Tuesday, March 31, 2009

Indicator Update for March 31st

Last week's indicator update concluded, "I would not be surprised to see consolidation following the strong price rise off the early March lows. That consolidation should be relatively flat if we're going to sustain another leg upward." Since that time, we did see further strength in the rally last week, followed by consolidation that took us beneath the 800 level in the S&P 500 futures.

The above charts show where we stood as of Friday's close, and we can see the double top in new 20-day highs minus lows (bottom chart), even as price had moved higher in the large caps. We can also see from the Cumulative Demand/Supply Index (top chart; a cumulative index of the number of stocks closing above versus below their short-term volatility envelopes) that we are at very overbought levels.

As I've stressed for several weeks now, these peaks in the Cumulative DSI (which is my preferred overbought/oversold measure) have occurred at successively lower price highs, which is characteristic of longer-term bear trends. We need to see an expansion of 20-day new highs and an ability to hold the 800 level in the S&P 500 Index on pullbacks before we can conclude that the current rally is something more than a violent bear market bounce.

To this point, rallies above 800 have been met with stiff selling, as we saw late in today's session. Should we see lower price highs on bounces in the Demand/Supply Index or should we see fewer new highs (and especially more 20-day lows) on bounces, I would be looking for a deeper correction into the broad trading range defined by last week's highs and the bear market lows. As always, I will be tracking Demand/Supply and new highs/lows daily via Twitter.

Catching Market Turns: When One Index Does Not Confirm Another

OK, so here's a little lesson for you developing traders out there. Was yesterday a weak day or a strong day in the stock market? Of course, it was a weak day, because many more stocks declined than advanced on the day and there was net selling pressure on the day, as measured by the Cumulative NYSE TICK. Indeed, the day was so weak, it toppled many stocks off their (up) trending perches. If you take a look at this morning's Twitter posts, you'll see that the ratio of stocks closing below their volatility envelopes (Supply) exceeded those closing above their envelopes (Demand) by over 25:1.

Look, however, at my 2:16 PM tweet yesterday, indicating that small cap stocks were not confirming afternoon weakness in the large caps. Even the large cap NASDAQ stocks (NQ futures) were not confirming the weakness in the S&P 500 Index. If you review the recent post on indicator non-confirmations, you'll see that, in the most durable trends, sectors will tend to move in unison. When important segments of the market can't hold their weakness, it's a sign that the downtrend does not have good legs. Now, this morning, we're seeing the result: much of Monday's decline has been reversed in overnight trade.

If you click on the chart above, you'll see how the Russell 2000 Index (IWM) did not confirm weakness in the S&P 500 Index (SPY) at point 2. You'll also see that the Russell actually closed above its opening price--hardly an indication of weakness on the day time frame!

Note, also, that at point 1, the Russell had not only begun outperforming the large caps, but had actually retraced its decline from the open. That was actually our first indication that not all stocks were tanking in the day session. Yes, Monday was a weak day, but the weakness became less broad over the course of the day. And that emboldens the bulls for the next day.

I will be providing decision support on some of these trading patterns with intraday Twitter posts on days I'm not working with traders. Subscription is free, or you can pick off the last five tweets on the blog page under "Twitter Trader".

Monday, March 30, 2009

Sector Update for March 30th

Last week's sector update concluded that "The 800 area poses significant resistance for the S&P 500 Index and this past week's action, as a whole, has done little to reassure us that the recent strong rally was anything more than a countertrend move in a downward market." We did, indeed, surmount that 800 level and remain above it for most of the week, though--as the intraday Twitter posts noted--signs of sector non-participation were present. With Monday's sharp decline, we fell back below that 800 benchmark, with broad market weakness.

For this week's sector update, I contrast each sector's Technical Strength numbers from Friday (first number in series) with the Technical Strength reading as of Monday's close (second number, following the / mark). Recall that sector Technical Strength varies from -500 to +500, with those extremes denoting strong uptrends and downtrends, respectively. A reading below -100 and +100 suggests a non-trending environment, and readings between -100 and -300 and +100 and +300, respectively, indicate moderate levels of trending (i.e., choppy trends).

Here's how we look across the eight S&P 500 sectors that I follow (Friday/Monday):

INDUSTRIAL: +200/+100
ENERGY: +180/-100
FINANCIAL: +60/-120
TECHNOLOGY: +220/+60

What we see is that, even with the rise of last week, the majority of sectors were in uptrends, but not strong ones. This is part of the weakness that I was detecting following the rebound from Wednesday's lows. After Monday, however, almost all of the sectors are in non-trending mode. The strongest of the pack is the defensive Consumer Staples group; note the weakness of Financial shares relative to two weeks ago.

A great deal of press was given to the fact that we had rallied over 20% from the market lows, suggesting that this might constitute the start of a bull market. While the rally has been impressive, I have found market action above the 800 leve in the S&P futures to be less so. Until we are shown otherwise, I am continuing to view this as a broad range market, bound by the early March bear lows and last week's price highs. Against that context, a correction back toward the center of that range is not so unusual, given the lack of sustained buying interest above 800.

As always, I will be tracking Relative Strength by reporting on the trend status of the 40 stocks (five from each of the eight sectors) each morning before the open via Twitter (free subscription here). Also via Twitter, I follow advance-decline statistics from the market's opening price to provide valuable clues as to the strength and weakness of the evolving intraday action; those were invaluable in identifying the market weakness at last week's price peak.

More On Free Trader Resources

My last post outlined several new resources for developing traders. One of the most popular resources has been the Twitter posts, which have included links to important market themes, daily market indicator readings, and intraday market comments. Subscription to the Twitter feed is free, providing a blog within the TraderFeed blog.

It's important, however, to have a big picture grasp of markets and how they move. For that reason, I began an e-book project that I called "An Introduction to Trading". The goal was to provide a conceptual framework for short-term trading that could aid active traders. This week, I will resume writing chapters for the book. All chapters are archived here, on the Trading Coach blog.

Eventually the book will include annotated charts with examples of trading patterns. The Twitter posts will then help to identify these patterns in real time. My hope is that the combination of the resources will provide practical guidance for traders who cannot afford thousands of dollars for education and training. The beauty of an e-book is that it can always be updated and revised, and it's available in real time for anyone in the world who has an online connection.

