Building a Stock Market Indicator of Momentum and Strength

Over the years, I've developed quite a few indicators, some of which (such as my volatility-adjusted pivot/target levels and the Demand/Supply measure) I post daily to Twitter.

The process of developing an indicator generally begins with an idea and then proceeds with various riffs on that idea. Sometimes this playing with data leads to something unique; most of the time, it doesn't.

I thought I'd share my first approximation of an indicator. This tracks the 20-day average of the number of "strong days" in the S&P 500 Index (SPY). To qualify as a strong day, a day must close in the top half of its daily trading range.

So this is a kind of oscillator to see if stocks tend to finish the day above, below, or at the day's estimate of value (average trading price).

When the number of strong days is above 10 and rising, we have a market in which traders are tending to buy intraday weakness. When we have the number of strong days below 10 and falling, we have a market in which traders are tending to sell intraday strength.

My hypothesis is that momentum leads price: the proportion of strong days should peak and trough ahead of price, as rising and falling markets lose steam and, as moves age, fail to pick up intraday buyers/sellers.

In future posts, we'll take a look at tweaking this very simple measure.

5/1/09 - Thanks to the Total Negative Slack blog for programming the above indicator.

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Nice Tell for Range Bound Trade

While the NYSE TICK has been in positive territory much of the morning, supporting relative strength among NASDAQ and Russell issues, we've seen no dramatic lifting of offers among large sellers in ES. That has kept us in a range mode, oscillating around VWAP, as noted in the morning tweet. One nice tell that we're more likely to be in a range trade is when cumulative TICK and cumulative Delta are not moving in sync.
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A Nice Measure of Stock Market Resilience

During April, the S&P 500 Index (SPY) has opened lower 11 times, creating a gap to the downside. On eight of those eleven days, SPY has traded higher from open to close.

Interestingly, during 2009 prior to April, the market traded in the same direction as its opening gap 41 times and in opposite directions 29 times. In April, it seems, there has been a mindset of buying stocks on overnight weakness.

We can think of this as a measure of resilience: how well a market absorbs--and ultimately reverses--overnight weakness. A converse measure of vulnerability would be day timeframe selling following overnight rises.

During 2009 overall, the correlation between the overnight market move and the move during the day session in SPY has only been .16. This suggests that the two time periods trade relatively independent of one another. A big part of what might sustain bull and bear moves is resilience and vulnerability--the tendency of buyers to treat overnight weakness (and sellers to treat overnight strength) as opportunities to get better prices.
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A Longer Timeframe Picture of Stock Strength

Shout out once again to one of my favorite sites, Decision Point, which tracks the percentage of NYSE stocks trading above their 200-day moving averages. It is common to see this percentage top out ahead of price during cyclical bull markets, generally reaching an "overbought" peak of 80-90%. We can see that the percentage topped out in early 2007, well ahead of price later that year. By the time we made a price high, the percentage of NYSE stocks trading above their 200-day moving average had broken into the 60s.

Note how the percentage bottomed well below 10% at the March lows, but has been climbing steadily since then. While the market is registering "overbought" readings on a shorter time frame, the percentage of NYSE issues above their 200-day moving averages--at around 30%--is nowhere near "overbought" levels. It is but one of quite a few indicators that I've highlighted--the advance/decline line, the Cumulative TICK, the number of stocks making fresh 65-day highs--that continue to make new highs during the recent market upswing. That reflects a situation in which price corrections to date have been relatively brief and mild. Should we begin to see divergences among these indicators, I would expect a more substantial correction.

It is interesting to see the patterns of stocks closing above their 200-day moving average as a function of sectors. Of the Consumer Discretionary stocks, fully 56% are above that benchmark; we also see 49% of Technology shares and 36% of Materials stocks above their averages. This relative strength suggests that stocks with growth themes, from discretionary spending to tech to raw materials, are driving the recent rally. I will be watching the relative performance of these sectors going forward, as they provide a useful sentiment gauge.
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When Markets Hold Strength on Bad News

One characteristic of a strong market--and a great sentiment indication--is the ability of stocks to absorb bad news and sustain buying interest. We saw strength in the preopening market going into the GDP announcement at 7:30 AM CT, but when the news came out worse than expected, we sold off quickly on high volume. That led to a quick bounce and a retest of the lows on much reduced volume. When we could not sustain those lows, buyers entered in force with strong NYSE TICK and we broke above the overnight highs to test recent multi-day highs. Knowing expectations for economic releases and seeing how markets trade around surprises and disappointments can be quite useful in setting up morning trades.
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The Importance of Stock Sector Participation

Here's an afternoon snapshot of the ES market that I took, highlighting the Market Delta screen. At the time of the upside breakout, we had favorable NYSE TICK and expanded volume lifting offers. What I noted via Twitter, and we couldn't see from those indicators, was that several sectors were not making fresh highs, including NQ, XLI, XLY, and XLV. As we've seen in the past, when we have multiple sectors not participating in a market making new highs or lows, that move frequently reverses. That's what we saw in the afternoon (chart above), as the breakout bulls were trapped and had to cover their positions. That led to a nice trade back below VWAP (red line on chart).

