Sunday, May 31, 2009

Trading Psychology Posts For Russian Language Traders

My deepest appreciation goes out to Denis Popov, author of the My Ideal Trade blog, who has translated a number of TraderFeed posts into Russian.

I welcome other translations of my posts and will gladly feature them on this site. Please send URLs to the email address listed in the section of the blog at right "About Me".

My hope is that this can help build dialogues among traders across the world.

Many thanks,


Sector Update for May 31st

Last week's sector update concluded that most of the eight S&P sectors that I track weekly were lodged in a multi-week trading range, with neutral Technical Strength. With Friday's late rally, we returned toward the high end of the month-long trading range, and many of the sectors displayed a resumption of their bullish trend.

Recall that Technical Strength for each of the sectors varies between +500 (strong uptrend) and -500 (strong downtrend), with values between -100 and +100 suggesting no significant trend. Here's how the sectors shaped up after Friday's close:

ENERGY: +360

We can see that, with the surge in commodity prices--particularly oil--energy stocks were quite strong on the week, with significant week-over-week strength among materials and technology shares as well. As I noted recently, consumer discretionary and financial shares are lagging to some degree and have yet to better their early May highs.

Indeed, most of the sectors showed greater strength during the week of May 8th than most recently; how we follow through on Friday's strength early this coming week will tell us a great deal as to whether we're on the threshold of a new bull leg or setting up unconfirmed new highs that will be at risk of reversal.

I will be paying particular attention to new 20-day highs vs. lows, and will be posting those to Twitter before each market open (follow here). We should see significant expansion of new highs if this is going to bring a new bull leg; absent that expansion--and we haven't seen it yet--I will continue to treat this as a wide range market defined by the highs and lows of the past several weeks.

Free Webcast of Next Week's Presentation at the L.A. Traders Expo

Quite a few readers have expressed interest in the presentation I'll be giving to the Traders Expo in Los Angeles this Saturday, June 6th. The talk will be on the topic: "Coaching Yourself for Trading Success: Best Practices", and it will be held 8 AM - 9 AM Pacific Time at the Pasadena Convention Center.

I'm pleased to announce that the session will be webcast live (and free!) for those who register but cannot attend in person. I also suspect that the webcast will be archived and made available for those who--for reasons of time zone, etc.--cannot participate in the live broadcast. More on that as information becomes available.

And for those who will be there in L.A., I'll be getting together with blog readers after the talk for a little informal coaching. I look forward to meeting new friends!

I would be remiss if I didn't mention that several fine bloggers will be participating at the Expo. Check out the sessions for Brian Shannon, Corey Rosenbloom, and John Forman.

Thanks for the interest; hope to see you there!


Saturday, May 30, 2009

Weekend Briefing

* A sobering look at the debt problem and continued prospects for housing foreclosures;

* Still demand for Treasuries, but purchases of Agencies and asset backed securities have "fallen off a cliff";

* Cargo data yet to show a bottom;

* Here is an excellent set of readings with an international, macro perspective; great site;

* Misperceptions of economic growth and more good readings for a Saturday;

* A look at deflation in the eurozone;

* Preferred stocks are on a tear and more good reading;

* Traffic on the blog is up 40% in the last three months and has doubled since May, 2008. With increased traffic comes increased email, and for the first time ever, it's reached a level where it is physically impossible for me to keep up with it. I apologize for the dilemma. As promised, I will still take questions about trading and psychology to those who write to me at the dedicated email address at the end of the Trading Coach book. Thanks for your understanding.

Three Uses of Biofeedback for Traders

A reader recently asked me to post on the topic of biofeedback. It's a topic that I have touched upon as a "best practice" in trading. My interest in biofeedback began with work that I conducted in Syracuse in hemoencephalography and continues to this day with heart rate variability feedback to help traders stay "in the zone".

As I stress in the Trading Coach book, "Biofeedback is a tool for training yourself to control the arousal level of mind and body." The basic idea is not unlike that of meditation: physiological self-control is a gateway to emotional self-control. That is, if you can control the body, you gain significant control over mind. It is difficult to be emotionally worked up if you are cognitively focused and physically relaxed.

The three most common applications of biofeedback for traders in my work are:

1) Relaxation - Traders will take breaks during the trading day and use the biofeedback to achieve and sustain reduced levels of arousal (reduced heart rate, lower galvanic skin response, etc.). This can be a very effective way to break patterns of frustration and overtrading.

2) Building Concentration - To stay in the zone with respect to heart rate variability readings, it is necessary to not only sustain relaxation, but also to remain focused. It is that state of calm focus, maintained over time, that produces the rhythmical HRV patterns displayed by the biofeedback software. In this sense, the biofeedback sessions are a kind of cognitive exercise routine, in which people build their capacity to sustain focus over time.

3) Behavioral Exposure Work - I deal with exposure techniques extensively in the Trader Performance book, as well as the Trading Coach text. The idea of exposure is that you can mentally rehearse problem patterns while sustaining a state of focused concentration, thereby reprogramming those patterns. The biofeedback helps people rehearse threatening trading situations *while they control their stress levels*, thereby enhancing self-control.