Thanks as always for your interest and support--


Sunday, March 29, 2009

New Resources for Developing Traders

As readers are no doubt aware, the new book The Daily Trading Coach is designed as a self-help resource for traders who are looking to utilize psychology to improve their trading performance. What, however, if you have trouble applying the book's ideas and techniques to your own trading? Two special resources are available in support of the book:

The first is the Become Your Own Trading Coach blog, which includes archived material from the TraderFeed blog and will eventually include supplementary material for the new book. See, for example, the trading techniques linkfest and the archived posts on developing yourself as a trader. Through this blog, the content for the new book will continually update, addressing reader questions and concerns.

The second special resource is that the new book includes a dedicated email address that readers can use to ask me coaching questions. The questions should refer to specific portions and page numbers of the new book; I will promply email you my best replies. This reflects my commitment to make the book as practical and useful a resource for you as possible.

And for traders that are looking for trading guidance? I will be refining the Twitter posts to make them as helpful for traders as possible. Your feedback on those real time posts will be invaluable going forward. And, yes, I haven't forgotten the next book project: the free e-book that will offer An Introduction to Trading. Stay tuned!


The Power of Repetition: Coaching Traders Linkfest

The previous post emphasized the importance of daily trading goals. The challenge for traders, however, is not simply to set goals, but to turn the achievement of goals into consistent habit patterns. When coaching--including self-coaching--doesn't work, it's often because traders initially reached their goals, but then relapsed into old patterns.

Such relapse occurs even when traders are ready to make changes. If change efforts are not made in powerful ways, and especially if they are not rehearsed to the point where they become automatic, the gravity of our old patterns becomes too great and we easily return to what we've overlearned. This is why repetition is key to making coaching efforts work. Through repetition, we internalize changes: they begin to feel normal and natural to us. When we rehearse new patterns of thought and behavior and link those to distinctive states of consciousness, we can summon those patterns whenever we re-enter that state.

If you can teach yourself to enter a state of focused relaxation each day and--in that state--mentally rehearse good trading practices, you will create a situation in which just taking a few deep breaths during trading can tip the scales and help you gain access to your best practices. As I stressed in an earlier post, the idea is not to become your own shrink, but rather to expand your mind's scope.

A key idea from the trader performance book is that practice multiplies experience. That is the key to learning how to trade, and it is the key to self-change. A key idea from the trading psychology book is that the solutions to our trading problems are already occurring, if we can just identify them and become more consistent in recruiting them. It is the consistency of change efforts that contributes to their permanence. The links in this post--and the links within those posts--should get you started on your self-coaching journey. My next post will outline what you can do if you encounter roadblocks on that journey.

Saturday, March 28, 2009

The Importance of Daily Trading Goals

Major props to the excellent traders and management at Kershner Trading, who were willing to spend a Saturday with me to work on their performance.

One very simple topic I discussed with the newer traders was having a concrete goal for each day of trading and a way of reviewing your performance at the end of the day to see if you reached your goal.

Setting a goal each day creates learning loops that improve you significantly over time.

Setting daily goals also keeps your head in the game, reinforcing your positive learning even during days and weeks where you're not making money.

Day after day of setting and reaching goals builds confidence and helps you internalize a sense of competence.

If you don't have goals and specific areas of performance you're working on, with concrete feedback to tell you how you're doing, how will you get to that next level of performance?

It's amazing how small changes compound into large ones when they become part of your daily experience.

Using Trading to Find the Heroic Within Ourselves

A reader of The Psychology of Trading notes the book's theme of developing one's heroic potentials and asks: "How do I channel these heroic impulses to help me achieve my goal of becoming a consistently successful trader? I fear that the heroic impulses related to trading may be setting the bar a little too high for now."

All of us have moments in which we experience ourselves nobly and heroically, as people capable of accomplishing great things. We lose our petty fears and insecurities and, instead, focus on what is possible and how we can attain it. Tapping into that sense of the possible is what provides reservoirs of energy, fueling unusual productivity and achievement.

Readers of the trading performance book know that a developing trader's goal should *not* be to become "a consistently successful trader." Rather, the goal is to become a consistently good trader. If success is defined as making a living from one's trading, that will be a project that requires substantial initial capital and skill development. While such success may be a long-term vision that sparks your efforts, you will not internalize a sense of heroic stature unless you are doing heroic actions daily.

A heroic action is not simply making a boatload of money on a given trading day. Any fool with a decent sized account can strap on the leverage and make money on a lucky trade. Rather, heroism is defined by the effortful pursuit of valued goals. The trader who overcomes an impulse to overtrade and instead makes just a few good trades in a day has accomplished an important piece of heroism. The trader who develops his or her own unique idea and acts upon it decisively to make money is living out a heroic role.

Over time, living that heroic role--day in and day out--leads to internalizing a sense of heroism. You become the person who, not only wants success, but deep inside lives it, expects it, and deserves it. This is the lesson of what may be my best post ever: create experiences that mirror back to you the person you wish to become. Heroism is about bridging the real and the ideal: enacting what is best within you. Your challenge as a trader is to structure each trading day so that you can experience yourself as a winner, even when you happen to lose money.

Friday, March 27, 2009

Approaching Markets With an Active Mindset

When I talk with a group of traders this weekend, I'll be focusing on the importance of approaching markets with an active mindset. Successful traders don't simply turn on the computer and follow the market. Rather, they actively look for themes and patterns, drawing upon the implicit learning that comes from longstanding market immersion.

Think of a person riding an elevator with classical music playing in the background. The act of listening is passive; the music is for atmosphere only. At a symphony concert, however, a listener will actively attend to the performance, picking out motifs in the work and following their development.

A tired person in the morning will gulp their coffee, barely tasting it. The coffee expert, however, carefully prepares the coffee to maximize the flavor of the beans and the temperature of the water. Tasting the coffee is an active process, appreciating the flavors that emerge in the tasting.

With growing expertise, the trader learns to actively process market patterns as they emerge and place them into a perspective that leads to trade ideas. It is when traders become passive that they react to markets, buying simply because prices are rising or selling at the first sign of weakness.

But how can we become more active market participants, even when we're not trading?

Several readers have told me that they're using Twitter to document their thought process through the market day. They then review the tweets to better understand how they could have done a better job of recognizing and responding to market patterns. It's a unique application of Twitter, and it may be quite useful in turning passive market following into active market mastery.