As important as it is to follow one's own stocks or indexes closely, it's just as crucial to be aware of the context of market moves. Moves that are narrow in their participation are more suspect than those that lift or drop the sectors in unison. As my schedule with traders allows, I will highlight participation in my tweets (free subscription on my Twitter page), both by tracking sector performance and by reporting on the participation of the 40 stocks in my basket (highly weighted issues from each of the eight sectors I track). More to come...
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Treasury Rates and Investor Sentiment

Treasuries at the longer end of the curve rallied strongly and rates came down sharply (see chart above) in mid-March, when the Fed announced a quantitative easing policy. Since that time, however, stocks have rallied steadily and 10-year rates have crept back to the 3% range.

This is another example of a nice sentiment gauge: as traders and investors fear economic decline, they seek a safe haven in Treasuries and rates fall. When confidence in economic recover takes center stage, traders and investors are willing to pursue riskier assets and sell Treasuries, pushing rates higher.
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We Gravitate Toward Our Self-Talk

I'll be doing a talk for a group of traders this afternoon. One of the topics I'll be emphasizing is that our actions naturally gravitate toward our self-talk: how we process information shapes how we will respond to situations.

The trader who engages in catastrophic thinking finds himself becoming risk-averse.

The trader who beats up on herself after a losing day loses the motivation to prepare for the next day's trade and misses a great opportunity.

The trader who is perfectionistic can't tolerate missing a move and ends up chasing highs, just as the market reverses.

The trader who thinks he can do no wrong after a series of winning days overtrades and blows through his downside loss limits the next day.

The trader who rehearses the good trade when reviewing possible scenarios for the day doesn't hesitate to put the trade on when economic data come out favorable and makes money for the morning.

In all these ways, how we think affects how we feel and how we act. Our self-talk constructs our personal reality and helps define the behavioral options open to us.

RELEVANT POSTS:

Changing Your Self-Talk

When Traders Lose Confidence

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Using the Overnight Range as a Reference Point

Early this morning, I illustrated the drying up of selling and then the creation of resistance when sellers began meeting the buying interest before the open. Here we can see the upside breakout from that premarket range, as very strong volume came into the market on favorable economic news, lifting offers. It's a nice illustration of how the overnight range acts as an effective reference point for intraday traders.
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Premarket Briefing: Tracking Volume and Sentiment Shifts

Here's a pre-opening snapshot of the ES market. Note how we had strong selling (and volume hitting bids) early in the morning and then a drying up of selling as the morning progressed. It was after that drying up that we began to see volume lifting offers in the last three 30-minute periods of the chart (bottom histogram). Notice how you could identify that sentiment shift prior to the market's lift off move that took us back to the day's VWAP (red line). As of my writing this, we're seeing some sellers greet the rising market at the 845.50 to 846 level. That creates an exit for short-term traders and it represents the formation of a possible resistance area for those looking to hold. Here's a very nice article from MG Trader on high volume regions and their trading significance.
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High-Yield Bonds and Market Sentiment

In recent posts, I've emphasized that the performance of more speculative, growth-oriented sectors vs. more established blue chips acts as a nice sentiment indicator for the stock market. Other sentiment indications can be derived from the performance of other asset classes.

Above we see HYG, the ETF for high-yield bonds. When economic assumptions and sentiment are favorable, these speculative bonds offer superior returns. When sentiment regarding the economy is bearish, investors will shy away from lower-rated bonds and seek the safe haven of Treasuries.

Notice how the average daily volatility of HYG skyrocketed in mid September with the Lehman collapse. We can think of volatility of HYG as a measure of uncertainty regarding the promise and risks associated with these bonds.

We can see that volatility has come well off its late 2008 peak, but still remains well above its pre-September levels. Like stocks, HYG has bounced well off its early March, 2009 lows; also like large-cap stocks, HYG has stalled out so far below its 4/17 highs and volatility has ticked up. In the wake of auto company woes, this is one reflection of sentiment that I'm watching closely.
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When Good Things Come in Smaller Packages

Since the market bottom in March, note how performance has been strongest among small caps ($SML), next strongest among midcaps ($MID), and weakest among large caps ($SPX). This is another case in which the relative movement of more and less speculative issues provides a sentiment gauge.

In a bull market mode, risk appetites and speculative interest lead traders and investors to smaller, more entrepreneurial issues with higher growth potential. In a bear market mode, risk aversion and the need for safety lead traders and investors to larger, more established blue chip names with higher perceived stability.

While the indexes are in a multiday range at present, with small caps underperforming large caps since 4/17, the overall bullish sentiment dynamic remains intact, reflecting strength in the NYSE TICK. Per my recent post, I would expect to see weakness in the Cumulative TICK and relative underperformance among small and midcap issues if we are to sustain a downtrend.
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A Quick Look at Small Cap Stocks

Here's a quick snapshot of one of my screens, illustrating a point made in my recent tweet: the Russell 2000 stocks (IWM) are struggling at multi-day highs, accounting for some of the dropoff in new stock highs we've seen recently. That narrowing of the rally is on my radar, as it often precedes more ongoing market corrections. I would become particularly concerned about the upside for the IWM stocks should we turn down in the Cumulative NYSE TICK, as this often reflects buying and selling interest across the broad market, not just among the large caps.
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Indicator Update for April 27th

Last week's indicator review found few divergences that would suggest a significant retracement. We did see weakness early in the week, only to once again see stocks challenge their bull market highs, with several indexes hitting fresh peaks. As noted in the recent sector review, the bull move has been occurring on a narrowing base, suggesting that we may be more vulnerable to a correction than in the past several weeks. The Cumulative Demand/Supply Index (top chart) has been making lower highs lately, suggesting a loss of momentum among the broad list of NYSE, NASDAQ, and ASE stocks. Similarly, this past week's late strength saw a reduced number of shares making fresh 20-day highs vs. lows (middle chart), again suggesting a narrowing of participation in the strength.

