Friday, February 28, 2014

How You Know You're On the Right Track in Your Trading

This is the first picture we have of Naomi, our second youngest rescue cat.  She had been traumatized at an early age and it took a great deal of work to bring her out of her shell.  A future post will tell all about Naomi and what she taught me about bouncing back from adversity.

After I wrote the post on doing well and doing good, I realized that I had come up with a pretty good litmus test for whether performance activities are worthwhile or not.  The worthwhile ones make you better across many areas of life:  they teach you life lessons and give you positive energy.  Raising Naomi gave me sensitivity and patience.  She pushed me to be a better human being, because that was the only way to pull her from hiding.

The wrong performance activities--and especially the right ones pursued the wrong way--consume your energy.  They bury the best within you.  Trading can be an energizing, meaningful performance crucible, but pursued addictively it becomes a destroyer of capital and families. 

When Naomi looks at me now with love in her eyes, I feel a pride in being a part of bringing her out of her trauma.  You want your trading to make you feel the same way:  proud of the person it pushed you to become.

Further Reading:  Turning Frustration Into Pride

Moving Past Trading Failure

In response to the post on making peak performance a lifestyle, one reader asks insightful questions:

does commitment come from belief in the possibility of change?

if yes, then if you lack belief (due to years of trying and failing without knowing what you were doing wrong and without knowing what you need to do differently and how to do it) AND your years of experiencing failure have made you think and feel like you are a loser who will never win...

how do you dig yourself out of that bottomless pit?

if you are in the unfortunate position of internally feeling like a failure, how do you develop enough belief that you can improve yourself?

It is indeed difficult if not impossible to make changes if the belief in the possibility of change is not there.  

The key to the reader's dilemma is "years of trying and failing without knowing what you were doing wrong and without knowing what you need to do differently."  In the post on finding your niche, I suggested that traders often experience failure because they place their capital at risk before they have truly identified their performance niche.  Another post on performance niche makes a similar point: 

...success is achieved when we find markets and styles of trading that take maximum advantage of our skills and talents. That keeps us focused on markets and absorbed in them, enabling us--over time--to internalize their patterns.

Many, many times, traders do not live up to their potential simply because they are trading markets and methods that do not draw upon their strengths. Without that fit, they are not absorbed in what they do; frustration replaces focus and learning suffers.

What we know from performance research is that, when our inborn talents, acquired skills, and deep interests line up, we experience an accelerated learning curve.  A learning curve that fails to take off is often useful information.  The successful longer-term investor might very well be a failure at rapid intraday trading.  Someone who has a deep knowledge and feel for commodity market trends and fundamentals would stumble attempting to trade chart patterns in stocks.  

When I was teaching at the medical school in Syracuse, I recall working with students who felt like absolute failures in their surgery clerkships, only to later shine when performing in family medicine or psychiatry.  

Trading, like medicine, consists of many specialties, many potential niches.  The answer to my medical students was not to put years into struggling with surgery:  that would have not have helped them or their patients!  Rather, the answer was to explore other specialty fields and see where there was a fit.  Being a failure at one type of activity is an invitation to try others.  Different time frames, different market instruments--all can be practiced on sites such as Zolio.  Once you're back on a learning curve, you'd be surprised how quickly enthusiasm can return.

Further Reading:  Deciding to Give Up Trading

Thursday, February 27, 2014

Doing Well and Doing Good: Trading as a Gymnasium

Some would have it that there is little ethical good in trading, implicitly or explicitly accepting the premise that what is good is what we do for others.  This creates a schism between doing well--earning profits in markets--and doing good.  Not a few traders in my experience have been caught in that dichotomy, undermining both their trading and personal success.

Wealth, Ayn Rand once observed, is the product of our capacity to think.  There is no surer road to ruin in markets than to follow the herd.  It is the independent mind, the capacity to see what others don't, that brings trading and investing success.  As markets continually evolve, success requires that we evolve with them.  Who among us has not known the once-successful trader who now cannot make money in changed markets?  Trading requires not just the ability to make ourselves, but also the capacity to continually remake our viewing and our doing.

