.

Indicator Update for January 26th

Last week's indicator review concluded "the move to price highs early in January has been reversed, and we are back to seeing 20-day lows exceeding new highs. As long as the new highs/lows remain weak, I expect continued price weakness and tests of the bear market lows." We did, indeed, see ongoing weakness in the new high/low statistics (middle chart), as the S&P 500 Index moved into moderately oversold territory on the Cumulative Demand/Supply Index (top chart). Interestingly, we are seeing moves below the November bear lows among financial stocks, but not most other sectors, which are showing only moderate weakness. I will be watching sector behavior carefully on any follow-through weakness, to see if we get glaring divergences.

The 800 level in that index is shaping up as a widely watched support level; a washout below that level would likely take the Cumulative DSI into oversold levels that have characterized intermediate-term market bottoms. The Cumulative NYSE TICK (bottom chart) has been holding up relatively well during the recent market weakness, as has the advance-decline line specific to S&P 500 stocks and money flow for Dow stocks. This again raises questions about possible divergences on any continued weakness; it is not clear to me that a spike below 800 would necessarily entail a fresh leg down in the bear market (though that would be a widely anticipated breakout move).

The new highs/lows should be helpful in confirming or not confirming any such move. Note that 65-day lows are modest at this juncture; Friday showed 129 65-day highs against 424 lows. Conversely, we had important upside resistance in the low 900 range in the S&P 500 Index; a break above that level with strong participation would be a significant bullish development. In sum, the indicators are leaning to the downside; as long as that continues, I expect a test of the 800 level and possibly the bear lows in SPX; but I also see evidence of diminished selling pressure during the recent market weakness.

I have reformulated my method for calculating pivot levels and price targets for the S&P 500 Index; the daily levels are issued prior to each market open via Twitter. The morning Twitter "tweets" also include updates on new highs/lows; Demand/Supply; and the proportion of SPX stocks trading above their moving averages (subscription is free via RSS; I will soon be adding more to the Twitter feature of the blog).

Meanwhile, here are weekly price levels for SPY. Background on using these levels can be found in this post and its links:

Pivot = 82.83
R1 = 88.62
R2 = 89.78
R3 = 91.33
S1 = 77.04
S2 = 75.88
S3 = 74.34

For short-term traders interested in tracking relative volume, here are median 30-minute volumes for ES (Central Time). Standard deviations are in parentheses:

8:30 - 259,412 (66,817)
9:00 - 194,961 (57,402)
9:30 - 143,791 (60,139)
10:00 - 132,556 (37,528)
10:30 - 125,055 (42,708)
11:00 - 99,075 (44,475)
11:30 - 89,360 (41,828)
12 N - 86,691 (37,697)
12:30 - 113,785 (53,362)
1:00 - 124,136 (69,600)
1:30 - 140,838 (67,488)
2:00 - 169,776 (50,382)
2:30 - 246,133 (77,931)
3:00 (15 min period) - 99,693 (28,446)

On days in which I am in front of the screen, not working with traders, I will try to send a Twitter message in the AM with a brief assessment of relative volume.

Sunday, January 25, 2009

Sector Update for January 25th

Last week's sector update found that the eight S&P 500 sectors that I follow closely for Technical Strength had largely moved into downtrends, with relative strength among defensive sectors and relative weakness among financial shares. That weakness spilled over to the past week during volatile and choppy trading. Here's how we look as of Friday's market close:

MATERIALS: -280 (17%)
INDUSTRIAL: -340 (8%)
ENERGY: -180 (58%)
HEALTH CARE: -160 (44%)
FINANCIAL: -380 (7%)
TECHNOLOGY: -100 (43%)

Recall that Technical Strength scores each stock on a scale of -100 (very strong downtrend) to +100 (very strong uptrend), with zero signifying no trending. The metric is similar to the slope of a goodness-of-fit regression line. I take five highly weighted stocks from each sector and add their scores together to arrive at an estimate for each sector. The resulting view of short-term trending suggests that the market remains in a downtrend mode, with financial and industrial stocks weakest.