Four Best Practices for Maintaining Your Focus on Markets

It probably was the wisdom of the unconscious mind at work that led me to post on the topic of preparing for the market day following the post on the challenge of market engagement. After all, you're most likely to stay engaged in market action if you have prepared for a variety of scenarios and are actively searching to see which will play out.

I joked in the preparation post that it's helpful to plan your inactivity as well as your activity. As we were in the middle of choppy, range-bound trade in the morning, that preparation proved invaluable in standing back, avoiding overtrading, and waiting for opportunity. That is why mental preparation is my number one best practice toward maintaining market focus. If you rehearse what the markets might do and how you would like to respond, it's almost as if you program yourself to do the right things in the heat of the trade.

Sometimes, even when we prepare for the day's trade, we get caught in the flow and react impulsively with poorly thought out decisions. Those impulsive maneuvers can cascade unless we actively interrupt them. For that reason, taking a break from trading is my number two best practice toward sustaining focus. During a break, you shift from being the actor to being the observer. You can evaluate what you've been doing, step away from the screen, and re-engage markets with a fresh perspective. The best traders I know don't spend every minute with their noses in the screen; they know that they need to pace themselves, sustain their attention, and keep themselves in a performance zone. Taking breaks accomplish those objectives.

So what do you do during your trading break? Slowing your body by regulating your breathing--breathing deeply, slowly, and rhythmically--interrupts the effects of frustration and anxiety. Focusing your attention on a single stimulus, such as music or a picture, clears your mind and helps you shift to a different state, where you can process information more effectively. These self-regulation strategies are my third best practice for sustaining engagement with markets. Biofeedback is an excellent self-regulation strategy, as it provides direct feedback to traders about when they are in and out of "the zone". With practice, traders can return themselves to an optimal performance state even after a frustrating blowup.

Finally, we're most likely to sustain engagement when we have a purpose that we're working toward. Goal-setting is my fourth best practice for maintaining market focus. As I stress in the new book, process goals are especially helpful in this regard, because you can control *how* you trade, even if you can't always control the outcomes of specific trades. For example, you might set a goal to hold your losing trades for less time than your winners. That goal gives you a purpose for the trading day, keeping your attention even when markets turn dull.

What these four best practices tell us is that an active mindset, in which we prepare for each day, set goals, step back to re-evaluate, and take measures to sustain our concentration, is the key to staying engaged with markets. When we lack preparation, goals, breaks, and self-evaluations, markets--and the emotions they evoke--are more likely to control us. There is a reason that sports teams prepare for big games, take time outs during games, set goals with coaches, and get pulled from games for a spell to rest and talk with coaches. You can't win the game if you're not in control of your performance.

Thursday, March 26, 2009

What We Can Learn From Indicator Non-Confirmations

We refer to non-confirmations when price makes a new high or new low, but one or more market indicators fail to follow suit. A good example came between 12 Noon and 13:00 PM CT, when the ES futures (top chart) broke out of their morning range and made fresh highs for the day. Those highs also took out multi-day highs and thus raised the prospect of a major breakout to the upside.

Notice, however, that the number of advancing stocks minus declining ones ($ADD; bottom chart) actually was weaker during the breakout than it had been early in the day. As my intraday Twitter posts noted, at the breakout, we had 25 stocks from my basket trading above their opening prices and 15 trading below--much more mixed action than one would normally expect for a breakout move. Moreover, as the Twitter posts noted, the new highs were not confirmed by several S&P 500 sectors and the 1945 new 20-day highs at the time, while impressive, fell short of Monday's level of over 2600. That is why I had my eye on a reversion to VWAP, rather than a moonshot to R3.

In a good trending market, the vast majority of stocks and sectors will move together. Non-confirmations tell us that the rising tide is not lifting all boats, at least at that juncture. Those are often occasions when breakouts turn into false breakouts, setting up nice reversion trades back into the range. One potentially valuable application of Twitter is to alert traders to these non-confirmations, so that they can think twice before chasing strength (free subscription here). Another application is identifying choppy, range market conditions, so that traders can refrain from overtrading.

Preparing for the Trading Day: Questions to Ask Yourself

The hourly chart of the ES futures for the last few days shows us near multi-day highs in pre-opening trade, above the 20-period volume-weighted average price (green line). This multi-day pattern is an important context for the day's trade and thus should be a major focus of your pre-market preparation. Some questions you'd want to think through prior to the open:

1) If we get a decisive breakout to the upside, what would be my price target(s)? On average, the longer the period of consolidation, the more significant the subsequent breakout move, as traders leaning the wrong way over time need to cover positions. What's your plan for taking full advantage of a significant upside break?

2) What kind of GDP and jobless claim numbers at 7:30 AM CT might spark an upside break or a reversion into the multi-day range? What is the consensus looking for?

3) Treasury Secretary Geithner is talking today. What could he say to rattle the markets or inspire them? What topics are money managers most interested in hearing about, and what would they act upon? (Hint: my Twitter links to articles often tackle themes that are on the minds of large traders; see the 6:33 PM CT post from last night).

4) We moved below 800 in the S&P 500 Index yesterday and then violently reversed that downmove. What does it mean when a market moves through an important price level and then violently rejects that move and returns sharply above that level? Longer term, are we building value at higher or lower prices? Did the market want to build value below 800? If we *now* get a move below 800, what would be the longer-term significance of that influx of new sellers (and that downside breakout move)? How would I play such a downside break? What targets would I look for?

5) If we are going to remain rangebound in today's session (i.e., within the multi-day range), what volume clues would I look for early in the trade? What is the volume-weighted average price for the day and for the range that would help me set a target for a fade at range extremes? What are the pivot prices for the last three days (from the Twitter posts) and what does it mean that they're almost identical? Would I want to be playing the market if we're hugging those average prices in a slow market? It helps to plan your market inactivity as well as your activity ;-)

6) If I look back at the new high-low data from the Twitter postings, is the market getting stronger or weaker each time it approaches the upper end of the multi-day trading range? What kind of sector behavior would I look for if the market is strengthening on a test of range extremes? Weakening? What sectors would I expect to lead market strength or weakness? (Hint: Note how weakness among small caps and financials were good tells for the recent retreats from the upper end of the range).