That having been said, we continue to bolt higher in the Cumulative TICK (bottom chart), as well as the advance-decline line specific to NYSE common stocks. We're also seeing smaller cap issues holding their own versus large caps, with smaller issues within the S&P 500 Index also outperforming their megacap counterparts. This continued strength in buying/speculative sentiment is not what we normally observe at major market tops, suggesting to me that any near-term correction that we see may be part of a more extended topping or consolidation, rather than the start of a fresh bear market.

As always, I will be updating the indicators each morning before the market open via Twitter. Tweets can be accessed from RSS subscription or from my Twitter page; the five most recent tweets appear on the blog page under "Twitter Trader". Have a great week trading.
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Trading Preview to Start the Week

Note the important resistance in the ES futures around the 870 level. We've opened lower in Globex trading; for swing traders, failure to take out that resistance targets the 20-day volume-weighted moving average (green line) around 836, with last week's low a logical target below that. A break to the upside accompanied by solid volume and participation would target the early 2009 highs around 939.

Although I'll be on the road much of this week working with traders, I will be posting indicators daily before the market open via Twitter (free subscription). I will particularly look for indications of market weakness: expanding 20-day lows and Supply (number of stocks closing below the volatility envelopes surrounding their short-term moving averages) exceeding Demand (number of stocks closing above their envelopes). A weekly indicator update will also appear early Monday AM.
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Sector Update for April 26th

Last week's sector review suggested that the eight S&P 500 sectors that I track weekly remained bullish overall, though their ascent seemed to be slowing. In action that became quite choppy at times, we did indeed see continued strength last week, with several indexes making fresh bull market highs. Here's how the sectors look with respect to Technical Strength, a proprietary short-term measure of trending:

MATERIALS: +420
INDUSTRIAL: +400
CONSUMER DISCRETIONARY: +180
CONSUMER STAPLES: +20
ENERGY: +100
HEALTH CARE: -60
FINANCIAL: +220
TECHNOLOGY: +280

What we see is that five of the eight sectors (see chart above) actually lost Technical Strength. Although we saw generally higher prices over the week, much of the movement can be attributed to continued strength in Materials and Industrial stocks. Fully three of the eight sectors are in a non-trending mode, with the two consumer-related sectors showing particular drops in their strength.

The defensive Consumer Staples and Health Care sectors continue to bring up the rear in strength; note the sizable drop among Financial shares in the wake of the Fed's release of its stress test methods.

As a rule, markets tend to continue their climb when the great majority of their components are participating in the strength. As bull moves age, weaker sectors begin to drop out and the market moves higher from a narrower base. We're seeing a narrowing of that base at present, and that leads me to believe that we're more vulnerable to a correction than we've been in the prior several weeks, when the rising tide was lifting most boats.
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A Valuable Sentiment Indicator is in Bull Mode

Kudos to the excellent Decision Point site for this three-year view of the weighted and unweighted versions of the S&P 500 Index.

When market sentiment is bullish, we see a speculative interest in the smallest components of the index. This interest leads to outperformance of the unweighted index versus its cap-weighted counterpart.

Conversely, when traders and investors are more defensive, they shy away from more speculative names and stick to the most established blue chips. That leads the weighted S&P Index to outperform the unweighted version.

Note how the ratio between the unweighted and weighted indexes (bottom pane) peaked early in 2007, well ahead of the bull market peak in $SPX. The ratio also bottomed in December, well ahead of the March bottom in $SPX. The ratio is currently in a raging bull market mode, exceeding its bull market peak.
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The Key to Changing Our Psychological Patterns: Coaching Traders in Real Time

What I have found is that applying cognitive, behavioral, and solution-focused techniques with traders *while they are trading* is the most effective form of coaching for traders. This passage from my second book will explain why, and the references at the end of the post point to specific techniques that you can apply, real time, to your own trading:

From Enhancing Trader Performance:

"Gurdjieff's fundamental insight--now finding validation in cognitive neuroscience--is that human beings are not 'always one and the same.' We experience different emotional, physical, and cognitive states in response to environmental events, leading us to think and behave one way in a given situation and quite differently in others.

An objective observer of the human race would conclude that people lack self-control. They are not always one and the same. This allows normally responsible individuals to forget about risk management when they are trading large size. It enables us to develop elaborate trading plans, only to see them fly out the window when markets move violently. We are not fully intentional beings: Too often our best intentions are derailed by momentary events and experiences.

How we think, feel, and behave are relative to our states of mind and body. We are not one and the same, because we continually shift states, processing the world very differently from one mode to another...

Brief therapies are effective to the extent that they integrate our selves and help us become more intentional. Cognitive therapies accomplish this by training us to process the world differently. Behavioral therapies unify us by creating novel response patterns to challenging life events. To think and act as we choose: This is the reward of becoming our own therapists...

The fact that we experience continuity in the self and yet can be so fragmented is the source of many of our emotional difficulties--and most of the problems we encounter in trading. Because of our sense of continuity, we identify with the states we are in; each, we think, is a reflection of reality...