Interestingly, economically sensitive technology and consumer discretionary sectors are displaying relative strength, along with the more defensive consumer staples and health care shares. Looking at a longer time frame with data from Decision Point, we can see the percentage of stocks in each sector trading above their 20-day moving averages (in parentheses above). The data show considerable weakness among economically sensitive consumer discretionary, materials, and industrial shares, as well as particular weakness among financial stocks. Energy stocks are notably strong, reflecting some recent upward movement in gasoline prices, and technology shares have displayed relative strength.

In all, only the energy sector shows a plurality of stocks trading above their 20-day moving averages. Throughout the week for the market overall, 20-day new lows have consistently outnumbered new highs. Unless and until that changes, the intermediate-term trend has to be viewed as bearish. As always, I will be staying on top of trend shifts by updating new highs/lows and Technical Strength before each market open via Twitter (free RSS subscription).

The Importance of the Market's Opening Price

The market's opening price represents an important synthesis of information, including the trading of overseas markets and the impact of pre-opening economic and earnings reports. Simply locating the open relative to the prior day's trading range provides meaningful information to the short-term trader.

Burning midnight oil this weekend, fueled by caffeine and club music, I reworked my proprietary system for calculating pivot and price target levels. The results were satisfying: 75% of all days touch the daily pivot level, which is an approximation of the average trading price for the prior day. The Resistance levels R1, R2, and R3 represent upside targets; the Support levels S1, S2, and S3 represent downside price targets for the current trading day. About 75% of all trading days touch either R1 or S1; 50% touch either R2 or S2; and 33% touch R3 or S3, based on backtesting to the year 2000. (Daily pivots will be posted each AM prior to the market open via Twitter. Most recent posts appear on the blog page; subscription via RSS is free).

Interestingly, when the S&P 500 Index (SPY) opens above its pivot level for the day, the odds of it hitting R1 have been 56%. When SPY opens below its pivot level, we hit R1 only 21% of the time. Conversely, when SPY opens below its daily pivot, we've hit S1 about 59% of the time. When SPY opens above its pivot, we hit S1 only about 19% of the time.

Once we have the pivot levels in place, many other historical patterns jump out, including how the prior day's volatility affects hitting price targets in today's session and how prior weakness or strength affects the odds of hitting price targets in the future. One of the more interesting patterns for study is time-of-day analysis: how the odds of hitting R2/S2 and R3/S3 are affected by the time of day that the market reaches R1/S1.

All of this is fuel for future research and future posts. Bring on the caffeine and music.


Saturday, January 24, 2009

Jobs With Proprietary Trading Firms: Five Pitfalls to Avoid

I've received a large number of emails from traders interested in joining a proprietary trading firm. Many of these correspondents appear to lack understanding of prop firms and what they have to offer. This leaves them open to pie-in-the-sky promises from less than reputable firms. The links below should help traders in their quest for a trading firm. Below are five pitfalls that you want to make sure you avoid:

1) Firms that promote high frequency trading and that make a significant portion of their money from the commissions they assess their own traders. Make sure that the prop firm makes money when you are successful, not simply when you trade;

2) Firms that charge high fees for training and then offer generic educational programs on technical patterns, how to use software, etc.--material that is readily available in the public domain. Make sure that the training is substantive and directly applicable to the trading you want to learn;

3) Firms that charge deposit fees or other down payments for joining. I have heard of several firms doing this; none of the reputable firms I work with would consider it.

4) Firms that charge money for getting in the door (either through high training tuition fees or down payments) and then strictly limit your access to capital and hold you to ridiculously small daily loss limits. You never have the chance to make real money, and once you lose half of the tuition/downpayment fee, you're shown the door. Total scam.