Once we see trading--or any great performance field--as a crucible for self-development, then there is no schism between what makes us good and what makes us successful.  My capacity to make decisions in fast market conditions has often come in handy in difficult family circumstances.  Principles of risk management that inform my trading have also helped me hold winners and exit losers in career opportunities.  Recognition that I cannot digest everything in markets daily has pushed me to find like-minded others and build mutually rewarding collegial relationships.  I have learned to become a more patient parent and spouse by markets that required my patience.

Any performance domain is a gymnasium that gives us the opportunity to exercise the best within us.  The right workouts help us earn the status of the 1%--in our relationships and careers, as in our bank accounts.

Further Reading:  Objectivism and Trading

Taking Trading Journals to the Next Level

Traders have long used journals as performance tools.  A trading journal is a great way to track your ideas about markets and also track your development as a trader.  Finding the right format for a journal is important, as a journal for your market ideas might be quite different from a trading performance journal.  The common goal of all journals, however, is to cement important observations and facilitate reflection and creative thought.  When we take ideas out of our heads and commit them to screen or paper, we become thinker, writer, and reader.  That enables us to process information more deeply and in multiple ways.

I am a big fan of using Evernote as a platform for journaling.  Evernote enables you to write journal entries online, store them in the cloud, and access them from just about any device.  Because Evernote stores pictures, videos, web content, and even handwritten information, it is a great way of turning a journal into a multimedia learning tool.  For example, you could cut and paste news articles about a market into a journal entry, annotate with your own comments and observations, and include relevant charts of that market.  

One of the most useful features of Evernote is that it allows you to tag content and acts as a searchable database.  That allows you to pull out all entries on a particular stock or all posts that pertain to a given topic, such as overtrading.  You can even use your phone as a scanner, take pictures of something from your trading screen, and save them to your Evernote journal.

Want to share your journal for coaching and mentorship?  Group journals enable multiple people to contribute to a single journal, or you can grant access to your journal to trusted colleagues.  

Used properly, a multimedia journal can be a great productivity tool and a powerful prod to creativity.

Further Reading:  Formatting a Trading Journal

Wednesday, February 26, 2014

Putting Predictability on Your Side in Trading

Abnormal Returns recently highlighted an insightful quote that suggested that market discussions should be evidence-based when it came to the issue of predictability.  

My sojourns through quantitative approaches to markets have taught me that predictability is itself a market variable.  Some market periods and some market time frames are more predictable than others.  Such predictability waxes and wanes over time.  The greatest statistical edge may be on a short time frame at one point; later, it will be over a longer horizon.

The problem with many trading approaches is that they are like blind men in the elephant parable.  They touch one part of the market elephant and assume it's the whole.  In the ideal world, one would be a daytrader when the day timeframe held the greatest edge, a momentum trader when there was evidence of momentum persistence, an investor when there were unique opportunities over long holding periods, etc.  Like the blind men, when we limit ourselves to single trading timeframes, assets, and holding period, we impose our assumptions and distortions and fail to see the whole.

One can study predictability elegantly by constructing rigorous trading systems for particular assets, time frames, lookback periods, etc.  (See Adaptrade for a particularly useful system-building tool).  What you'll find is that sometimes it is impossible to construct a statistically significant model without running hundreds of tests with dozens of variables and thereby overfitting the data.  (Check Marcos Lopez de Prado's work on backtesting to better understand the issue of overfitting).  For other markets or time frames, one can identify robust systems that didn't require undue complexity in construction.

Treating predictability as a variable changes a lot of things:  what you trade, when you trade, how you trade--and how you prepare for trading.  If you think markets offer constant opportunity over all assets and occasions, you'll constantly trade.  If you perceive that opportunity is distributed irregularly and asymmetrically, then the most important part of trading is identifying opportunities when predictability is on your side.