Quite simply, the 'me' in us--our sense of who we are--is stronger than our 'I'--our ability to intentionally guide our actions. To the extent we are divided, we do not have a fully free will. We are at the mercy of environments and events and what those trigger in us...

Too often therapy is long term, not because the problems are so severe and intractable but because therapy is occurring while the client is in one state of mind and problems occur in quite another...Brief therapy yields changes in short periods of time because it operates in real time: It works with people in the settings--and in the states--in which problems typically occur...You cannot achieve unity of self unless you work on it while you are fragmented" (p. 193-194).

Self-Help Resources for Traders (Practical Brief Therapy Techniques):

Enhancing Trader Performance:

-- Chapter Eight: Cognitive Techniques for Enhancing Performance
-- Chapter Nine: Behavioral Techniques for Enhancing Performance

The Daily Trading Coach

-- Chapter Five: Psychodynamic Frameworks for Self-Coaching
-- Chapter Six: Cognitive Approaches to Self-Coaching
-- Chapter Seven: Behavioral Approaches to Self-Coaching
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Thoughts on NYSE TICK and Significant Buying and Selling Activity

Recently we've seen speculation that program trading activity, particularly initiated by Goldman Sachs, has been dominating markets and perhaps contributing to recent market volatility. If program trading is indeed expanding and contributing to volatility, we would expect the volatility of the NYSE TICK (which moves higher and lower as baskets of stocks simultaneously uptick and downtick) to be expanding. At least during 2009, my data show that this has not been the case. The standard deviation of $TICK has not been higher lately than earlier during earlier in the year.

Above we see a one-minute chart for the S&P 500 (SPY) and a moving one-day total of minutes in the market when $TICK is greater than +800 (pink line) and when the moving one-day total has been less than -800 (yellow line). This has acted as an interesting overbought/oversold measure: when we've had a notable plurality of buying or selling minutes over a one-day period, we've seen reversals.

Tracking the number of significant buying and selling minutes as a day unfolds has been a very handy way of gauging the general sentiment toward stocks. A relative absence of significant minutes has suggested a more range-bound, less directional environment. A useful adaptation of this notion would be to define significant buying and selling minutes in Market Delta, based on the proportion of relative volume that occurs at the market offer and bid.

Another pattern I've noticed is that the number of significant buying minutes tends to peak ahead of price: as buying dries up late in a rally, we see fewer very high $TICK readings. Note that the most recent rally has occurred with fewer significant buying episodes.
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Leveraged ETFs: Making Volatility More Volatile?

Here we see the five-minute ES futures for Friday, plotted with a 20-period volume-weighted moving average. Note how volume and volatility picked up dramatically around the 13:00 PM hour, with the announcement of bank stress test details. Twice in the day, we saw buying interest peter out at new highs for the day, followed by violent selling and equally herdlike buying. This created volatile oscillation around the VWAP, trapping buyers and sellers alike.

We've been seeing an increasing amount of this herdlike intraday behavior, especially in afternoon stock market trading. This is playing havoc on short-term traders and also longer-term swing traders, who find good positions quickly going bad. There is speculation that leveraged ETFs are contributing to these bandwagon effects, which could ultimately generate 1987-style portfolio insurance-style risks for the market.

Here is the original article that outlines how frequent portfolio rebalancing among leveraged ETFs "magnifies intraday movement". What this suggests is that volatility itself is becoming more volatile as an increasing number of leveraged ETF participants join the market. Today's trade may just be a harbinger of things to come--and adjustments traders need to make.
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Midday Briefing for April 24th

Here we see a Market Delta chart of the morning action in the ES futures. Although we had some early weakness, especially among banking/financial stocks, we never hit significant selling levels in NYSE TICK, as noted in the intraday tweet. At the same time, as we broke above the 4/22 high near 859, we picked up volume at the market offer, as seen in the bottom histogram.

If this breakout is valid and we have shifted to an uptrending environment, we should see a continued positive cumulative TICK and continued net volume in ES at offer vs. bid, as well as a rising VWAP (red line), with the index trading above that VWAP level. Note that, as of this writing, XLF has also caught a bid and is trading above its 4/22 highs.
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Morning Market Briefing for April 24th

As this quickie chart from Big Charts illustrates, we're in a two-week range in the S&P 500 Index (SPY), with the value area (region of most concentrated volume transacted) squarely between 84 and 86. Note that today's pivot is 84.95. The big issue as we start trading today and attempt to test recent highs is whether we can build volume at the upper end of this range and eventually establish a new value region. If not, we'd expect a reversion into the value area above and that 84.95 pivot. Note that, as of my posting this, we're trading near R1, testing the 4/22 highs. How that test fares will set up the day's trade.
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When Price and Volatility Move in Opposite Directions

Here we see the S&P 500 Index (SPY, blue line) versus the 20-day moving average of its daily high-low price range. Note that volatility, as measured by price range, continues to fall as stocks have moved higher and now sit in a multi-day trading range.

What makes breakouts from trading ranges so promising for traders is that they offer opportunities in which both volatility and price are moving directionally. Lately, we've been seeing volatility move opposite to price, which has created stasis.