5) Firms that have you put up a share of capital in case of losses. This is not a prop firm. There are "arcades" in which you can trade your own capital and keep the vast majority of your profits. Beware firms that find ways to hold onto your cash (by not paying you a significant portion of your profits, for instance, at the end of a pay period), so that you're at risk, not them.

There's no substitute for interviewing at a firm, talking with their traders, and finding out who is making serious money there and who is satisfied or dissatisfied. If a firm restricts your ability to perform due diligence, run--don't walk--in the opposite direction. Given unemployment, the ease of trading online, and recent market volatility, prop firms are springing up like weeds, making alluring promises to would-be traders. Be careful.


Macro Perspectives for Short-Term Traders

An enduring theme in this blog, reflected in my recent post, is that it is important for traders to know how large participants are thinking and behaving in the marketplace. Markets are not moved by shapes on charts or patterns among indicators. Rather, the supply and demand for equities is a function of many macroeconomic factors, from central bank policies (and perceptions/anticipations of shifts in those) to interest rates, relative currency movements, and expectations regarding inflation and economic growth.

The challenge for the short-term trader is to understand the trees--the moment to moment shifts in buying and selling sentiment among participants--and also the forests: the factors that ultimately lead to important market trends. My experience working as a trading coach at prop firms and hedge funds finds that this dual perspective is rare. It is common to find prop traders who understand order flow in their instruments, only to get run over by shifts in trend that they don't comprehend. Similarly, it's common to find portfolio managers who have sound long-term macro views, but who are essentially tone-deaf with respect to executing these ideas on a day-to-day basis.

Many of the links that I pass along via Twitter are selected for their big picture value. Taken together, they provide a taste of themes that are top of the mind among money managers. For instance, while the mainstream media was trumpeting the optimism of a new year and a new presidential administration, the commentary from wise macro observers suggested that many fresh signs of economic trouble were brewing. Traders who understood the concerns over bank nationalization emanating from the UK were ready to see the relevance for US bank shares and their preferred stock. Those themes have significant relevance for the broad stock market.

As an example of excellent macro thinking, I want to call attention to the insights of The Baseline Scenario blog. (See also their beginner's guide to the financial crisis). This is the kind of analysis that can aid you as an investor as well as trader. If you take a look at the top 25 blogs cited by 24/7 Wall St., you'll see a number of sources that do a great job of highlighting broad themes that influence the movement of capital. A good football quarterback has an overarching game plan, but also the flexibility to call plays at the line of scrimmage. Traders are not so different: some of the best profits come from good trading that is aligned with investment trends.

Friday, January 23, 2009

Relative Volume and Volatility: Understanding Who is in the Market

This is an important post on a topic I rarely see discussed. As background, you might want to check out my posts on tracking large traders in the market and the volume realities that every short-term trader should know. The reason volume analysis is important is because the majority of volume--and the shifts in volume--can be attributed to the participation or non-participation of large market participants. These institutional traders have the resources to move markets, so it is critical to understand when they are relatively active and inactive in the markets you're trading.

I took a look at the last 14 days of trading in the ES (S&P emini) futures contract and found that the volume of each 30-minute period during the day correlated with the size of the high-low price range for that period by .78. That means that about 60% of the variance in volatility can be accounted for simply by knowing the volume traded during that period. When we identify whether volume is high or low for a period, we're also able to make an estimate of likely volatility for that period.

Above we see the median volume for each 30-minute period in ES for the last 14 trading sessions (top chart) and the median high-low percentage price range for those periods. The correlation between volume and volatility is obvious. Also obvious is that volume and volatility shift substantially within the trading day. Indeed, the median volume of the 11:30 AM CT - 12 Noon CT bar is less than half of the median volume for the market's opening 30-minute bar. The median price range per 30-minute period--the total price movement--is 40% smaller for the midday period compared with the opening one.