Perhaps the greatest benefit of biofeedback, however, is the most subtle. As I point out in the latest book, "Access to intuition requires a still mind." By learning to clear our mind and sustain a high level of focus, we become more attuned to the cues from implicit learning that lead to our best trades.

Was Friday's Late Rally the Start of Something Big?

I received quite a few emails asking my opinion about Friday's late surge in the stock market averages, which saw SPY touch a post-crash bull high before pulling back slightly below its prior high of 5/8/09.

The long and short of it is that I don't see good leadership in the recent strength. For example, Friday's market registered 1401 new 20-day highs against 351 new lows across the NYSE, NASDAQ, and ASE. That compares with 2862 new 20-day highs and 224 lows on May 4th and 2199 highs and 245 lows at the closing price high of May 8th. At least for now, fewer stocks appear to be participating in the strength.

The chart above may help to explain why. I've charted the relative performance of three key sectors--financial stocks (XLF), homebuilding stocks (XHB), and consumer discretionary stocks (XLY)--and plotted that from the May 8th price high to Friday's close. What we can see is that, throughout most of May, these sectors have underperformed the S&P 500 Index (SPY).

Conversely, the more defensive health care (XLV) and consumer staples (XLP) sectors have outperformed SPY since that time.

It seems to me that if the market is discounting a lasting recovery, we should see continued leadership from the beaten down financial, homebuilding, and consumer discretionary shares. Stated another way, it is difficult to imagine a sustained bull market in which we don't see optimism expressed toward banks, housing, and the consumer.

An opinion contrary to the late Friday exuberance is that, with the falling dollar and rising Treasury/mortgage rates, not to mention the prospect of reflation/inflation, the stock market is beginning to see greater leadership from defensive sectors than from growth-oriented ones.

Friday's rally may be the start of a big upside breakout; if so, the indicators that I track weekly on the blog and daily via Twitter should capture the expanded momentum and participation on any follow through next week. For now, however, I remain agnostic.

Friday, May 29, 2009

Commodities, the U.S. Dollar, and Reflation

We tend to forget that every trade is a pairs trade. It's just that we tend to keep the denominator constant, in local currency. The fact remains, however, that an asset class can rise either because it is strong against all currencies, because the local currency is weak, or both. Lately, commodities have been hitting new highs (top chart; DBC) as the bullish U.S. dollar index ETF (UUP; bottom chart) has been hitting new lows. Reflation seems to be the theme of the moment; I am closely tracking its impact upon interest rates and stocks.

When Participation is Weak During a Market Rise

Although the S&P 500 e-mini index (ES) moved above its open around 9:20 CT, a solid majority of the ES stocks in my basket (five highly weighted issues for each of eight sectors) were trading below their open, as noted in the intraday Twitter comments. That suggested that only a minority of stocks and sectors were contributing to the strength. Fading such moves is often the best short-term strategy, as the lack of participation generally fails to bring fresh buying into the market.

Why Do We Keep Making the Same Mistakes in Trading?

A reader asks:

How can a person avoid repeating the same mistakes again and again, in spite of planning not to do before trading? Like for example I decide I am not good at picking tops/bottoms and so I wont try to do that, but as soon soon as I am in front of the screen and happen to see a pattern emerging, then I don't wait for confirmation of trend reversal and I take a position anticipating a bottom or top.

The key is recognizing that the behavior you're seeing as a problem is actually a coping response to a threat that you're probably not acknowledging.

For instance, if missing a market move feels like a threat to you and would trigger self-blame and frustration, it will be natural to cope with that threat by trying to avoid missing a move. By entering the trade early and trying to pick tops and bottoms, you are actually managing your emotions rather than your trade idea.

Many repetitive, bad trading practices are the result of a trader's difficulty coming to terms with the inevitability of losing and the fear of the mood swings that losing can bring. To change that mindset, it is helpful to turn losing trades into learning experiences: focus on what you've learned about yourself, your trading, or the market when a trade loses money. Journaling can be an excellent medium for working on that mindset shift.

Markets Focused on U.S. Debt

As investors flee U.S. Treasuries and 10-year rates rise, we're seeing this morning breakout weakness in the U.S. dollar vs. the euro (top chart) and continued strength in gold (middle chart) and oil (bottom chart). Markets appear to be focused on the debt levels accumulating in the U.S., and they are expressing their lack of confidence in the greenback. It's difficult to imagine that rising rates and a shrinking dollar create an environment favorable for the long-term holding of U.S. equities.

Thursday, May 28, 2009

Interlude: Dr. Brett's Favorite Keyboard Cat Videos

In case anyone had the mistaken impression that I am a mature professional, here are my five favorite Keyboard Cat videos:

* Pinky doesn't exactly find a home;

* Jonathan gives his classic reply to a reporter's question;

* "It's very safe to operate"

* "Shit flyin' in my mouth...Gotta get out of this country..."

* Sometimes beauty really is skin deep.