The trader who sits down in front of the screen several minutes ahead of the open, heedless of the above questions (not to mention their answers), can only go by immediate price action to guide trading decisions. They miss the larger picture and thus the larger trades. Even the excellent short-term traders such as the ones I recently mentioned pay attention to the context of the trading day and prepare themselves accordingly. Even when you're cutting down one tree at a time, it helps to know you're in the right forest.

Free Subscription to the Twitter Posts: Market theme links, indicators, price targets, intraday market observations.

Wednesday, March 25, 2009

The Challenge of Market Engagement

A very experienced trader I was meeting with at a prop firm in Chicago mentioned the challenge of "sustaining your engagement" with markets. His phrase so caught my notice that I whipped out my laptop (thank goodness for wireless broadband) and posted a note to Twitter on the topic, along with a link to a relevant blog post.

What does it mean to "sustain your engagement" with markets? Many of the traders at this firm will place 100 trades or more per day. To put that into perspective, the stock index futures markets are open from 8:30 AM CT to 15:15 PM CT. That's a little less than seven hours. The trader who places 100 trades in a day is averaging about 15 trades an hour or a trade every four minutes.

The only way you can trade with such frequency is if you have a very low commission structure (a very major advantage of prop firms that are exchange members), superior technology (getting orders into the book quickly can make the difference between getting filled and not getting filled), and an ability to concentrate on--not just the tick by tick movement of prices--but the movement of orders in and out of the book.

It's not just paying attention that matters; it's an active processing of information, in which the trader is alert to minute events, such as a series of large trades that are lifting offers. In a flash, the trader sees those transactions, realizes that they are occurring at a key price level, and places the action in the broader context of the day structure (trending/non-trending). Little wonder that my trader performance book (which features two traders from this firm) compares active electronic trading with air traffic control: lots of things to watch continuously, and real risks of lapsed concentration.

Think of all the factors that can interfere with this active market engagement:

1) Distractions, from phone calls to conversations around you;
2) Fatigue, and normal lapses of concentration after long periods of focus;
3) Frustration following bad trades, missed trades, and difficult markets;
4) Worries about losses during slumps;
5) Overconfidence following profits during hot periods;
6) Information overload;
7) Getting caught in fixed views of markets;
8) Equipment failure;
9) Boredom during slow markets;
10) Tunnel vision and loss of big picture perspective

Active traders need strategies that they can use during the trading day to help them sustain their market engagement. My next post in this series will outline some of these strategies.


Stock Market New Highs and New Lows: Modifying the Standard Indicator

My recent post focused on a revised advance-decline indicator with interesting intraday applications. If you click on the above chart, you'll see another modified indicator: below each day's bar for March's S&P 500 Index (SPY), you'll see the number of stocks across all major indexes that made fresh 20-day highs (top number) and the number that made fresh 20-day lows (bottom number). Major props to the excellent Barchart site for these data.

Notice that, as we bottomed in the early portion of the month, the number of stocks registering fresh 20-day lows leveled out, with new lows peaking ahead of price. This is not an unusual pattern. As a market tops or bottoms, leading sectors begin to make their reverse moves, so that fewer stocks are making new highs at price peaks and fewer issues are registering new lows at price bottoms.

Also observe that, during this rally, new 20-day highs have expanded smartly. This tells us that a trend is intact: an increasing number of stocks are participating in the rally. As long as new highs or new lows are expanding, we can view pullbacks in new highs or lows as potential points to enter the trend on a swing basis (given that price is likely to top or bottom thereafter).

What is not often appreciated is that the new high/low data also have implications for intraday traders. Take yesterday's market (please). When we touched the previous day's high, as noted in my Twitter comment, only 1593 issues at that time had made new 20-day highs, down from over 2600 the day previous. This was an indication that the broad market was *not* gaining strength and that we were not likely to break out to the upside. Knowing whether new highs or lows are expanding can be quite helpful in gauging whether or not a possible breakout move is likely to turn into a trend.

The advantage of tracking 20-day highs and lows is that the data are much more sensitive than the standard 52-week new highs/lows typically quoted by news services. After a bear market such as we've had and the subsequent healthy rally, relatively few issues are making fresh 52 week highs *or* lows. By tracking new highs and lows for the past month, we can detect shorter-term shifts in market strength and weakness.

So let's add new highs/lows to the emerging daytrader analyst effort on Twitter. At key market junctures (when I'm at the screen and not working with traders), I will update the intraday status of new 20-day highs and lows. Let's see if that proves helpful for decision support. As always, subscription to the Twitter posts is free via RSS feed, or you can keep up with the last five tweets on the blog page.


Tuesday, March 24, 2009

A Fresh Look at Advance-Decline Statistics

As I mentioned in the previous post, one of the new indicators I'm rolling out for decision support is an advance-decline measure that tracks the movement of stocks from their opening price rather than from the previous day's close. Specifically, I'm tracking price movement from the market open for 40 highly weighted stocks equally divided within eight S&P 500 sectors. This is the same basket of stocks that I track in my morning Twitter posts with respect to trend status.

As luck would have it, this revised advance-decline measure was helpful in today's trading of the ES (S&P 500 e-mini index) futures. The market opened considerably lower from its prior day's close, which gave us a very negative reading for the traditional advance-decline indicator. When we looked from the market open, however, we saw a much more mixed performance, as noted in the intraday Twitter posts. Indeed, even when the ES futures were trading below their open during the early morning, there were more stocks in the basket up from the open than down. This told us that the S&P 500 Index was not as weak as the traditional indicators might suggest, keeping us from selling into early weakness.

(Conversely, we obtained consistently negative readings from the NYSE TICK during early morning trade, reflecting weakness of the broad market relative to the S&P 500 large caps. That weakness served as a caution regarding chasing strength. In a trending market, indicators will tend to tell similar stories. It's when sectors are moving in different directions that we get mixed, inconsistent readings from indicators, a helpful tell that we're in a range market.)

In a trending market, we should see the vast majority of stocks trading above or below their opening price. We should also see major sectors moving in unison. When there is mixed sector performance and a mixture of advancing and declining stocks (as computed from the open), it is a worthwhile indication that we're in a non-trending environment. This revised advance-decline measure should also be helpful in identifying when range markets breakout and become trending ones (the great majority of stocks should flip to advancing or declining) and when those breakouts are false (the majority of shares fail to sustain advancing or declining status).