This changing volume/volatility dynamic within the trading day has important implications for the intraday trader, including the placement of stops and price targets. I recently corresponded with a rookie trader who placed his stops and price targets a fixed number of points from this entry. While this provided the illusion of managing risk, it was ineffectual. The fixed stop point was hit simply by random price movement during the busy periods of the day, taking the trader out of good trades. Conversely, during slow periods, the trader's price targets were never hit, leading to reversals of his paper profits. The trader sought me out for help in dealing with his emotions, but in fact his problem was his failure to adapt to shifts in volatility.

This same problem occurs among even relatively sophisticated traders who bring expectations of price movement from the last day or two to the present trading day. They anticipate more or less movement than the market is actually giving them, leading to premature exits from good trades on busy days and failure to take profits on trades when markets are slow.

So how can we estimate the volatility of the day that we're currently trading, so that we can adapt accordingly? The idea of relative volume is that you compare the volume for the recent time period with the average volume for that same time period over the past X days. For example, I know that the median volume for the time period of 12:30 - 1 PM CT is 113,785 contracts, with a standard deviation of 53,262 contracts. If I see volume for that period exceed 200,000 contracts during the trading day, I know that this is a significant jump in volume relative to the recent past. It alerts me that institutional traders are relatively active in this market, so I will pay particular attention to whether they are buying or selling (by analyzing NYSE TICK and Market Delta for that period). It is out of such surges in participation that breakout moves and trends are often born.

Conversely, if I know that if the opening half hour of trade averages 259,412 contracts with a standard deviation of 66,817 contracts and see that the current opening period has only traded 150,000 contracts, I know right away that large traders are not dominating this market. This will lead to reduced volatility, and it typically leads to a choppier trade, as market makers push the market to and fro to make their scalping profits. A market dominated by market makers trades very differently from a market dominated by prop traders and fund portfolio managers. By recognizing relative volume, you can also identify who is relatively active in the marketplace--and that will provide you with valuable clues as to how much--and what type of--opportunity is present.

Note: If there is sufficient interest, I can post real time relative volume info via Twitter and as part of the indicator updates on the blog. The RSS subscription to Twitter is free of charge; the weekly indicator updates typically appear on Monday prior to the market open.

When Is There Significant Buying and Selling in the Stock Market?

You just sold the S&P emini futures, the market starts to go your way, and then it spikes upward and returns to your entry level. Is this fresh, significant buying that should lead you to scratch your position, or is it mere short covering that has little import for the general market trend?

One way of addressing this important question is with the NYSE TICK. Recall that the TICK is the number of NYSE issues trading on upticks minus the number trading on downticks. Another way of viewing this is that the TICK assesses the number of stocks trading at their offer price minus the number trading at their bid. When buyers are more aggressive, they will "pay up" to get into the market and the trade will transact when the instrument is trading at its offer price. Conversely, when sellers are desperate to bail out of stocks, they'll "hit the bid" and the instrument will transact at the lower, bid price.

NYSE TICK is helpful, because it is a real time gauge of very short-term sentiment across the broad list of stocks. When we create a cumulative line for the one-minute TICK values during the day, we find that uptrending markets tend to occur during uptrending cumulative TICK lines and vice versa. Gauging the direction of the cumulative TICK as the day unfolds is very helpful in identifying market trends.

Now suppose we have a TICK value that exceeds +1000 or plunges below -1000. That not only means that 1000 more stocks are trading at offer or bid; it means that they are doing so at the same time. This can only occur when institutions execute basket trades to buy or sell large segments of the stock market. An individual trader--or even a large trader at a prop house--cannot make 1000 stocks trade simultaneously at their bid or offer prices. It takes real buying or selling power to do that.

One way of defining significant levels of buying or selling is to look at the distribution of one minute high and low values for TICK and examine the standard deviation of these. Going back to the beginning of October, we find that the average one-minute high value for TICK is around +250 and the average one-minute low value is around -250. The standard deviation is approximately 450. That tells us that, roughly, two-thirds of all TICK values will fall between +700 and -700. About 95% of all TICK values will fall between +1040 and -1040, making values greater than +1000 or less than -1000 rare indeed.