Further Reading:  Every Trader is a Trading System

Useful Trading Tools - Part Five: Dow TICKI

Past posts in this series have looked at stock market breadth, unique data visualization, volume information, and the NYSE TICK.  In this next series post, we'll look at the Dow Jones Industrial Average equivalent of the NYSE TICK:  the TICKI.

TICKI represents the number of Dow 30 shares trading on upticks vs. those trading on downticks at each moment of the trading day.  Its distribution is far noisier than NYSE TICK, as the Dow shares trade frequently and often as part of basket trades executed by institutions.  Indeed, one of my favorite uses of TICKI is to examine the frequency of extreme values:  +20 or above vs. -20 or below.  For a great majority of Dow stocks to be upticking or downticking at the same time, there must be baskets of trades hitting the market on the buy or sell side.  This is a nice way of tracking the sentiment of large market participants.  If we see many significant positive readings, we know they are lifting offers and executing on the buy side; many significant negative readings suggests a hitting of bids and selling pressure.

Because TICKI is so noisy in its moment to moment readings, I keep a cumulative sum of the one-minute average high-low-close readings.  That TICKI Sum measure is depicted above, relative to yesterday's S&P 500 Index (SPY).  What you can see is a persistent bid to large cap shares through the session, even as the NYSE TICK was flattish to down on the session.  Buy programs in the large caps were going off, but the buying was not across the broad stock universe.  That was a nice tell for a mixed market.  It was also why I didn't believe we'd sell off significantly during the day session.

There are many uses of NYSE TICK and Dow TICKI data.  For instance, very short-term intraday traders can use pullbacks in these measures to help time the execution of buy and sell trades.  In an uptrend, you want to buy pullbacks in TICK and TICKI--especially when you see pullbacks occurring at higher price levels.  The reverse logic applies to downtrends.  When you see very few significant high and low readings, you know that institutional players are not dominant in the market and we are much less likely to have a volatile, trend day.

Among the high frequency data available to traders, I find the TICK and TICKI to be most useful in gauging market participation and sentiment.  Somewhat related information is also found in the Market Delta measure, which I'll be writing about shortly.

Further Reading:  Dow TICK and Market Patterns

Tuesday, February 25, 2014

Succeeding at Trading by Not Trading

One important performance variable that isn't tracked often is the variability in a trader's risk-taking.  Opportunities are not distributed perfectly evenly over time:  some markets offer more opportunity, some less.  As a result, the skilled trader will vary risk-taking as a function of the opportunity set:  sometimes trading actively and in size, other times pulling back from trading.  What traders refer to as "overtrading" is the result of an inability to regulate decision-making by opportunity set:  taking risk when rewards are quite uncertain.

"When are you mostly out of markets?" is a question I like to ask.  The ability to not trade is itself a performance edge when it helps traders hang onto their gains during times of market uncertainty.  This is yet another area where having a full and rich personal life becomes important to trading success.  If all you have to sustain you psychologically is your trading, it is going to be difficult to not trade.  If you have a full and rich life outside of trading, then it is much easier to take risk when rewards justify the effort--and put trading aside otherwise.

It's great to have a passion for trading; better to have a passion for successful trading.  And sometimes that means engaging in other passions and refraining from marginal trades.

Further Reading:  Addictive Trading

Making Peak Performance a Lifestyle

Here's a nice graphic I noticed on Matthew Porter's site, taken from Jeff Janssen's work with athletes.  The idea is that change is a function of commitment--and very little change occurs without deep emotional buy-in.  One of the most frustrating aspects of change efforts is the desire for change, but the lack of true buy-in and follow-through.  (Consider New Year's resolutions as case in point).  This is also a key challenge for managers in organizations:  it's not too difficult to elicit compliance from employees, but it's rare to inspire commitment and the sense of compulsion.