Making Sense of the Current Stock Market

Here we see a compressed 60-minute chart of the S&P 500 e-mini (ES) futures. That market is itself compressing, as we've been seeing lower highs and higher lows for much of the month. That has kept us in a range bound mode across many of the S&P sectors. I notice that today we registered 835 new 20-day highs across the NYSE, NASDAQ, and ASE, against 474 lows. That's a far cry from the 2862 20-day highs and 224 lows recorded on May 4th.

Should we see new price highs among the large cap indexes in the days to come, there is a good likelihood that those highs will not be confirmed by commensurate strength among the individual stocks and sectors. Until we see evidence of broad market strength, I am treating the current price action as part of a larger topping process and leaning toward fading all moves as long as we remain in the range environment.

Identifying a Short-Term Market Transition

Per the recent Twitter post, note how the test of the ES morning lows above was accompanied by reduced volume (blue arrow) and non-confirmations from the Russell and NASDAQ indexes, as well as many sectors (such as financial stocks). We also saw a nice non-confirmation by the NYSE TICK, as the -1000 area readings could not force the market lower. That led to short covering and then increased buying. Readers will recognize this as the "transition pattern" that I've emphasized in recent posts.

View of a Morning Reversal

With Treasury rates backing up once again, we've seen a major reversal in stocks, with Consumer Discretionary shares (XLY; bottom chart) leading the downside. As noted yesterday, this is a paradigm shift; where rising rates had been a healthy sign of risk appetite earlier (exiting Treasuries, buying riskier assets), now those soaring rates are viewed as a threat to the consumer and the prospects for economic recovery, not least because of their threat to housing (XHB; top chart).


Thursday Morning Briefing

* Watching the banking sector here (above), as we stand right at multi-week support. Banks were among the sectors leading yesterday's weakness.

* Thanks to an alert reader for pointing out
this analysis of the banks and their relationship to the government;

* Demand and supply in the bond market;

* Evidence that we've seen the worst in the credit crisis;

* What we can expect when the semiconductor sector is strong;

* Hidden correlations in ETF returns and other good reading;

* 10 most popular stocks among hedge funds and lots more;

* What the pundits are saying; excellent blog site;

* Posts on trading techniques and setups.

Wednesday, May 27, 2009

How Do I Handle the Mood Swings of Trading?

A reader asks the question:

"How do I avoid the inevitable mood swing when a couple of trades go bad? For a few days in March I was afraid to get back on the horse and had to tell myself to jump back on/trade as the only way to get over it."

My response is that you'll *always* have situations in which "a couple of trades go bad". If you average 55% winning trades, you'll have two consecutive losers about 20% of the time. For the active trader, that means that "a couple of trades go bad" occurs every week, if not daily.

Mood swings when trades go bad are *not* inevitable. The professional trader *plans* to be wrong and manages positions accordingly. That trader knows that you can trade well and still have a couple of trades go bad. Embracing risk and uncertainty, the successful trader limits losses by controlling position sizes and establishing loss limits (per trade, per day).

The good trade gone bad often provides a trader with valuable information--if the trader is open to the message. Today I worked with a trader who tried to buy the market in the afternoon, only to get stopped out. Shortly after, he noticed weakness in the 10-year Treasury notes and reversed his position. By day's end, he was profitable by a healthy six figure sum. The "bad trade" offered opportunity, not threat.

If you do experience mood swings around losing trades, it's probably because you are evaluating yourself by the criterion of being right--not by the criterion of trading well. It isn't the losing trade making you feel bad; it's the perfectionistic expectation that you should always be right. By embracing uncertainty and staying open to learning from it, the threat of losing can turn into the opportunity of rethinking market assumptions.

Catalyst for a Stock Market Break

Often it takes a catalyst to move a market out of a trading range. Following the recent Twitter post, note how we moved sharply lower in the ES futures (bottom chart) as yields backed up in 10-year Treasuries.

This represents an important paradigm shift. When we had the recent market weakness, Treasuries were viewed as a safe haven and saw buying when stocks sold off. Now falling Treasuries and rising interest rates are viewed as a potential threat to economic recovery, weighing on stocks.

Six Ways to Identify a Range Market

Thus far this morning, we've seen a classic range bound trade. Here are the things we look for in identifying a range day:

* Price oscillating around the open and/or the volume-weighted average price (red line);

* NYSE TICK oscillating around the zero line;

* Relative balance between volume transacted at the market bid vs. offer (bottom histogram);

* Mixed performance of stocks from their open (as noted in Twitter posts);

* Mixed behavior of market sectors from their open;

* Muted relative volume (i.e., lower than average volume traded).

When I see a narrow overnight range, I like to assume range behavior into the market open unless the market shows me otherwise. Staying patient during a range trade can lead to nice "reversion" trades at the range extremes, but can also help traders remain vigilant for the eventual breakout trade.

Is the Supplemental Liquidity Provider (SLP) Program Affecting Trade in the Stock Market?