Recall that the R1/S1, R2/S2, and R3/S3 profit target levels posted each morning via Twitter are based, in part, on the market's recent volatility. As volatility expands along with price, we have very high odds of hitting these target levels. Knowing this can help traders do a better job of riding their winners. Conversely, as volatility has been contracting, more modest profit targets become relevant, such as the overnight and prior day's high and low.
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Tracking Dwindling New Highs and Expanding New Lows in the Stock Market

As we can see from the chart above, the S&P 500 Index (SPY, blue line) is hovering near its recent highs, but the number of NYSE, NASDAQ, and ASE stocks registering fresh 20-day highs minus lows (pink line) has been dwindling. We are seeing an increasing number of sector non-confirmations (one sector makes short-term highs, others do not), and small cap stocks have retreated from their upside leadership.

The 391 new 20-day lows registered on Tuesday was the highest number we've seen since early March; even today's 281 is well above the level seen earlier in the month. I will be watching closely to see if these numbers continue to expand, as this would suggest a more serious correction of the recent market upturn.

We've also seen weaker readings in the Demand/Supply numbers, which track the number of stocks closing above vs. below the volatility envelopes surrounding their short-term moving averages. For example, Demand hit 160 on April 2nd and 137 on April 9th, but peaked at 100 so far this week on Tuesday.

To keep the upturn going, we need to see continued participation across market sectors. I will be scrutinizing any tests of new price highs accompanied by multiple divergences among indexes and sectors. Those interested in tracking these indicators daily will find them posted each morning via Twitter prior to the market open; subscription is free, or you can pick the tweets off on the home page.
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Secondary Anxiety and Trading Performance

A while back I wrote about performance anxiety as the most common emotional issue faced by traders and covered some of the techniques that are most effective in combating performance anxiety. There is, however, another variety of anxiety that affects traders that receives almost no attention. Psychologists call it secondary anxiety.

Let's say a person has a panic attack, an overwhelming experience of anxiety and dread that isn't connected to anything obvious. That panicky feeling may be so frightening that the person develops a fear of the attacks. That is how panic disorder patients often develop agoraphobia: they assume that their attacks are caused by something in their environment, so they avoid going places that (they think) might trigger further attacks.

Similarly, I've worked with students who have suffered from test anxiety, a very common form of performance anxiety. They become so fearful that they'll become anxious during a test that they generate the very fear that they hope to avoid!

When people become anxious about their own anxiety, that is called secondary anxiety. It is a particularly thorny problem, because it sets up a vicious cycle: more anxiety leads to more fears of anxiety leads to further nervousness.

A key element that perpetuates the cycle is avoidance of situations that might trigger anxiety. As long as we try to avoid what we fear, our fears control us. Psychologically, the only cure for anxiety is to directly confront our fears *while we remain under control*. That way, we learn in our experience that threatening situations are manageable.

What happens with traders is that they respond to losses (or threatened losses) with disruptive anxiety, often because they are trading excessive size/risk. As a result, they develop a fear of these disruptions and avoid situations that could lead to repeat incidents. One trader I worked with never increased his size in a way that was commensurate with his skills. He made money, but never as much as he should have. It turns out that this was his way of coping with large, painful losses early in his career. His small size was his way of keeping secondary anxiety at bay; he wasn't simply afraid of losing money, but was also afraid of losing his mind.

Another trader I worked with was so afraid of going on "tilt" that he overanalyzed trading opportunities, often missing good trades. The "tilt" that he feared had its roots in anxiety: losing control over trading, because of losing emotional control.

The approach I've found most helpful for such secondary anxiety is guided imagery, aided by biofeedback. In intensive sessions, I will have traders mentally rehearse scenarios of losing money *while they keep their bodies under control*. Heart rate variability biofeedback has been especially helpful in this regard; the Freeze Framer program that I refer to in this post is now known as emWave and has worked well for me.

The key is to use the biofeedback as a training device to help yourself stay physically calm and collected, even as you visualize the anxiety provoking situations that would normally trigger secondary anxiety. By repeating these situations in your mind again and again until you sustain physical control, you literally train yourself to master your responses, eliminating secondary anxiety by building self-efficacy.

We cannot avoid feelings of nervousness, fear, and anxiety, especially in situations that involve performance under conditions of risk and uncertainty. We can, however, avoid become nervous about our nervousness and fearful of our fear. We will always have emotions while trading; we don't have to be controlled by them.
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Sector Non-Confirmations: Recognizing the False Breakout

A trending move in a market is one in which there is a fundamental revaluation: value that was established in one region shifts to another. If a trend is valid, we should see evidence of that revaluation across the board, not just among certain stocks or sectors.

Here we see the ES futures break out to a new high for the day in the afternoon (top chart), but there is dramatic non-participation in the very important banking sector (middle chart). We also fail to get a confirmation among consumer discretionary shares (bottom chart). Once ES falls back into its morning range, the false breakout becomes clear and we retrace most the morning's gains.

These false breakouts are often quite profitable trades, especially late in the day when trapped traders who don't want to take overnight risk scramble to exit the market. Identifying sector non-confirmations--the occasions in which the rising tide is not lifting all boats--is often the first step in recognizing the failing breakout.
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Catching a Market Transition

If you click on the Market Delta chart for this morning's trade, you'll be able to see how selling pressure (transaction volume at bid) dried up early in the session per the intraday Twitter post. This led buyers to come into the market and first hit the VWAP target (red line on chart), then take out the preopening highs, following the NQ leader. This transitional pattern sets up frequently and on varying time frames.
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Trading on Tilt: Regaining Self Control

Here is a sequence I observe among many active traders:

It begins with uncertainty. The trader isn't sure which way the market is going, but feels the need to make a trade. Instead of sitting back and letting the market show its hand, the trader is leaning forward, hand on mouse, ready to pounce.