If I've sold the market and, after going my way a bit, it bounces higher on +500 TICK, that by itself will not take me out of the trade. In a purely statistical sense, that is not significant buying. The same is true if I am long the market and we retrace on -500 TICK. It's when we get above +700 or below -700 that I look much more closely at the trade. It's when you start to get a cluster of such readings that you realize that the Cumulative TICK is shifting and that you need to think about an exit. And, of course, if the TICK moves toward or above +1000 or toward or below -1000 when you're short or long, that is very significant sentiment against your position and warrants genuine caution.

Less important than individual TICK readings is the distribution of TICK values over time. In the chart above, we see the first hour of trade for Thursday's market. The center blue horizontal line is placed at zero, and we have horizontal lines at the one- and two standard deviation points to the upside and downside. Click on the chart for a good view and take a look at whether the bars, over time, are distributed more above the zero line or below. Further look at whether more bars exceed the +1 and +2 standard deviation levels or the -1 and -2 levels. Clearly, the net distribution of TICK is skewed negatively, and we're seeing more bouts of significant selling than buying. That keeps me on the seller's side until I see clear evidence of a shift in the distribution of TICK values.

Knowing what is significant and what is not can be the difference between staying in a good trade and getting whipped out of it. Reference lines such as the ones plotted above can help you keep your eye on the true sentiment of the market. For more background on trading with NYSE TICK, the links below should get you up to speed.


Thursday, January 22, 2009

Top Financial Blog Sites and More

* Finding Top Financial Blog Sites - Many thanks to 24/7 Wall St. and their kind mention of TraderFeed in their latest listing of 25 best financial blogs. Their list shows considerable thought; the sites are worth checking out. I found a few good ones that I was not familiar with. There was some interesting overlap between the 24/7 recommendations and the blog sites that contributed to my forthcoming book--also a list worth checking out. An excellent source for mainstream media financial information is the RealClearMarkets site.

* Tough to Swing Trade - As the chart of the S&P emini futures (above) shows, we have had considerable volatility, but not much trending. The market has swung quite a few percent in each direction over the past week, but overall has gone essentially nowhere. Very important to buy weakness and sell strength in such an environment: execution is half the trading battle.

* Thanks - My appreciation to the readers who took the time to offer excellent suggestions for additions to chart software. I am told that all of the suggestions are being looked at by the management of the software firm as I write this.

* Recognizing Trends - My recent post on how to recognize trending days in the market has led to considerable traffic and emails. I am reworking my S&P 500 pivot/target levels and will include more "state of the market" posts via Twitter. The Twitter subscription list (free via RSS) is well over 1700 now, with an equal number of readers taking the recent "tweets" off the blog page. Over time, I hope to include more trading-centric posts to the current offerings of links, market indicators, and upcoming economic reports.

What's Missing From Your Charts?

Dear Readers,

An interesting development recently arose: I'll be meeting with a software firm tomorrow to discuss features that they might add to their charting programs. This is an informal meeting, not a paid consultation. My sense is that they have read the blog and are very open to feedback from users, including suggestions regarding new features.

So here's a quick poll: What unique information, indicators, statistics, and features would you like to see included in a charting package? What are some functionalities that would be valuable to your trading that you're not currently finding in your platform? Be creative!

Leave your suggestions as comments to this blog post, and I will bring the list to my meeting. This could be a nice opportunity to create greater value for traders. And, if the suggested features are incorporated, I'm hopeful we'll be seeing a special free trial for blog readers. Thanks as always for your interest and support.