This post is going to require a bit of background reading. First, recall the post on the increased frequency of herding days in the stock market. Also for review is the post that highlights the NYSE TICK as a measure of institutional sentiment. The Zero Hedge blog noted the shift in the NYSE TICK late yesterday and attributed the earlier buying strength to algorithmic trading, specifically the program trading associated with the NYSE's Supplemental Liquidity Provider program (SLP), much of which can be attributed to Goldman Sachs. More on SLP can be found here.

I think Zero Hedge is on to something, but I suspect there's more to the story than the directionality of TICK values. If the distribution of TICK values is elevated over time, it means that programs are being executed with an upward directional bias. SLP is supposedly a non-directional market making program; if it were actually run in that manner, it should not persistently elevate or depress TICK, since the market making would be a two-sided trade.

However, if market making programs were unusually influential in the marketplace, we should expect to see a higher standard deviation of TICK values. That is, more baskets executed should yield a wider variability in one-minute ranges of TICK readings. Those tracking TICK should see a large number of elevated TICK readings alongside a large number of depressed readings, as the liquidity provider(s) operate on both sides of the market executing their basket trades.

Recently, this increased variability of TICK readings (along with elevated volume in the ES contract) is exactly what we've been seeing during late day trade. The above chart provides an example from yesterday's trade, with a moving 20-minute standard deviation of one-minute high-low-close NYSE TICK readings. Notice how we get more programs executed as the session moves toward the New York close. Unlike the readings from earlier in the day, which were skewed positively, the late day readings featured many extreme one-minute readings on the buy and sell side--precisely what you'd expect if market makers were active in program trading.

A quick disclaimer: I am a psychologist who works with hedge fund portfolio managers, bank traders on proprietary desks, and proprietary trading firms; I make no claim to expertise when it comes to the microstructure of the market. Nor do I possess the macro perspectives of my club fighting colleague from Zero Hedge. What I can tell you, as one who trades and works with active intraday traders (including several that account for a meaningful percentage of total volume in the CME S&P 500 (ES) e-mini contract), is that the late day trade has changed recently and those changes have directly affected active market participants. Those changes include increased herding behavior (a historically unusual number of days skewed toward buying or selling) and increased market volume and volatility during the last hour of trading.

My sense, from the data above and my observations of the market, is that program trading has been affecting this market, but the impact appears to be particularly concentrated late in the trading day. If SLP were providing supplemental liquidity throughout the day, one would expect a general elevation of the TICK standard deviation compared with, say, a year ago. My analysis of historical data suggests that that has not occurred. Rather, it appears that liquidity providers are exploiting anomalies that occur toward the end of the day. I suspect these anomalies are related to three factors:

* Increased participation of proprietary (directional) traders who typically cover their positions by the market close;

* Increased intraday management of positions and portfolios by portfolio managers hesitant to hold overnight risk, given the diminished risk appetites of investors;

* Portfolio rebalancing among increasingly popular leveraged index ETFs, which may amplify existing directional moves.

Given the concentration of this program activity in the last hour, a skeptic might be led to conclude that this trading is more designed to aid the liquidity of participating trading firms than the liquidity of the marketplace. There is nothing wrong with this--unless the activity is funded in part or whole by a stock exchange working in conjunction with financial institutions backstopped by the government, creating a less than level playing field for independent traders and investors.

Tuesday, May 26, 2009

Making the Most of Your Trading Weaknesses

Thanks to the Wall St. Cheat Sheet site for posting personal anecdotes based upon the lessons in the new Daily Trading Coach book.

Here is their take of Lesson Three, which involves making friends with one's weaknesses.

If you are going to coach yourself for success, you have to embrace your shortcomings and view them--not as threats--but as opportunities for growth.

If you are threatened by your weaknesses, you'll tend to avoid thinking about them. That's a great way to ensure a lack of professional development.

If, however, you look at each weakness as a personal challenge to overcome and an opportunity to become more than you are, you will sustain the optimism and motivation to extend your learning curve.

A Quick Look at Strong Buying Pressure

I've talked with several traders who were trying to sell the market this morning, only to lose money. Here is where it's important to track the distribution of the NYSE TICK. You can see that, all day, the moving average of TICK (blue line) has stayed above the zero line (black). As I stressed in the intraday Twitter posts, we had no TICK readings below -600 all day into the early afternoon. What that tells you is that institutions are not actively executing sell programs, so that large numbers of shares are not downticking at the same time. Until that dynamic changes, it is difficult to sell such a strong market for more than a scalp trade.

Indicator Update for May 26th

Last week's indicator review found that we stood in a wide trading range defined by the month's highs and lows. With strength early this past week and weakness following, that situation has continued. We continue to trace lower highs and lower lows in the Cumulative Demand/Supply Index (top chart), suggesting that fewer stocks over time are displaying significant upside momentum. New 65-day highs have also tailed off on market bounces, indicating less participation to the upside (second chart from top). Sectors, meanwhile, remain in a range bound mode for the most part.