The market moves higher by several ticks, as one or more program trades take out a few levels in the ES futures.

The trader now expresses frustration, "I should have bought there." He leans forward even more, hanging on every tick.

The market ticks down, then up. It's a slow market. The trader doesn't see that the recent move up was on minimal volume and that the midday trade is quite narrow. Suddenly the market ticks up one more time and the trader can't take it any more. He lifts the offer with his usual size, afraid of missing the move up.

There is no profit target or stop loss articulated. This is not a trade designed with good risk/reward parameters, because there *are* no parameters. This is a trade designed to minimize the discomfort associated with not being on board for a move.

The market suddenly reverses and retraces its recent gains. Now the trader either has to get out with a loss or hang in there and hope for a reversal. His frustration builds, leading him to continue his overtrading, and making it more likely that he will stick with--and even add to--losing trades.

Our trader is not trading to make money. He is trading to regulate his emotional state. Once he becomes attached to the need to trade and make money--and once his perfectionistic voice of "I should have bought there" enters the picture--he is no longer grounded in markets. It's when those frustrations build over time, becoming self-reinforcing, that traders "go on tilt".

By staying physically relaxed in one's breathing and posture and by mentally rehearsing a mindset in which it is OK to miss moves--there will always be future opportunity--traders can prevent many of these train wrecks. The practice of taking a break during the trading day, reviewing one's state of mind, and clearing one's head is remarkably effective in this regard. Clearly identifying the parameters of one's trade--the optimal size, reasonable targets given market movement, stop loss points that put risk and reward into proper alignment--also ensures that you are controlling your trading, not the reverse.

There are many ways in which the body controls the mind. If you are not physically calm and collected, it will be difficult to make calm, focused trading decisions. By working at observing yourself as you trade, you gain the ability to interrupt destructive sequences and regain control. Ultimately, going on "tilt" is the result of a loss of self-awareness. Once you remember yourself, you'll be able to access your skills and knowledge.

RELEVANT POST:

Trading Scared and Scarred

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Late Day Volume Surges: One Way to End Your Trading Day Profitably

Hats off to this post from Daily Options Report on how the leveraged ETFs are affecting the last hour of trading in the stock market.

If you go back to my post on relative volume, you'll see that average volume is actually highest at the end of the trading day, not the beginning, as it once was. Market Tells makes the excellent point that this dynamic may be contributing to increased intraday herding behavior.

A closer look at my relative volume post shows that the standard deviation of volume is also significantly higher late in the day than early on. That means that we're more likely to see volume extremes (and hence volatility extremes) late in the trading day. This has important implications for late day trending and reversal moves. Catching those late day volume surges might lead to very good trades to finish your day.
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Identifying Overhead Supply in the Stock Market

Here is a recent snapshot of my trading screen. If you click on the chart, you'll see how large volume entered the market around 830 in the ES, as buyers brought in fresh sellers putting the market in balance. That is why I tweeted that this established 830 as a near term resistance area. For very short term traders, these volume surges are often good points to take profits or even fade moves, as they suggest that buyers and those covering shorts are meeting overhead supply.
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Relative Volume for ES Futures

Recent posts have emphasized the relationship between volume and volatility (and between VIX and volatility) as key to anticipating trading movement and opportunity. The specific tool that I've found most helpful in anticipating intraday movement is what I call relative volume: the comparison of volume at a certain time of day with the median volume for that time of day. When relative volume is above average, we can expect good movement in the ES futures; when we have below average volume, trade is often narrow and range bound.

Below are the half-hour periods of the regular trading day, the median volumes in ES for 2009, and the standard deviations for each of those. I've found these norms to be quite helpful in identifying when volume is picking up and slowing down, which alerts me to whether markets are facilitating trade at particular key price levels. All times are Central Time US:

8:30 AM - 242,978 (55,247)
9:00 AM - 208,202 (50,743)
9:30 AM - 173,246 (43,980)
10:00 AM - 142, 250 (53,507)
10:30 AM - 117,904 (46,620)
11:00 AM - 104,093 (36,316)
11:30 AM - 97,808 (32,632)
12 Noon - 108,429 (36,057)
12:30 PM - 113,074 (41,832)
13:00 PM - 133,750 (60,438)
13:30 PM - 147,448 (60,432)
14:00 PM - 180,139 (53,454)
14:30 PM - 264,140 (84,050)
15:00 PM (15 minute period) - 112,686 (31,815)

Please note that I will continue to use Twitter to update how we're trading relative to these norms (free subscription here). The last five tweets always appear on the blog page.
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Another Look at Intraday Volume and Volatility

For this investigation of the relationship between volume and volatility, I updated my look at 30-minute high-low ranges in the ES futures as a function of their 30-minute volume. The data cover all full trading days in 2009. Below we can see the group numbers, the average 30-minute ranges, and the corresponding volume levels:

One 0.508 <100,000
Two 0.634 100-125K
Three 0.729 125-150K
Four 0.827 150K-175K
Five 0.893 175K-200K
Six 1.002 200K-250K
Seven 1.351 > 250K

When 30-minute volume was under 100,000 contracts traded (Group One), the average high-low range in ES was .51%. By Group Four (between 150,000 and 175,000 contracts traded), the average 30-minute range was .83%. When we've had 30-minute volume above 250,000 contracts (Group Seven), the average range has been 1.35%.