Porter makes the excellent point that we can assess our level of commitment across the many aspects of our lives, from our physical and spiritual development to our relationships and productive work.  Think of each of these aspects as a potential source of energy, self-affirmation, and growth.  When we are committed, push our boundaries, and extend ourselves in each of these areas, we gain an awareness and inspiration that can feed the other areas of life.  This is one more way in which positive life experience radiates across personal and performance domains.

The risk is not just lack of commitment, but also one-sided commitment.  Imagine someone who goes to the gym religiously and only works out the upper portion of his body.  He is deeply committed to having the most sculpted pecs, the largest biceps, etc.--all the while ignoring his weak back, flabby stomach, and spindly legs.  He might portray himself as a deeply committed person, but his one-sided development makes him grotesque and unbalanced.  Eventually, his poor development will even take a toll on his upper body workouts once his weak back gives out, his lack of aerobic fitness catches up to him, his social isolation leads to reduced mood and energy, etc.

How many traders who loudly proclaim their passion for trading are like that guy in the gym?  It's only a matter of time that their lack of personal, physical, social, and spiritual development handicaps and sabotages their performance efforts.  

So how committed are you across life domains?  How much energy are you getting from your physical development?  Your intimate relationships?  Your professional relationships?  Your spiritual life?  Great things can happen when peak performance becomes a lifestyle and multiple facets of life reinforce and renew one another.

Further Reading:  The Essence of Elite Performance

Monday, February 24, 2014

Risk Management and Learning From Our Losses

My recent post emphasized the importance of being an adaptive trader.  One of the most valuable tools in staying adaptive is learning from your losses.  If markets were unchanging--if they only followed a single regime, a single set of rules--then losses would be the result of poor rule-following.  Discipline is necessarily the greatest virtue in a static world.

If, however, markets are not static and their underlying rules shift over time, then losses can take on a different meaning.  We can trade in a fully planned and disciplined manner and still lose money.  That is because the markets themselves have changed.  When regimes shift, losses can become valuable information:  they are telling us that what worked in trading before is no longer working.  That is a wakeup call to revisit assumptions and develop a different trading approach.

This is one reason why risk management is so important.  We are not omniscient.  There will always be times when we are imperfect in anticipating regime shifts in markets.  That fallibility ensures that we will always have drawdowns.  We cannot adapt and bounce back if those drawdowns take us out of the game.  Good risk management means that we assume position size and portfolio risk at levels that we can tolerate should markets change their tunes.  It is very difficult to use losses as information and adapt to changing markets if we are traumatized by drawdowns.

Once we accept that the world is a dynamic, changing place, we become free to embrace drawdowns.  They are there for a reason; they can teach us something.  It's easy to lose the lessons in drawdowns if we respond to losses solely as threats.

Further Reading:  Risk Management and Trading Psychology

The Importance of Becoming an Adaptive Trader

Above we can see the performance of the S&P GSCI commodity index over the past several years.  It's an interesting chart and helps explain why commodities traders have not had an easy time of it recently.  You can see that the volatility of prices--as well as the trend--have been crushed in a steady grind.  Momentum and trend traders are likely to perform poorly in such an environment.  From 2009 to early 2011, however, those traders probably did well, as volatility and trend had ramped higher.

It's a great illustration of how markets--and even asset classes--can shift "regimes".  They play by one set of direction and volatility rules in one environment and then follow a completely different set of rules in another.  Any trader who conducted historical studies in the GSCI to anticipate future price patterns was at risk of extrapolating from a past to a greatly changed present and future.  You could imagine that a trading system based on yesterday's regime could backtest wonderfully and then fail miserably once the market trades by a different set of rules.

If good trading simply were a matter of planning and exercising discipline in following plans, many more people would succeed at it.  Disciplined plan-following works well when regimes are relatively constant.  Once markets start playing by a different set of rules, however, the challenge is to adapt--not just double down on rigidly following old strategies.