Some of Brett's likely suggestions:

* Charting of Cumulative NYSE TICK
* Charting of relative volume (how today's volume compares with past X days)
* Charting of pivot/price target levels
* Charting of intraday money flow

Tuesday, January 20, 2009

Six Ways to Identify a Trend Day in the Stock Market

Recognizing a trend day while it is in progress can lead to a number of home run trades, not least of which is simply selling the market and staying short through the day. Here are a few ways of recognizing a downside trend day in the making, drawing upon today's excellent example:

1) Cumulative NYSE TICK and Cumulative Market Delta start negative and go into a downtrend early in the session;

2) Advance-Decline statistics are skewed from the open, with declining stocks swamping advancers by 2000 or more issues within the first hour of trading;

3) The market opens below its pivot level (average price from the previous trading session), never trades above it, and hits S1 early into the trading session;

4) The market's leading weak sectors going into the day's trade (financial/banking stocks, in this case) continue their weakness and lead the market downward;

5) Multi-bar bounces in the ES (and NYSE TICK) occur at successively lower price highs;

6) Significant buying (NYSE TICK, cumulative Delta, Dow TICK, advance-decline improvement) does not enter the market after taking out S1 and S2.

It is easy to get stopped out of a good trade in a downtrending market; the enhanced volatility ensures that countertrend moves will be uncomfortable. A close inspection of today's chart will show many multi-point countertrend moves during the market's steep fall. Traders who wish to ride the trend need to place stops wide enough to weather these movements. One of my favorite techniques is to look at a prior bounce in the market that occurred at a higher level than the current bounce that I'm selling and place my stop around that level. Sizing your trade so that you won't lose your shirt if you're stopped out (or so that you won't exit the trade prematurely because you can't take the heat) is key to maximizing the home run trade.

Moving forward, I will be posting trend related information during trading days via the Twitter service (free subscription via RSS).


Indicator Update for January 20th

Last week's indicator review concluded that a resumption of the bull move needed to see new 20-day highs continue to outnumber 20-day lows and a resumption of strength among sectors, money flow, and NYSE TICK. "A move below the 850 region in the S&P 500 futures would represent a violation of important support and would break the pattern of higher lows on market pullbacks." We did, in fact, get that pullback below 850, returning us to well inside the trading range that dominated during the latter part of 2008.

The pullback took us from a highly overbought level in the Cumulative Demand/Supply Index (top chart) to a neutral level and returned us to a situation in which new 20-day lows once again are outnumbering new 20-day highs among NYSE, NASDAQ, and ASE issues (middle chart). Sector technical strength has turned negative; as I noted in my morning Twitter update today, only 2 stocks in my basket were trading in uptrends; 15 were neutral; and 23 were in short-term downtrends.

As the chart from Decision Point (bottom) indicates, the advance-decline line for NYSE common stocks is only modestly off its recent highs. This relative strength is also reflected in a Cumulative NYSE TICK line that is not far off its recent peak. Selling pressure has been intense in the financial sector; the big question going forward is whether or not this weakness spills over to the broad market. I will be watching Cumulative TICK closely and posting to the blog on the topic as one way of addressing this issue.

In sum, the move to price highs early in January has been reversed, and we are back to seeing 20-day lows exceeding new highs. As long as the new highs/lows remain weak, I expect continued price weakness and tests of the bear market lows. A move above the January highs, particularly on strong breadth and with solid expansion of new highs, would be decidedly bullish. The first order of business for bulls is to sustain prices above the weekly pivot of 85.19 in SPY. Failure to do so targets the weekly S1 level a bit below 80. (Daily, weekly, and monthly price targets are sent out via Twitter, along with daily updates of indicators; subscription via RSS is free).

Monday, January 19, 2009

Catching Longer-Term Market Moves With Price Targets

My recent post described how weekly price targets for the S&P 500 Index can be used to frame swing trade ideas. Here we widen the time frame even further and take a look at the price targets for January derived from December price data and adjusted for recent volatility. The pivot, R1, and S1 levels are drawn as blue horizontal lines. Note how we tested R1 very early in the month, but could not sustain a move to R2 (which was at 95.27). The general rule is that such a failure targets a move back to the pivot level and, if that cannot hold, down to S1.