The Cumulative TICK (second chart from bottom) has leveled off, but is not in a downtrending mode. Interestingly, we did not make lower lows in the advance-decline line specific to NYSE common stocks last week, but did make lower lows in the A/D line for small caps, as the chart from the excellent Decision Point service indicates. I will be watching the small caps closely along with Cumulative TICK, as I suspect they will point the way toward either a resumption of the wide range trade this week or a breakout to the downside.

In the large picture, we are experiencing resistance at the early 2009 highs and could view all of the present action as within a range defined by the 2009 highs and lows. Should we expand new 20-day lows beyond the levels seen in the last two weeks (roughly 600 across the NYSE, NASDAQ, and ASE), I would view this as an intermediate term correction and the start of a possible move back into the broad range defined by those 2009 highs and lows. Until that time, however, I continue to view us as within the May range, leaning toward fading range extremes unless expanding new lows and collapsing NYSE TICK tell us otherwise.

Short-Term Trends In The Stock Market Are Not Your Friends

I thought I'd quickly follow up on the "Why Short-Term Traders Lose Money" post that I recently linked via Twitter.

Data come from the excellent Barchart site: We're looking at the S&P 500 Index (SPY) going back to late 2003. Our system buys SPY if it closes above the two standard deviation Bollinger Band surrounding the 20-day moving average. The system sells SPY if it closes below that band. We exit the trade once the average moves back within the envelope defined by the upper and lower bands.

The logic of the system is that we wait for a significant trend--one that is a two or greater standard deviation move away from an average price--and then jump on board.

The average holding time per trade is 3 days. The system gave us 105 trades since late 2003. Of these trades, 70 were long and 35 were short.

Of the 70 long trades, 25 were profitable and 45 were unprofitable. Of the 35 short trades, 14 were profitable, 20 were unprofitable, and 1 was scratched. In all, the system gave us 39 winners out of 105 trades--about a 40% winning percentage. The gross P/L for the system (not including commissions or slippage) was -39.70 points, or almost 400 ES points. This is because the average size of the losing trades was larger than the average size of the winners.

I in no way suggest that this is an indictment of Bollinger Bands. On the contrary, they appear to be a decent starting point for a winning system if one trades against the trend. Rather, the lesson is that once a trend becomes "significant", it is already long in the tooth. If we simply follow human nature and extrapolate the recent past into the present, we will be well on our way toward losing money consistently.

Monday, May 25, 2009

Sector Update for May 25th

Last week's sector review found that the majority of S&P 500 sectors that I track for Technical Strength (a quantitative measure of short-term trending) were in a neutral mode, with a wide multi-week trading range. After early strength in the week, we fell back into that range, closing the week near the range lows.

As we can see above, five of the eight sectors are firmly lodged in neutral trending mode, with relative strength among the defensive health care stocks and weakness among the more growth-oriented technology issues. Here is how it broke down as of Friday's close:


Recall that Technical Strength varies from +500 (strong uptrend) to -500 (strong downtrend), with scores between -100 and +100 suggesting no significant directional tendency. The recent consolidation range has extended for most of this month and should eventually lead to a significant breakout move. Tracking the themes that are dominating the current market as well as the basket of stocks drawn evenly from the sectors will help us catch that move when it occurs. Meanwhile, fading the range extremes if we do not get an expansion of new 20-day highs/lows and Demand/Supply readings is the operative strategy.

Traders interested in tracking the 20-day highs/lows, trend behavior of the basket of stocks, and Demand/Supply readings will find these posted before the market open each day via Twitter (follow the stream of tweets here).

Topics for the Proposed Chicago Trading Potluck

Earlier I proposed a summer coaching seminar in Chicago with a potluck format: each participant would bring one unique, worthwhile trading idea. At present, I'm working with Trevor Harnett of Market Delta to secure a meeting room at one of the Chicago exchanges. I'll post details to this blog as they become available, including possible dates.

Some topics that I plan to touch on include:

* Calculating and using pivot-derived profit targets for intraday trading;

* Advanced strategies for reading shifting short-term market sentiment;

* Psychological "best practices" utilized by professional traders.

I suspect that, if each attendee brings one good, practical trading idea, everyone will gain far more in content (and professional networking) than is typically accomplished at the most expensive seminars.

Thanks to all who have expressed interest. More to come shortly--


Fighting the Isolation of Trading

A reader poses an excellent question:

What ideas do you have to help traders fight the isolation of trading alone with few outside contacts to discuss this style of making money? Most people are not very interested in discussing. Twitter is okay for news, but to share ideas it is just so so.

I addressed an important aspect of this issue in my post on virtual trading groups a while back; I also tackle this topic in the Trading Coach book. There is no question in my mind that, if I were to start trading full-time--knowing what I know now--I would either join a proprietary trading firm or would form my own "virtual trading group" by connecting online (and in real time) with a handful of like-minded traders.

Frankly, there is no guarantee that joining a prop firm will provide access to fresh perspectives and ideas, but at the good ones, the guys are always talking shop and you can pick up good stuff. My experience is that when you're prepared to give, you're likely to get. I often begin my interactions at prop firms that I work with by sharing my own ideas. It's surprising how often that leads to mutual brainstorming and exchange.