Realized volatility in the stock market has percolated higher of late.  Is this part of a regime shift or do the old market rules apply?  Can we extrapolate from the past--say 2013--to anticipate market movement in the near future, or do we need to figure out the new market rules before making inferences?  I spent a good chunk of my weekend reworking my regression models for stocks precisely because I detected the underlying rules were shifting.

What builds a career of trading success is the ability to recognize change and adapt to it.  At some point there will be a volatility breakout in GSCI and commodities will become a very different performance game.  It's the adaptive trader that will recognize the game shift early, avoid getting run over, and profit from emerging trends.  It helps to have conviction in your trading, but longevity requires flexibility in conviction.

Further Reading:  Adapting to Shifts in Market Regimes

Sunday, February 23, 2014

Integrating Quantitative and Discretionary Approaches to Trading

In coming days, I'll be posting on the topic of integrating quantitative approaches to trading with qualitative, discretionary approaches.  I find that good things can happen when talented, experienced discretionary traders can further their edges with well-backtested market patterns.  Historical research tells us what has happened in the past given a set of circumstances.  The pattern recognition of the discretionary trader sheds light on whether such past patterns are indeed playing themselves out in the present.

Shoutout to Larry Connors for finding The Whole Street, a useful compendium of quant-related blog material.  The site also has a blogroll with many promising sources of quant insight.  

A site I'll be playing with in the near future is Paststat, which tests a wide range of trading patterns. 

Are there other quant-oriented sites that you've found helpful in your research and trading?  Please share via comments; thanks!

Further Reading:  Historical Patterns in Markets

Being Your Own Trading Coach

So this is Roberta's Pizza in Brooklyn.  There are two types of people:  those who wouldn't be caught dead at a place like Roberta's and those who absolutely have to try out such a funky place with a great rep.  Now, to be sure, when Margie and I first stood in front of the restaurant, I did have a minute of doubt.  But the enthusiastic recommendation of trading colleague and friend Mike Chan won out and we went in.  Great food, great people, great craft beer.  What more could you ask?

If you want to be your own trading coach, you have to be the person who goes in the door at the funky place, not the person who would avoid it like the plague.  We recently planned a vacation for this spring and decided on northern Alaska in a remote area where there is world-class wildlife viewing on the glaciers.  It's completely out of the comfort zone and appealing precisely for that reason.  How can anyone expand if they don't move beyond their boundaries?

Think of an athletic coach or trainer:  That job requires challenging competitors and pushing them to expand their capacities.  You can't increase your sprinting time or boost the weight you lift unless you routinely challenge yourself in practice.  Keeping score is the first step in a process that leads to working to improve your score.  If there is one common thread among performance professionals, it is keeping score and pushing the comfort zone to improve scores.

Some of the best traders I know make pushing the comfort zone a lifestyle.  They will find the offbeat restaurant, the challenging vacation voyage, the stimulating theater or dance performance.  One thing I love about working out in the home gym early in the morning is that it starts the day on a note of pushing boundaries.  Being your own trading coach means approaching markets--and life--in a way that doesn't settle for comfort.

Why?  Because on the other side of comfort there are experiences, insights, and parts of yourself you otherwise would have never known about.  Because the path to greatness--in any facet of life--is never through stasis.

Further Reading: Steps Toward Becoming Your Own Trading Coach

Saturday, February 22, 2014

Getting a Fresh Perspective on Stock Market Breadth

This morning's post looked at stock market breadth as a useful trading tool.  While it can be helpful to examine the breadth of the entire market, it is also useful to examine breadth on a sector by sector basis.  What we see above is taken from the Index Indicators site:  it tracks the percentage of stocks making 100-day new highs among S&P 600 small cap shares only.  Notice how the small cap index is much further from its late 2013 and January, 2014 highs than its large cap counterpart (S&P 500 Index).  We can also see that, with each rally, fewer small cap shares (in green above) have been making fresh price highs.  Even as the index has moved higher for the past couple of sessions, fewer components have participated in the strength.