I'll be tracking this indicator in future intraday Twitter posts (free subscription here, or check the last five tweets posted on the blog page under "Twitter Trader") and including it as one of a core group of measures that becomes part of my eventual "daytrading analyst" resource. My hope is that it will be helpful in teasing out when large caps are under- or outperforming and when action from open to close is different from action measured from close to close.

Twitter as a Daytrading Analyst

If you were to observe hedge fund portfolio managers at work, you'd notice that they interact frequently with one or more analysts and assistants. The role of the analysts is to help generate ideas for trading and investment. For example, a single portfolio manager specializing in equities might work with a number of analysts, each of whom is devoted to a particular sector. The analysts scour financial statements, talk with brokers, visit companies, and read everything they can about companies in order to generate recommendations for buying or selling. It is then up to the portfolio manager to figure out how (and whether) to incorporate that recommendation in the portfolio, when precisely to buy and sell it, when to scale into and out of the position, etc. Very often, the analysts will generate research reports that summarize their recommendations and make the case for why the idea should be expressed in the portfolio.

Active traders make buy and sell decisions on a very different basis. They are primarily looking at short-term price and volume action, news event catalysts, and other immediate data. Much of their skill consists of an ability to immerse themselves in the flow of markets and detect shifts in supply and demand. Talking with analysts--and certainly reading research reports--during the day would take them out of this flow and disrupt their work.

Nonetheless, active traders could benefit greatly from the right kind of analyst input. A common problem among daytraders is that they are so immersed in the order flow for their particular stocks or futures contracts that they miss what is happening in the wider market. For example, a leading sector could be breaking out to the upside, but a trader focused on each tick in the stock index futures could miss that altogether. That information could aid decision support for the trader. Note that, unlike in the portfolio management setting, the role of the daytrading analyst would *not* be to recommend particular trades. Rather, it would be to provide information to the trader that could be utilized in making new trades and managing existing ones.

A major challenge for the daytrading analyst is to present only the most relevant information in a format that is minimally distracting. Squwak boxes attempt this by presenting information in an auditory channel, where it will not distract a trader watching the screen. This can also be a liability, however, as the message is lost once it's delivered.

Instant messaging may be more promising as a means for conveying decision support to a trader, while taking up minimal real estate on the screen. The Twitter application, which limits each message to 140 characters, may be ideal for this purpose. The idea would be to use messages selectively to provide valuable information to a trader that the trader could not easily obtain for himself or herself. For example, a "tweet" might summarize a significant historical trading pattern or highlight an important shift in a market indicator or stock sector.

A fighter pilot typically relies on a co-pilot to monitor those things that would take the pilot's eye off what he is doing. When a job demands intense concentration and quick reflexes--such as the work of a surgeon--there is a need for helpers who can perform all the peripheral tasks and monitor a variety of conditions in real time (surgical nurses, anesthesiologists, etc.).

Ultimately, the role of a daytrading analyst is to expand the cognitive bandwidth of active traders: help them see and process more than they could on their own. The analyst does not substitute for the trader's judgment, but supports it. Think of the vast array of CIA analysts that support a single intelligence officer in the field or the scores of military analysts that support a battalion commander. All of us have limited mental bandwidth; the key is to use teamwork to make high quality decisions that no individual could achieve on his or her own.

The beauty of Twitter as a vehicle for a daytrading analyst is that it is totally scalable. The work that would go into supporting one trader could assist thousands. This means that a trader who normally could never afford to hire an individual analyst could easily subscribe to an analytical service.

Keep an eye on my intraday Twitter posts (subscription is free via RSS; the last five tweets appear on the blog page). Gradually, I will be shifting in the direction of creating what I believe to be the first dedicated analyst service for active traders. You will see updates of unique indicators and data, and blog posts will explain how to utilize this information. The first tool will be an advance-decline indicator based upon the 40 stocks in my basket (five highly weighted issues from eight S&P 500 sectors) and measuring, in real time, advances vs. declines from the market open (not from the prior day's close). My next post will explain why such a tool is valuable.

Monday, March 23, 2009

The Trading Rodeo: Staying on That Bull

A very experienced trader commented to me at the end of the day, "It's amazing how much opportunity there is if you just keep your focus." On a day like today, where we start strong out of the gate and end very close to the day's highs, it looks so easy in retrospect to just buy and hold for a killer day. What isn't apparent is all the counter moves and choppiness between the surges that can knock you off the bull that you're riding.

As any rodeo champ knows, you stay on that bull by moving with it, not by fighting it. Once you lose your center of gravity, you're in the dust, making sure the bull doesn't stomp on you.

So what are your centers of gravity as a trader?

One important one is price levels from trading ranges. There are many relevant levels and ranges during any particular day. Some of the ones that I emphasized in the intraday Twitter posts were the ES 791 overnight high and the ES 802 multiday high.

A useful rule is that, when we break out of a range--particularly on strong volume and volatility, with most sectors participating-- we don't fade that move unless and until we see prices move back into that range. In other words, if a breakout is genuine, we should not return to that prior range.

What that means in practice is that, once we vault above the price level corresponding to the upper edge of a range, we may consolidate and pull back a bit before continuing higher. If your aim is to ride a trending move, you don't view that normal profit taking as a threat. Indeed, it could even be an opportunity to add to a position.

To be sure, there will still be those times when the bull bucks and gyrates, knocking you on your seat. I wouldn't fault a short-term trader for getting out of the way when weakness entered the market near 12:30 PM CT. Still, as the Twitter comment pointed out, we did manage to stay above the key overnight high price level, setting up a second wind for the bull. Knowing where your ranges are helps you identify when you're rangebound, when you're breaking out of ranges in a trend, and when you're re-entering those ranges to reverse a trend.

In short, you don't try to predict the end of a move; you have to wait for the market to tell you it's over. Similarly, you don't lean one way trying to predict which way the rodeo bull will toss and turn; you keep yourself centered, maintain your feel for the movement, stay loose, and react. Everyone gets tossed at times, but it's amazing how, with your focus, you can find quite a bit of opportunity just by staying on that bull a little while longer.


Relative Volume Update: How Much Participation Can We Expect During the Day?