Once again we see that volume and volatility are closely intertwined: there is more movement when large traders are participating in markets. Understanding how current volume compares with average volume for that particular time of day is essential in gauging how much you can take out of trades.

Tomorrow I will update 2009 relative volume norms (expectable volume for each time of day) on the blog to help you read when markets are average, slow, and busy.
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When Market Indicators Are In Sync

Here is a snapshot of my Market Delta screen as of a few minutes ago. Once large volume started hitting bids as we came to the bottom of the opening range in ES (850 and below) and then continued hitting bids as we came down, it became clear that lower prices were attracting the participation of large traders (see red vs. green in the bottom histogram). This set up a profitable trade down to S3, per the intraday Twitter posts. I've found that the best trending moves have come when NYSE TICK and cumulative Market Delta are in sync.
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Indicator Update for April 20th

Last week's indicator review suggested that "the market is strong on an intermediate-term basis and gaining strength over time". We did indeed see further strength during this past week, taking stocks to new recovery highs. A look at the sectors, however, as well as at selected indicators, suggests that the pace of the rally has been slowing. That, in itself, does not necessarily mean that we're in for a fresh bear market leg, but it does raise the possibility that the rise of six consecutive weeks may take a breather.

We continue in an overbought mode in the Cumulative Demand/Supply Index (top chart), with prices moving steadily higher throughout. To get a normal pullback in this indicator, we would most likely need to take out this past week's lows. Such a pullback would also take the 20-day highs minus lows, which has also sustained strength (second chart from top) toward zero. If this is a fresh bull market, such a pullback should be an opportunity to buy stocks. If we are to see another bear leg, such a correction would begin a topping process, with waning momentum and participation as we test old highs.

At this juncture, we're seeing steady strength in the Cumulative NYSE TICK (second chart from bottom), suggesting that buyers have remained dominant. As the bottom chart from Decision Point illustrates, this strength is also reflected in the rising advance-decline line, which hit new recovery highs this past week. Along with the new 65-day highs, which hit a fresh peak last week, we're not seeing the kinds of divergences in these indicators that would lead us to believe that a fresh bear market is around the corner.

I will be tracking many of these indicators daily via the morning Twitter posts to update market views. Subscription is free; the last five tweets appear on the blog page.
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VIX and Average Daily Volatility in the Stock Market

I recently emphasized the importance of tracking shifts in volume and volatility within and across markets, as these help determine the amount of movement traders are likely to experience. In this post, we look at volatility in the stock market (daily trading range, SPY) as a function of option premiums (VIX).

I went back to 1990 and broke the market down into six VIX categories:

Group One: VIX < 15 (N = 1501)
Group Two: VIX = 15 - 19.99 (N = 1315)
Group Three: VIX = 20 - 24.99 (N = 1091)
Group Four: VIX = 25 - 29.99 (N = 507)
Group Five: VIX = 30 - 39.99 (N = 288)
Group Six: VIX > 40 (N = 154)

What we see is that the average daily range is closely related to VIX levels, such that we see about three times the volatility in Group Four as in Group One. Note the sharp difference between groups Five and Six, which illustrates how extreme the recent markets have been--and how much volatility has dropped off as we've moved from a VIX approaching 80 to one below 35.

(Also note the N size associated with each VIX group. It shows us how historically unusual the recent markets have been).

I would argue that, by knowing the current VIX level and whether volume for the current day is running above or below average, we can make very reasonable estimates of the likely volatility for the unfolding trading day. This has real implications for how much we can expect to take out of trades, where we should place stops, and how we should size positions for prudent risk taking.

RELEVANT POST:

Anticipating Volatility for the Trading Day

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When the Body Controls the Mind

Thanks to readers for their interest in The Daily Trading Coach. It seems as though the book, with its 101 short, practical trading "lessons", has struck a chord with traders and portfolio managers looking to improve their performance. As I write, the book is sitting near #1000 on the Amazon list, unusual for a niche trading text.

One aspect of the book that is unusual is the inclusion of a dedicated email address that readers can use to ask me questions about applying the techniques. A number of traders have taken advantage of that feature, and I'm happy to offer them tips on customizing the ideas and getting the most from them.

A theme that the book tackles is how what goes on in the body affects the mind. Indeed, many times traders use their bodies to gain control of emotional turmoil, only to lose control in a more profound way. The following segment comes from Lesson 47:

"...defenses are coping strategies that protect us from the emotional pain of past conflicts. One of the most basic defenses is repression: keeping thoughts, feelings, and memories out of conscious awareness so that they cannot trouble us. The problem with repression, of course, is that a conflict repressed is a conflict that remains unresolved. We can't overcome something if we remain unaware of its presence. Many traders use their bodies to repress their minds: their physical tension binds them, restricting the physical and emotional expression of feelings. I've met traders who were quite tight physically and yet who had no insight into the degree and nature of their emotional stresses. In an odd way, getting tense was their way of coping: they were always mobilized for danger, tightly keeping themselves in control. It is difficult to stay in touch with the subtle cues of trading hunches--the implicit knowledge we derive from years of pattern recognition--when our bodies are screaming with tension and even pain" (p. 151).