The Index Indicators site breaks down new highs and lows, as well as the percentage of stocks above various moving averages, for quite a few indexes (large cap, mid cap, small cap, NASDAQ 100, and even the DAX.  Indeed, if you go on the site and look at the new highs vs. lows for the DAX, you'll see a pattern similar to the U.S. small caps above.  For much of 2013, the rising tide was lifting most boats.  Thus far, that has not been the case in 2014.

Further Reading:  Short-Term New Highs and Lows

Useful Trading Tools - Part Four: Stock Market Breadth

Previous posts in this series have looked at unique data visualization, volume information, and the NYSE TICK.  Today we'll take a look at stock market breadth and what we can learn from measures of strength and weakness across a broad range of shares.

The idea of monitoring breadth comes from the fact that index movement by itself can be deceptive.  Because most of the major stock market indexes are capitalization weighted, a small proportion of large cap shares can disproportionately influence the overall index movement.  For instance, the broad list of NASDAQ shares may not be particularly strong, but solid updays in $GOOG and $AAPL can push the NASDAQ 100 Index higher.

As a rule, breadth narrows as intermediate and longer-term bull moves age.  At important intermediate-term lows, we often see something similar:  the majority of shares will make lows ahead of the overall indexes.  If a market has been rising with an increasing number of stocks making fresh new highs, my working hypothesis is that a uptrend is intact.  When we see divergences--higher index prices with fewer shares participating in the strength--my hypothesis is that we may be topping out.

There are many ways of measuring market breadth.  One of the most popular is also my least favorite:  advance-decline lines.  I find those are slower to pick up divergences than measures of the number of stocks making fresh new highs and lows.  Another measure that I like and will post about shortly is the proportion of stocks trading above their moving averages.

The above chart is unique in that it looks at the number of common stocks across the major indexes that are making fresh three-month highs minus those making three-month lows.  I obtain these data from the Barchart site, which also posts other useful technical data.  In a longer-term uptrend, peaks and troughs in the new high/low data will occur at higher price points; vice versa for downtrends.

You can see that new highs vs. lows have been waning in the last few days, but also since late December.  I am watching this closely, as it suggests that we may be toward the top of a rangebound consolidation period in stocks at the very least--especially given the expansion of new lows during the most recent market drop.

Further Reading:  Derek Hernquist on Market Breadth

Friday, February 21, 2014

A Valuable Visualization of Stock Market Social Sentiment

Thanks to @chicagosean from StockTwits, who pointed out very helpful data visualizations of social media participation.  The above chart is a heatmap of stocks broken down by sector, sized for number of mentions on the StockTwits site, and color coded for whether the posts were dominantly bullish or bearish.  Also available on the StockTwits site is a breakdown of the stocks experiencing the greatest gains and declines in social volume.  Finally, there is a breakdown of the most active participants on the StockTwits site, broken down by sector. 

It's an interesting way to think about speculative sentiment and shifts in sentiment.  Three things I'd be curious about would be:  1) stocks with low but growing social volume and the implications for trending and volatility; 2) stocks with high but topping social volume and the implications for trend reversal; and 3) social volume across all stocks and its relationship to general movements in the broader sector and market indexes.

Further Reading:  Learning Styles and Trading Success

Yet Another Example of Unique Data Displays

My last post took a look at the value of unique data visualizations.  Here is a different example from John Ehlers' site, integrating cycle and trend perspectives across multiple time frames.  The middle (orange) display captures dynamic cycles; the bottom is a forecast heat map organized from the longer time frame (top of display) to the shorter one (bottom).  So you can see SPY is in bullish mode over the shorter time frame and is starting to turn more neutral from bearish in the longer period.  

It takes a while to get a feel for new displays, but the effort is worth it.

Useful Trading Tools - Part Three: Unique Information

The first two posts in this series covered volume information and the NYSE TICK.  For our third segment, we'll take a somewhat different approach and examine not just unique data, but also unique ways of processing information.