I know from my interactions with readers that there are many who are interested in mutual learning. Indeed, that is why many people responded favorably to my idea of a Chicago summer seminar in which the only "registration fee" was to bring one good, unique trading idea. My hope is that an event such as this could lead to further networking, from which could spring virtual trading groups.

Hint: Check out the most frequent participants in the comments sections of your favorite blogs and online forums. Many times, these will be the individuals most interested in networking and sharing ideas.

Sunday, May 24, 2009

Twitter as a Virtual Analyst

When I first began my participation on Twitter, that app was not the household name it is now. What appealed to me about Twitter was that it was what I called at the time "a blog within a blog". In posts of 140 characters or less, I could pass along information in real time much more efficiently than through an endless series of blog posts.

In those early days, only a couple hundred people were following my tweets. Most of the tweets were links to news articles, blog posts, and sites that I thought provided useful information to traders. One day, after working with hedge fund portfolio managers, I thought about the analysts that they had available to them and the ways in which those analysts provided a useful trading edge. It struck me that the tweets themselves could serve as a kind of virtual analyst. As I began using Twitter for explicit decision support, to my surprise, the tweets became almost as popular as the blog itself, with over 4800 people now following the stream.

The idea behind Twitter as a real time analyst is that the tweets provide traders with background information to aid their trading--not with trade ideas themselves. This is a very important distinction. The goal is to increase traders' mental bandwidth by providing a set of eyes and ears on markets, even as the trader is immersed in short-term price action.

Consider the following tweet from last week:

10:56 AM CT - ES testing its opening level; financials bk near highs for AM; 13 stks up, 27 dn; still broad mkt weakness.

The S&P 500 e-mini futures had declined from their opening price and then rallied back toward the open. That's what a trader fixed on the chart would see. What the Twitter analyst added was that, although there was strength among financial stocks, there were still signs of broad market weakness. Of the 40 stocks in my basket, drawn from eight S&P 500 sectors, twice as many were down from the open as up. Only a relative handful of stocks were leading the rally back toward the open.

How a trader utilized that information was completely discretionary. A trader may have used the information to fade the rally, to take profits, to hold off on a trade to the long side, to take the side of the financials, or to do nothing at all. Just as a spotter calls out the positions of cars to a race car driver, providing a clearer view of the track, the tweets call out relevant information to the trader. Over time, a trader develops a feel for which tweets are helpful and which are not to their particular style of trading.

In short, the goal is to augment a trader's trading, not interfere with his or her judgment. An analyst may recommend a stock, but it is up to a portfolio manager to include or not include that name in the portfolio, how much of the stock to acquire at given prices, etc. Similarly, a Twitter analyst may caution a trader about slow market conditions and reduced volatility, but it is the trader's ultimate responsibility to factor this information into trading.

Over time, I will be refining the tweets to make them more useful for real time decision making. Interested traders are encouraged to follow along; it's free of charge and involves no registration of personal data. And, of course, I'm always open to ideas and suggestions regarding the tweets. I can best serve as your eyes and ears if you let me know what is most useful for your trading. Thanks for the continued interest.

Four Pillars of Psychological Well-Being

As background for this post, check out the earlier entry on subjective well-being and trading--including the self-assessment questionnaire and its interpretation.

One of the most important insights that I gained from working with traders is that lasting success in the markets is most likely to occur when one's positive emotional experiences from trading outweigh one's negative experiences.

Because all traders undergo drawdowns during their learning curve, as well as periodic slumps in performance, that means that a key skill is sustaining emotional well-being even when you are losing money.

One way to do this is to have a diversified emotional portfolio, so that all of your self-esteem eggs are not in the trading basket.

Another way to do this is to focus on making steady improvements in your trading processes, thereby focusing on what you *can* control.

There are four pillars to emotional well-being:

Joy - The happiness that results from exercising one's strengths and competencies;

Contentment - The inner peace that comes from knowing that you've done your best;

Energy - The excitement and enthusiasm that spring from focusing on opportunity;

Affection - The bond that results from sharing your life with others of like values and visions.

It's not an excess of stress that overwhelms traders; it's the lack of well-being from these four sources to balance trading's stresses.

I know of successful traders who are grossly lacking in one or more of those four sources of well-being. I've never known traders to sustain their success, however, when those are lacking. Without joy, affection, and contentment, we pursue trades for the wrong reasons. Without energy, we cannot withstand the rigors of risk and uncertainty.

The wise trader structures his or her day to maximize experiences of well-being: that is what sustains motivation, concentration, and the ongoing learning needed to adapt to ever-changing markets.

Saturday, May 23, 2009

Building the Internal Observer

Perhaps the most important psychological challenge facing active traders is sustaining the capacity for self-observation. When traders are trading well, they are focused on markets. When they are not trading well, they find themselves immersed in distractions. In both cases, they are not observing their performances and what they are doing right and wrong. That is why it is important--during and after the trading day--to create procedures that facilitate one's "internal observer": journaling, meeting with coaches and mentors, reviews of performance, etc.