Relative volume is a concept that assesses current volume as a function of the normal, expectable volume for that particular time of day. This is important, because relative volume tells us something important about volatility and who is participating in market moves.

Here are the median volumes for January to the present for the ES contract on a half-hourly basis (Central time; the time given is the starting time for the half-hourly period). Standard deviations to help you gauge shifts in relative volume are in parentheses. I also mention relative volume in my intraday Twitter comments:

8:30 - 249,628 (60,916)
9:00 - 210,109 (49,641)
9:30 - 176,713 (47,441)
10:00 - 150,998 (58,135)
10:30 - 124,357 (52,555)
11:00 - 112,447 (38,514)
11:30 - 111,184 (32,758)
12:00 - 113,583 (34,148)
12:30 - 122,089 (43,015)
13:00 - 144,050 (64,873)
13:30 - 153,997 (62,491)
14:00 - 188,381 (55,594)
14:30 - 260,692 (84,687)
15:00 - 111,856 (30,520)


Indicator Update for March 23rd

Last week's indicator review noted, "As long as the indicators remain strong, it's premature to fade market strength; as long as we see lower price highs and lower price lows during successive peaks and valleys in the indicators, it's premature to conclude that the bear market is over." We did, indeed, see further strength in the indicators during the week before a selloff late in the week. Nonetheless, as we can see clearly in the Cumulative Demand/Supply Index (top chart), we're hitting overbought levels at successively lower price highs, consistent with bear market dynamics.

That doesn't mean that a bull move cannot continue for a while here, as we had some extended upside action following the November lows. If that is to happen, a common pattern is for pullbacks in the Cumulative DSI to occur with relatively modest price corrections, such that new upthrusts in the DSI occur at higher price levels. Such a scenario should lead us to take out the 800 area resistance in the S&P 500 Index during the coming week.

Given the neutral trend status across most sectors, I'm currently viewing the S&P 500 Index in a range defined by the Wednesday and Friday lows (around 761) and those 800 area highs. Note that new 20-day highs expanded nicely on the week following the Fed announcement (middle chart); on strength, I will be looking for indications that we can expand those new highs to sustain the uptrend. Conversely, weakness in the Demand/Supply numbers (posted each morning prior to the open via Twitter), will suggest difficulty in sustaining a move above that range and a likely test of the lower end.

The Cumulative TICK (bottom chart) also expanded during the early portion of the week; I'll be looking for new highs in that indicator to confirm any price strength. Weakness that takes us below the Friday readings will likely have us testing that lower end of the trading range.

In sum, I would not be surprised to see consolidation following the strong price rise off the early March lows. That consolidation should be relatively flat if we're going to sustain another leg upward. A deeper correction, particularly one that takes out that 761 support area, would have me thinking about a bottoming process and eventual test of bear lows.

Later today, I'll be posting relative volume norms for the ES contract to help traders gauge likely volatility and participation in market moves. Intraday updates regarding volume patterns will also appear via Twitter (free subscription).

Sunday, March 22, 2009

Odds and Ends Before a New Week

A few odds and ends:

* Tonight at 8:00 PM CT, Brian Shannon of Alpha Trends will be offering a webinar, where he discusses market analysis, stocks he's looking at, and more.

* Any chance, Ray Barros, that we could get a link to an archive of your recent webinar?

* Watch for more decision support posts via Twitter and a future blog post on decision support.

* Are we looking at a short-term range between the 761 lows and 800 area highs in the ES futures?

* Many thanks to SMB Trading for the kind book review.

* Click on the ETF table in Market Rewind's post; lots of good info there. Thanks, too, to Jeff for the book mention.

* If we weaken the dollar through continued easing, will we see energy (XLE) and materials (XLB) outperform the rest of the S&P 500 Index, as commodities become more valuable in dollar terms?

* Not enough reading? Here are a few of my older, classic articles in a PDF.

Have a great start to the week--


Sector Update for March 22nd

Last week's sector review concluded, "a good part of the recent rally has been short-covering among...beaten down sectors. We will need active, continued buying to move the sectors from neutral to solid uptrending status." We did, indeed, see a continuation of buying for much of the week, before selling hit the market at the important 800 level in the S&P 500 Index.

Here's how Technical Strength (a quantification of short-term trending) looks for the eight S&P 500 sectors that I track. Recall that sector-based Technical Strength varies from -500 (strong downtrend) to +500 (strong uptrend, with values from -100 to +100 representing no significant short-term trend:

MATERIALS: +180 (79%)
ENERGY: +40 (88%)
HEALTH CARE: +60 (30%)
FINANCIAL: +140 (63%)
TECHNOLOGY: +200 (83%)

What we see, surprisingly, is that the weakness late in the week took much of the starch out of the uptrend among the sectors. Most are trading in a neutral trending mode, with relative strength notable only in technology and materials shares. The latter reflects commodity strength on the back of dollar weakness due to the Fed's announcement of quantitative easing.

When we look at the percentage of stocks closing above their 20-day moving averages within each sector, as reported by Decision Point, we find that most sectors show more than half their components trading above that benchmark, with notably weak performance by health care shares. Interestingly, that defensive sector, which had performed relatively well in the market's downturn, is now underperforming its counterparts.

Note also how financial stocks have weakened since last week, given concerns over the toxic asset plan scheduled to be unveiled this coming week. That sector is key to the issue of economic recovery, and I will be following its response to leaked details of the plan early this week.

The 800 area poses significant resistance for the S&P 500 Index and this past week's action, as a whole, has done little to reassure us that the recent strong rally was anything more than a countertrend move in a downward market. What would we need to see to convince us that a more significant transition to bull mode is upon us? We'd want to see firmness among those financial shares and sectors sustaining positive Technical Strength and a majority of components trading above their 20-day moving averages.

Absent those indications, I'm viewing the current market as within a broad trading range defined by the 800-area highs and the recent bear market lows. Inability to surmount the top end of that range would initially target the range midpoint on an intermediate-term basis. I update the Technical Strength status of my basket of 40 stocks (five top-weighted issues from each from the eight sectors above) each morning prior to the market open via my Twitter posts (subscription is free). Those updates will help us gauge whether the rally will have legs or ultimately lead to further regression into the wide range.