What we know from learning research is that processing information more times and in more varied ways leads to deeper assimilation of knowledge and greater retention.  In other words, if we read something, then hear it, then discuss it, and then map it relative to other things we know, we're more likely to make productive use of the information than if we simply read it and keep it in our heads.

My favorite site for processing market-related information is the Finviz site.  Suppose I wanted to step back and examine which market themes have been dominant over the past month.  I could look at many asset classes, ETFs, and stocks to answer that question or I could look at a heat map display such as the above.  In a single display, we see major ETFs grouped by category and color-coded by performance.  Of course, during this past month, we can see how commodities have been the leaders.  With a simple click, we can change the frame of reference to the past trading day, the past week, etc.  

Their groups display provides a visualization of stock market sector strength and weakness; there are also visualizations for forex and futures.  Other productivity tools include a stock screener and a news feed that is a very effective way to keep on top of headlines from major financial media and posts from popular blogs.  All of the above is free; an elite service offers real time quotes and many more analytics.  

Now suppose that you are processing unique information in unique ways through sites such as Finviz and then using a social media platform such as StockTwits to connect to a group of trusted and respected peer traders to share and discuss the information.  Suddenly you have multiple eyes and ears on markets and multiple perspectives on the information--as well as multiple avenues for processing that information.

I have long believed that if you look at the same information as others, in the same way as others, you're likely to achieve the same returns as others.  Unique, superior returns require unique, superior ways of processing market-related information.  Leveraging distinctive sites and platforms that have exploded with the rise of social media can be an effective way of moving past the herd.

Further Reading:  Information Processing and Trading

Thursday, February 20, 2014

Become the Trader You Already Are

Here is a worthwhile self-coaching exercise:

Keep track of your best trading days or weeks.  Those may or may not be your most profitable periods, but they should be the periods in which you feel you have done your best trading.

Each good day, keep notes on the following:

How you prepared for the day/week:  What was your market preparation?  What research did you conduct or consume?  What did you read?  What conversations did you have, and with whom?  How did you eat?  Sleep?  Exercise?  Prepare yourself mentally?

How you generated your trading ideas:  Where did the ideas come from?  What was the process that led to the ideas?  What made them good ideas?  What gave you "edges" in your trades?

How you expressed your ideas:  What market(s) did you use to express your views?  What instruments?  How did your expressions provide you with superior risk/reward?  If you held multiple positions, how did you size them relative to each other and gauge their correlations?

How you managed your positions:  What kind of trade planning did you do?  How did you size positions and gauge your risk taking?  How did you manage your risk?  What led you to scale into or out of your positions?

How you managed your performance:  How did you review your performance?  What did you learn?  How did you use your learning to improve your future performance?  

Imagine you kept these notes every period you traded well.  Eventually you would have a catalog of your own best practices.  You would come closer to understanding the drivers of your successful performance.

Now imagine that you only kept notes of your trading mistakes and poor trading performances.  What would that reinforce in your mind?  Would such a negative catalog truly inform you of your strengths?

Becoming great means identifying what you are doing greatly right now--and becoming more of the person you already are at your best.

Further Reading:  Becoming Solution-Focused in Your Trading

Why Teamwork is a Powerful Trading Tool

In a recent post, I suggested that the quality of our downtime can serve as an engine for our work efforts.  The research of Barbara Fredrickson and colleagues suggests that the way this happens is that positive emotions generated from high quality life activity both broaden our potential range of thought and action and build new emotional and behavioral strengths.  One of my favorite studies from this literature created a positive or negative mood in subjects and then showed them quick visual displays of information.  The subjects with the positive mood processed the visual information at the edges of their visual fields significantly better than the subjects with the negative mood.  When in a positive state, we literally broaden our perspectives and take in fresh information.  When we are stressed and distressed, we tend to become tunnel-visioned and miss information that is right in front of us.  How relevant is that to markets?