This is part of a much larger problem that impacts traders: when our modes of coping interfere with our day-to-day performance. One of the most important functions I perform when coaching traders is simply watching them when they trade and helping them stay loose mentally and physically. It's amazing how flexible we can be mentally when our bodies are not filled with tension.

Free Chapter From The Daily Trading Coach

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Comparing the Technical Strength of Sectors

At a reader's suggestion, I have compiled the last five week's data on Technical Strength for eight S&P 500 sectors and displayed them above. This gives us a quick visual look at which sectors are strongest and weakest and which are gaining and losing strength.

Technical Strength is the name that I gave to a proprietary indicator that measures short-term trending behavior. Basically, a stock, sector, or index can be said to be trending if it has a high ratio of directional movement to total movement. The Strength readings for each sector vary from +500 (strong uptrend) to -500 (strong downtrend). Readings between -100 and +100 suggest no significant trending.

Each morning before the market open, I post to Twitter the Technical Strength status of the 40 stocks in my basket (five of the most highly weighted issues in each of the above eight sectors). This is a great way of staying on top of the market's day-to-day shifts in trending behavior.

Notice that almost all of the bars are above zero. Right away that tells you that we've been in an intermediate-term uptrend. That might seem obvious, but you'd be surprised how many people have been emailing me for the last several weeks, telling me that the rally is phony, that it's about to turn, that it's not grounded in fundamentals, etc. Perhaps that will prove to be worthwhile investment advice. It is worse than worthless as trading guidance.

When the great majority of stocks are moving in sync, that's not usually when markets sustain a turnaround. Rather, prior to important reversals, we see rallies peter out, with fewer stocks registering fresh new highs and fewer stocks and sectors sustaining their Technical Strength. Lately, we've seen strength in the Materials sector (note the rising Technical Strength week over week, above) and among the Financial stocks. The Materials shares are reflecting growth themes, especially among emerging economies. The Financial stocks are reflecting growing optimism regarding bank recapitalization. It is difficult to sustain the downside when these themes are dominant.

That having been said, look at the last two column bars for each of the sectors. Some of the sectors gained Technical Strength on the week, others lost a bit. This kind of mixed performance while the overall S&P 500 Index is making new highs suggests that the rising tide is not lifting all ships equally. I am watching this carefully, as such slowing down of strength is what we'd expect to see prior to a market consolidation (See the recent indicator post for further evidence of a slowdown in market strength).

Finally, watch that XLY to XLP ratio; it's a nice indicator of growth interest vs. defensiveness among stock traders. It pulled back last week, as the chart indicates; we also pulled back in XLF, which strongly reflects banking stock interest. Those themes will be front and center as we start next week's trade.
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Sector Update for April 18th

Last week's sector review noted, "As long as pro-risk themes are dominating and the majority of sectors are displaying Technical Strength, it is premature to fade this rally for anything more than a short-term trade." Those themes did continue to hold sway this past week, as stocks added to their gains.

A look at Technical Strength for the eight S&P 500 sectors that I track each week continues to find trend strength across a variety of sectors. Recall that Technical Strength is a measure of short-term trending, varying from +500 (strong uptrend) to -500 (strong downtrend). Values between -100 and +100 suggest no significant directional movement.

MATERIALS: +440
INDUSTRIAL: +380
CONSUMER DISCRETIONARY: +380
CONSUMER STAPLES: +240
ENERGY: +60
HEALTH CARE: +100
FINANCIAL: +400
TECHNOLOGY: +320

Once again, the more defensive health care and consumer staples sectors , along with energy, are weaker than the materials, financial, industrial, and technology groups. Overall, however, sectors remain in a bullish mode, though we do see some evidence of a slowing of the uptrend among market indicators and in some moderate rotation in the above groups. As before, I would want to see some evidence of a shift in the themes of the last two weeks before taking an outright bearish stance on this market.
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Integrating Indicators for a Multifaceted Market View

As the stock market (SPY, blue line) has moved higher, we've seen a steady expansion of new 65-day highs vs. lows (top chart), even as 20-day highs minus lows have leveled off at high levels (middle chart). That tells us that a large, but not expanding number of shares are making shorter-term new highs, but--among that group--an increasing number is registering fresh longer-term highs. It's when we stop expanding the new high/low balance at both time frames, as happened early in March, that we're most likely to see trend reversals of note.

Meanwhile, we can see a more sensitive indicator, Demand minus Supply (bottom chart). This is an index of the number of stocks closing above vs. below the volatility envelopes surrounding their short-term moving averages. This captures momentum quite nicely; it's common to see downside momentum trough ahead of price (as happened prior to the early March bottom), and now we're seeing that upside momentum has peaked ahead of price.

When we put the indicators together rather than view them in isolation, we develop a more nuanced picture of a strong market that is slowing down. That's part of the structural view of markets noted earlier. The above indicators are part of the morning Twitter posts that are part of my market preparation for the day; subscription to the Twitter feed is free, and the most recent tweets appear on the blog site.

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The light never goes out.

Tracking Growth/Recovery Themes Across Markets

As the U.S. dollar has rallied against the euro (bottom chart), we see firmness in 10-year Treasury rates (second chart from bottom), buying of high yield bonds (middle chart), buying of municipal bonds (second chart from top), and buying of stocks (top chart).

It's a nice example of how intermarket themes dominate markets in a global economy. This week's theme has been one of anticipated economic recovery and growth.
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