Much of my recent book, The Daily Trading Coach, consists of specific behavioral, cognitive, and psychodynamic exercises to help us become better self-observers. These are also techniques that allow us to interrupt problem patterns, so that we can avoid repeating past mistakes.

No techniques can be effective, however, unless there is a willingness--and a recognition of the need for--time away from the trading screen. Many traders talk themselves into the assumption that any time away from trading will create missed opportunities. That keeps them locked in their old patterns.

I see time away from the screen as a kind of insurance policy: you *might* miss a move occasionally, but that's the premium you pay to insure that you'll be in the right mode when you are trading. You don't complain if you never have an opportunity to file claims against your homeowner's insurance policy. It's there for peace of mind and security.

There's a similar peace and security that comes from the self knowledge and self discipline--the internalized sense of control--that comes from ongoing self-observation. It's not enough to work on markets; your work on yourself is what gives you control over exploiting your edge with consistency.

Reasoning, Preparation, and Trading Success

A recent post described a framework for trading in which evolving market action (the behavior of price, volume, and volatility around key price levels) is used to form ongoing estimates of the odds of touching predefined profit targets. By observing how volume and volatility behave on upward and downward movements—and by gauging the degree of participation in those movements—we can obtain a feel for whether trade is directional or non-directional and anticipate continuation and reversal moves accordingly.

Underlying this framework for trading is a reasoning process that synthesizes ongoing information within and across markets and time frames. Much of what is learned during the process of obtaining market expertise is a refinement of this reasoning process. Psychology becomes important to trading outcomes insofar as it promotes or interferes with the reasoning needed to adapt to the flows of market-generated information.

The reasoning process, however, begins before markets open as part of the trader’s daily preparation. By observing how markets trade overnight, evaluating the behavior of correlated asset classes prior to the open, and by assimilating economic data, news, and earnings releases (and market responses to these), the trader gains a feel for the market day before the opening bell rings.

Key to the trader’s reasoning is an elaboration of “what-if”scenarios that review hypotheses regarding likely market action. What if we open with low volume, near the previous day’s pivot level on a day with no scheduled economic releases? What if we open weak in the S&P 500 Index, but see firmness among the small cap stocks and a mixed open among the major stock sectors? What if the market breaks above a key price level, with bullish behavior in bonds, the dollar, commodities, and the more speculative stock sectors? What if the market breaks below support, but breadth remains mixed?

Each of these scenarios calls for a specific trader response. Each offers potential trading opportunity. By mentally reviewing the scenarios in advance, the trader becomes more prepared to act upon them. The trader also becomes more sensitive to their unfolding, so that trading opportunities can be properly anticipated and mapped out.

Two sources of hypotheses for the day ahead can be especially useful to preparation. First, by tracking indicators such as stocks making new highs and lows; momentum measures such as Demand/Supply; and the percentage of stocks trading above their moving averages, we can gauge whether a market is gaining or losing momentum to the upside or downside (or whether it is trading in a range with little momentum). Drawing on the principle that strong momentum moves in one period will tend to carry over into subsequent intervals (and weak momentum moves will tend to reverse), we can formulate ideas as to whether markets are likely to hit particular targets today as a function of yesterday’s trade.

Second, historical market patterns—queries as to how markets have traded in the past under the present set of conditions—can help us formulate hypotheses for the coming day. For example, we might find that a low momentum up day yesterday which is also a five-day closing high has a relatively poor chance of closing higher today. That provides us with a hypothesis that enables us to anticipate weakness should we be unable to hold a particular upside price level.

From this perspective, the successful trader is one who formulates meaningful hypotheses prior to trading and then processes unfolding action quickly and accurately to determine whether or not those hypotheses are finding support. Not all traders trade this way; nor should they. What I am describing is a framework that I have cultivated over years of trading and working with traders that makes use of my cognitive strengths in synthesizing information into meaningful patterns and themes.

Your challenge is to learn what you can from my way of viewing markets, but not to mimic what I do. Good things happen when discover where your cognitive strengths lie and adapt the styles of others to create your own niche.


Friday, May 22, 2009

How Volatility Affects Future Price Movement Expectations

What a difference volatility makes!

Above we see two days in which the previous day's pivot price (an estimate of average trading price) was quite similar. We had a pivot price of 89.12 in SPY for yesterday and a price of 89.04 in the much more volatile environment of 11/14/08.

The proprietary R1/R2/R3 and S1/S2/S3 SPY profit targets that I calculate each morning before the open and post to Twitter are volatility adjusted and backtested to 2000. On about 70% of trading days, we will touch R1 or S1; roughly half the time we'll hit R2 or S2; and about a third of the time we will reach R3 or S3.

Above we see where the placement of those profit targets was for the two days. Notice how price movement expectations were so much higher in late 2008 than at present. It's a concrete illustration of how markets shift in volatility, not just direction, affecting where we place both stop loss points and profit targets. For another nice illustration, see this post on how VIX correlates with average daily volatility.