Recognizing When You're Wrong In A Trade

Sometimes we're just wrong. We're interpreting price and indicator action one way and the market smacks us the other way. Key to trading survival is getting out of the trade quickly when it goes sour. Key to trading success is using the failed trade to revise your view and formulate new, promising trade ideas.

So let's look at Friday's market. No question about it, I was leaning the wrong way in the late morning as I watched the market between phone calls with traders. If you click on the top chart (ES, 3 minute), you'll see where the X's are that I was looking at a rounding bottom process. The TICK (middle chart) hit its low point between 10:00 AM and 10:30 AM CT, and by the time we approached that 11:00 AM period, it seemed that selling was drying up and we were making a higher low, just beneath the 20-period volume-weighted moving average.

So things were good on the long side: we moved smartly above that moving average, and TICK made a new high on the move between 11:00 and 11:30 AM. We should be able to take out those highs from between 9 and 9:30 AM and stay above our moving average if this idea is solid.

Well, look just one bar later at the bottom chart. We get vicious selling on twice the recent volume and greatly expanded volatility, propelling us below the moving average. What next?

The phrase that goes through my head at these times is "This shouldn't be happening." In other words, if we're picking up buying interest (rising TICK, staying above the moving average), there's no way we should get an influx of sellers and for the market to move down so readily in the face of selling pressure. Indeed, one of the things I liked about the long side was that the little market dip prior to 11:30 AM stayed above the moving average. The selling shortly thereafter ripped below that low and violated something I liked about the trade.

I've learned that the "This shouldn't be happening" thought running through my head is usually a good point to get out of a trade. Instead of gaining confidence in the idea, I'm losing it. I need to fight that "shouldn't be happening" feeling to rationalize staying in the trade. Those rationalizations are almost always losers.

Could it be a temporary whipsaw? It's possible, but what has a trader lost by getting scared out? If a good upmove is to follow, the trader can play an upside break of the 780 level (from which the selling started). By that time, the trader could be looking to test the AM highs and would still have a good risk/reward trade.

But when volume and volatility are going against your trade and violating your levels, more often than not, you want to acknowledge that the market proved your idea wrong and then try to learn from that. Learning to make friends with being wrong is key to long-term success.

Indeed, exiting the long trade with an open mind would prove helpful several bars later, when the downside volume and volatility continued and thrust us below the morning lows in a breakout move. And even if you did not catch that breakout, there was plenty of time to see that bounces were feeble and make money on the downside. But only if you first were able to exit your trade, accept being wrong, and use the trade as information for the next one.

Let's see if some intraday Twitter posts can identify, not only some market ideas, but some points where those ideas prove wrong. Those, we see, can also be times of opportunity. The intraday market posts via Twitter will appear on the blog page under "Twitter Trader" (last five tweets), or you can subscribe to the posts free of charge via RSS.

Saturday, March 21, 2009

Learning When to Not Trade

The previous post emphasized managing the psychological risks of trading as a key challenge for those learning to trade. An astute reader commented on the post, noting that limiting daily losses and taking time outs are important trading practices.

I could not agree more heartily. Many times traders press too hard to make money, leading to overtrading. Instead of trading for logical reasons (their edge), they trade for psychological reasons. That trader with the 55% win rate suddenly becomes a trader with a 45% win rate when overtrading. Without limits on daily losses and a process for taking a time out, that trader can blow up in a short amount of time.

The other reason it's important to limit daily losses and take those times away from trading is that markets themselves go through shifts. Adapting to changing market conditions is a challenge even for the most experienced and successful traders. When hedge funds and CTAs experienced redemptions from investors, their trading patterns changed; that has made 2009 a very different environment from 2008 across a range of markets. Similarly, when computerized trading began to dominate market making, many of the profitable ways of scalping markets dried up.

Because market conditions change periodically, one's edge in trading is never fixed. We go through periods of greater or lesser edge. For that reason, a central skill to long-term success is recognizing when your edge is eroding and pulling back from risk taking.

I saw this first hand at proprietary trading firms during the low volatility markets of 2005 and 2006. Traders who did not adapt to those conditions and reduce their profit expectations (per trade, as well as per week and per year) fought the slow, choppy markets and did not last to see far better conditions in late 2007 and 2008. Similarly, many daytraders who raked in money during the tech boom of the late 1990s did not pull in their horns after early 2000 and lost their money and their trading careers.

The takeaway message is that successful traders are always students of markets, always learning, and always adapting. They have periods of feast and famine, and they learn to keep themselves afloat during the lean times so that they can participate when things get better. In that context, learning when to not trade is a crucial component of trading success.

Learning How to Trade: Managing the Psychological Risks

A couple of years ago, I posted an article (now available as a PDF) on managing the psychological risks of trading. I encourage you to review that article; it offers an important perspective for those learning how to trade.

The financial risks of trading are fairly well known: If we size positions too large or incur too many runs of losing trades, our capital will become depleted. Lose half your money and suddenly you have to double your remaining capital just to return to breakeven. If you trade every day and average 55% winning trades, you'll incur runs of four consecutive losing trades roughly every month. Size those trades too large and you'll be looking for a new vocation or avocation.

(Another article in PDF worth reviewing is Henry Carstens' Introduction to Testing Trading Ideas. Even if you're a discretionary trader, knowing your typical win ratio, average loss size, average drawdown, etc. helps you gauge your financial risks).

When you are learning to trade, those financial risks turn into psychological ones quite quickly. We might have a 55% win ratio, but we don't know how that 55% will be distributed over time. Consider Henry's P/L forecaster illustrated above. We have a small trader with a $33,000 account who has an average win equal to their average loss ($1000 per week after commissions) and a 55% winning percentage. The above chart shows one possible path for their two-year (100 week) P/L.

Overall, the trader is quite successful. The two-year return on capital is 33%, enough to support a career in the portfolio management world. But note that the first 15 weeks are spent in the red. Moreover, there is a drawdown late in the period in which nearly one-third of profits are lost. These adverse events--entirely expectable and having nothing to do with altered or poor trading--create many of the psychological risks of trading.

Most new traders, facing 15 weeks in the red, will change what they do, abandoning profitable trading methods. Many more, facing a profit drawdown, will shut down or change their methods, again drifting from their strengths. The resilient trader learns to expect these setbacks as a normal part of doing business. No matter how good you are--and I work with some very good traders--you will have extended periods in the red. The psychological risk for those learning to trade is not that you'll lose your money--proper position sizing and risk management can prevent that-- but that you'll lose your nerve. Just because you have an edge doesn't mean it won't feel at times like you're on the ledge.