You can see how we did indeed return to the S1 region but have since bounced higher. The key for traders now is to handicap the odds of returning to the pivot level vs. continuing the downmove to S1 and even S2 (which is at 79.02). The day-to-day strengthening or weakening of the market indicators (new highs/lows, Cumulative TICK, etc.) provide us with evidence for handicapping those odds and framing trades accordingly. Should we see an inability to take out Friday's high in Tuesday's trade, along with weakness in NYSE TICK, for example, I would expect a test of S1 and would be selling the S&P accordingly.

I will post the monthly pivot/target numbers to Twitter later today. Once again, the last five Twitter posts appear on the blog page under "Twitter Trader". The full list can be found on my Twitter page, where you can also register for free subscription via RSS.

On a related note, I talked at length with Trevor Harnett of Market Delta today and learned that they are coming out with significant additions to that program at no additional expense to users. Those additions are in beta testing at present and should be ready for roll out in the next few weeks. My initial look suggests that the new features will be of particular help in gauging real time market strength/weakness to help traders anticipate moves toward the price targets. More to come!

Swing Trading With Weekly Price Targets

I recently wrote about how I use empirically-derived price targets to trade intraday moves in the S&P 500 Index. This approach builds on the pivot-based methods I described two years ago, in that the price targets are a joint function of recent price movement and recent volatility. I have tested these levels going back to 2000, with roughly a 75% hit rate for touching yesterday's pivot level in today's trading and a 75% hit rate for touching *either* the upside R1 or downside S1 levels derived from yesterday's trade. An example of how I use these levels can be found in this recent post.

Although my methods for calculating these levels remain proprietary for now, I post the levels for SPY each morning via Twitter prior to market opens (free Twitter subscription via RSS). Also included in my morning posts are data that capture strength/weakness in the previous day's trade. These data include the percentage of SPX stocks trading above their moving averages; Demand/Supply (an index of the number of stocks trading above/below the volatility envelopes surrounding their moving averages); and the number of stocks making fresh 20-day highs and lows.

As a rule, in a strong and strengthening market, I'll look for price to stay above the pivot level and test R1 and R2 levels. In a weak and weakening market, I'll look for price to stay below the pivot level and test S1 and S2. In a range bound market of mixed strength, I'll look for prices to revert to their pivot levels on moves toward R1 and S1. The idea is to use the ongoing stream of market data (volume/volatility; leading sector behavior; market themes; cumulative TICK) to gauge the odds of hitting these price levels and then enter the market at points that provide favorable risk/reward (e.g., your stop level is closer than your target point).

Often, not always, one level will serve as a target (say, S1) and another (pivot) will serve as my stop. In other words, if we're in a short-term downtrend, my trade says we should hit S1 and stay below the prior day's pivot (which is an approximation of average trading price). Many trade ideas can be crafted by knowing these levels, assessing the market's strength/weakness day over day, and gauging the strength/weakness in the current session's data.

Suppose, however, you are a swing trader looking to trade less frequently and take more out of market moves. Such a trading style is ideal for those that don't want to be married to the screen intraday. I've been working on an adaptation of the above trading methods for the wider timeframe and now have a backtested set of parameters based on weekly data. The weekly pivot has an 80% hit rate (i.e., going back to 2001, the current week has touched last week's pivot 80% of the time), and the odds of hitting either the weekly R1 or S1 levels is about 75%; R2 or S2 is 50%.

Once again, by gauging market strength/weakness day over day, the swing trader can play for multi-day moves to the R1/S1 levels and beyond. The weekly target numbers also enable short-term (intraday) traders to leave a piece of their positions on overnight to take advantage of the moves to the weekly levels.

These weekly levels in SPY will be published Monday before the market open and, again, will be free of charge via Twitter. For traders that prefer to not subscribe via RSS, the last five Twitter posts always appear on the blog page under "Twitter Trader", so you can simply check the blog prior to market opens for the target data. Over time, I plan to expand the targets to other indexes (NASDAQ 100, Russell 2000, sector/international ETFs), as well as other asset classes (bonds, gold, oil, etc.). Stay tuned!