Recent Intermarket Relationships on the Radar

Some intermarket relationships impacting recent trading: weak stocks (top chart), weak dollar versus euro (second chart from top), strong gold (second chart from bottom), rising Treasury rates (bottom chart). Could we be looking at inflation sooner than expected? If so, that would have important implications for Federal Reserve policy, interest rates, commodities, and the prospects for sustained economic recovery.

Stock Market in a Broad Range

Here we see the Dow Jones Industrial Average (DIA; 60 minute bars), with the new 20-day highs (top number) and 20-day lows (bottom number) superimposed for key trading days.

Note that we're trading in a wide range defined by today's (and the 5/15) low and the highs of 5/20 (and 5/6). We can see that new highs tailed off at the 5/20 highs relative to the early May period, and now we see new lows approaching the level seen on 5/13.

A break of the range lows accompanied by an expansion of 20-day lows would be a bearish development on an intermediate-term basis. Weakness in 10-year Treasuries (rising rates) and a weak dollar have been taking a toll on stocks lately, particularly since the recent release of Fed minutes. I'll be watching those markets for further indications of macro dynamics that could weigh on stocks.

Thursday, May 21, 2009

Using Volume and Buying/Selling Sentiment to Track Market Transitions

Above we see the reversal formation that I have described as a "transition pattern" (ES futures). The upside transition typically occurs against the backdrop of an oversold market; the downside transition occurs against overbought conditions.

In the case of the upside transition, a high volume decline occurs with very negative TICK, indicating a selling washout. That is the momentum low for the decline. Price then continues to make lower lows, but on reduced volume (see blue arrow above) and higher TICK bottoms (see blue numbers under the candlestick bars).

The reduced selling intensity brings bulls into the market, as seen by fresh, significant positive TICK readings (blue numbers above the candlesticks). This buying is accompanied by increased volume, much of which is initially fed by short covering (rising blue arrow). The entire pattern takes on a reverse head and shoulders appearance in this case, but it is the volume and buying/selling dynamics--not the shape--that is most important to the shifting demand/supply equation.

This pattern sets up across multiple time frames and will be a topic of presentation at the proposed summer seminar.

The Importance of the Opening Price

The opening price (shown by the blue line for ES futures today) represents the market's first attempt at locating value on the day. A trending market will stay above or below the opening price for the majority of the session, as we reject that early estimate and probe value higher or lower. A bracketing or range market will tend to accept the early estimate of value, and we will oscillate around the open and/or the day's volume-weighted average price for much of the session.

Note how we attempted to establish value above the open in early trade today, but then rejected that level into mid morning. An attempted rally late in the morning could never push us above the open and we have been accepting value lower since that point.

An excellent tell, noted in the Twitter posts, was that--even as we were trying to rally to the ES open--the great majority of stocks in my basket were down from their opening prices. In other words, the move toward the open was dominated by a relatively small number of stocks (in this case, the financial issues). Once the financial shares could not sustain new day session highs, the entire market pulled back in the afternoon.

Knowing how we're trading relative to the open--but also seeing how individual stocks and sectors are trading relative to their opening prices--is useful in gauging evolving market strength and weakness.

Municipal Bond Strength: A Bit of Risk Appetite Among Investors

Here's a two-year chart of daily closes for the Vanguard Intermediate-term municipal bond fund (VWITX). Note how we've recovered from the large losses late in 2008 and now are back up to the prior price highs. In a low interest rate environment, those tax-free yields have looked attractive to retail investors and, amidst hopes of economic stabilization, investors have been willing to move away from Treasuries and into munis.

Two Days Down, Followed by a Down Open: Will Trend Be Your Friend?

We've already hit the S2 price target posted to Twitter prior to the market open in SPY following a downside reversal day, so things look pretty bleak for the day session.

Sometimes a look at the historical data can prevent traders from making hasty assumptions. When SPY has been down for two consecutive days since 2000 and then opens the next day lower, the day session averages a gain of .14% (105 up, 77 down). Across all other sessions, the day trade has averaged a loss of -.03% (1086 up, 1089 down).

It's not a wildly bullish edge, but neither is it a bearish one. It is easy to assume that the immediate past--especially when it's vivid--will carry over into the future. Markets don't always reward the easy assumption. Checking our assumptions--not getting locked into opinions in advance--is a useful psychological tool for active traders.

Update On Chicago Trading Coach Seminar

The moral of the story is: be careful what you ask for... :-)

Seriously, though (and not all those emails in my inbox are about the seminar!), thanks to all who have expressed interest in a Chicago seminar. One way or another, I will make it happen and will post details (with plenty of advance notice) to the blog.

At this juncture, I'm looking at possible locations and dates, with the greatly appreciated assistance of Trevor from Market Delta. I'll also look into the possibility of a webinar, either of the Chicago session or maybe a separate session altogether. The webinar would be scheduled at a time convenient for international participants and/or archived for ready access.

As always, I am appreciative of the interest and support--