Friday, March 20, 2009

Catching the Breakout Trade: Recognizing Rejection of a Key Price Level

Here we see today's S&P 500 e-mini (ES) futures market (blue line) plotted against the day's volume-weighted average price (VWAP; pink line) and the previous day's support level drawn in red.

Notice that we traded around that resistance level for much of the morning in a range trade, but could not sustain rallies above VWAP and largely remained below the day's opening price.

As noted in the Twitter post just prior to the noon CT hour, selling picked up along with volume and volatility, as we rejected both the resistance level and the current VWAP as an estimate of value. This breakout from the morning's range led to a significant downmove that took us near the S2 support level.

Differentiating moves with normal volume and volatility that meander around an average price from moves away from that price that are accompanied by expanding volume and volatility is key to recognizing breakout trades.

Tells that I did not emphasize in my Twitter posts that deserved greater attention were the inability of the market to trade above its opening price and the consequent downward slope of VWAP. Even with extensive preparation, there are always things we miss; things we need to work on. That's one of the things that keeps the trading game endlessly challenging.

Morning Preparation for Trading

One of the most valuable trading practices, I've found, takes place before markets actually open. It's the practice of framing "what-if" scenarios for the day, so that you're prepared to act when your market hits crucial price levels. Note that I emphasize scenarios in the plural; the idea is to be prepared for a variety of situations, not to get locked into any single one. The goal is to promote mental and behavioral flexibility, not to pull out a crystal ball that will entice your confirmation bias.

A trader I work with called me yesterday and shared how he profited nicely from the Fed announcement. I was initially surprised, because--going into the announcement--he was leaning the wrong way. He had played out the scenarios in his head, however, and was prepared for an announcement that the Fed would be buying Treasuries. Very shortly after the news came out, he flipped his positions and, from that point forward, made a very nice profit.

The combination of an open mind and an ability to quickly and decisively act upon fresh developments is something I've found in successful traders. Much underperformance comes from the inability to keep the mind open and the inability to be decisive when markets shift.

Above we see a snapshot of an hourly chart of the ES futures just before 7 AM CT. Recall from my Twitter posting yesterday afternoon that 778 was important intraday support. An attempted rally from that point failed late in the day, and we moved lower. Observe also that this support area roughly corresponds to the level at which we launched the upmove following the Fed announcement.

During pre-opening trade, we have moved smartly above that 778 level (blue line), placing us back in the prior day's range. (Green line is 20-period volume-weighted moving average). I am going to be watching that level closely in early trading. If early selling cannot take us below 778, I'm going to expect a bounce well into the previous day's range, with the day's pivot as an initial target. I'll be watching the distribution of NYSE TICK and the advance-decline ratio ($ADD) for confirmation that buyers have the upper hand before committing to the long side.

Conversely, should we fail to hold 778 and we see distinct signs of weakness among those indicators, I'll be thinking about selling bounces for a move toward S1. Should we see weak volume and choppy trade on this expiration Friday, I'll be thinking range market and will look to fade moves away from VWAP and the market open. Most of all, I'll chill in the early minutes of the morning trade to let the market tell me what it's doing.

Going back to the Twitter posts, I have the profit targets set (see 6:30 AM tweet) and written down in front of me; I have the lines drawn on my chart; and I have scenarios laid out. All well before an hour is left before the open, when I can relax, exercise, scope out correlated markets, and update my views.

Whether in sports or trading, so much of the game is won before the initial tipoff, kickoff, or faceoff. Preparation is a powerful psychological tool, because it primes us to act on our perceptions.

Thursday, March 19, 2009

Coaching Yourself for Self-Control: Lesson From The Daily Trading Coach

Some good news this week: The Daily Trading Coach is now shipping from Amazon and a contract has already been signed for a Japanese language edition.

The book, unlike my first two, is explicitly structured as a self-help book for traders, focusing on 101 lessons for changing patterns of thought, emotion, and behavior. It also includes ideas for managing a trading business and using Excel to identify historical patterns in markets. My thanks to the many excellent trader/bloggers who contributed their original coaching ideas to the book.

Here is a segment from Lesson 53:

"Suppose someone hijacked your computer as you were trading and suddenly switched the screen from your markets other some other, random ones? Suppose your mouse was taken out of your control and clicked on trades that you didn't want? I guarantee, if that happened to you, you'd become very upset. You would not tolerate someone controlling your computer or your mouse. You would do everything in your power to regain control of your equipment. That has to become your attitude toward the hijacking of your mind [by negative thought patterns]."

Keeping cognitive journals, performing experiential exercises to challenge your self-talk, reframing automatic, negative thought patterns: there are many techniques for shifting how you perceive yourself and your markets.

Are your ways of thinking helping or hindering your performance? Are you actively framing and reframing your views of markets, or are impulses, needs, and fears hijacking the ways in which you think? My goal with the book is to provide tools that enable you to become your own coach and psychologist, so that you are controlling your trading--not the reverse.

Taking Control of Perception and Motivation

A post from 2007 that is worth reviewing describes brief therapy for the mentally well. The basic notion behind that post is that making psychological changes typically requires the ability to program our states of consciousness.

A great example involves traders who report that they lack the motivation to keep a journal, set and pursue goals, etc. For them, motivation is either something that comes to them or doesn't. They do not operate with the framework that they can generate their own motivation.

Once you recognize that motivation is an outgrowth of how you perceive an activity, then you realize that it is potentially in your full control. If you perceive that not getting something done will result in dire consequences, you're more likely to get it done. If you perceive that getting something done will bring great returns, you'll be more likely to pursue the activity. If you perceive that an action is central to who you are and who you want to be, you'll be more likely to take that action.

When perception is passive, we are not in control of how we relate to the activities of our lives. Once we take charge of how we construe the world, we become able to summon pools of energy and drive that we didn't recognize were there.

If there is something you've been wanting to do but haven't gotten around to it, your perceptual process is what is holding you back. How would you have to perceive that activity to make it a pressing priority? How could you make that perceptual scheme a regular part of you? What perceptions currently drain you of energy and drive?

Perceptions are the food of the mind--and body. Much of success boils down to eating well.