What I've increasingly seen is traders working in pods or teams, where there are multiple eyes and ears on markets, widening the perceptual field.  An important function of this teamwork is to maintain positivity, even during periods of challenging performance.  Because the right team members challenge one another and bring camaraderie to the workplace, the social aspect of trading can become an important component of trading success.  Show me a high performance team and I'll show you one where belonging to the team adds fun, support, and stimulation to trading.  It's precisely in such an environment that team members are likely to broaden their market views and build fresh ideas and trading approaches.  

Further Reading:  A Quick Evaluation of the Emotional State of Your Trading

Wednesday, February 19, 2014

Useful Trading Tools - Part Two: Volume

The first post in this series covered the NYSE TICK and how it offers insights into who is participating in markets.  In this post, we'll take a look at what can be learned from raw volume data.

The above chart covers today's trading in the late morning in the S&P 500 e-mini (ES) futures.  Notice how we were trading in a narrow range for much of the time with volume averaging about a couple thousand contracts traded per minute.  At 11:49 AM, we got a flow to the upside, with over 9400 contracts traded that minute.  NYSE TICK hit a high of 587 during that minute and we traded right back into the range subsequently.

What did that tell you?

Buyers came in and couldn't lift the market higher.  There was a relatively large buying flow, but it could not raise the TICK to statistically significant levels.  That tells us that the buying was not heavy across the full stock universe.  It was aggressive buying (significant volume), but it could not generate significant directional movement.  

Not a bad piece of market information.

Sure enough, at 11:58 AM--just nine minutes later--the ES contract prints over 9900 contracts during the minute and volatility expands, breaking us out of the range.  Moreover, NYSE TICK plunged to -797 and then to -997 the following minute.  That is significantly broad selling on significant market volume.  

In Market Profile terms, we have rejected value in the prior range and now are trending to establish a fresh, lower value area.  The fact that the move out of the range occurred with significant, broad market participation is an indication that directional participants have taken control of the market.  As you know from the remainder of the day session, they did indeed take control and we closed near the lows of the day.

It is common for traders to refer to the minute-by-minute movement of the market as "noise".  For those who understand the dynamics of price action, however, there can be important signals amidst the noise.  When we have low to average volume, we know that market makers are dominant and directional participants are relatively inactive.  When we have significantly expanded volume, we know that directional traders have taken the market reins and we can adjust expectations accordingly.  A meaningful shift in volume is often a nice tell for meaningful shifts in trading patterns.

Further Reading:  Relative Volume and Volatility

Positivity and Creating the Right Life Mirrors

In my recent post on quality of life and the pursuit of trading excellence, I suggested that the quality of our downtime--our time away from markets--is a key component of trading performance.  The example I used was creativity:  a process which blends the immersion in analysis with the mind-broadening of synthesis.  It turns out, by the way, that positive emotional experience enhances creativity--and creativity leads to further positive experience.  The quality of our time away from work is an important contributor to the quality of our work.

Responding to that recent post, Bella from SMB posted an important query of traders:  What would you like to spend more time doing?  He offers his own list, including meaningful social experiences, reading stimulating books and articles, and fitness activities.  The common thread is that each of these is an activity that gives energy.  Sometimes that is raw physical energy, as in getting pumped up during a workout.  Other times it is emotional energy, as in connecting with loved ones.  Low quality activities either take energy or fail to renew our vitality.  We may feel like couch potatoes after a hard day at work and plop down in front of the TV, but rarely is that going to tap us into fresh energy stores.

One of my most important blog posts made the point that we are what we eat--and we are always "eating" life experience.  Our daily experiences are what we consume moment to moment.  Sometimes we have a nutritious meal of experience, inspiring us, challenging us, extending what we thought possible.  Other times, our experience is a kind of junk food.  Jotting down your activities each hour of each day and rating them for their quality is a great way to ascertain the value of your time at work and away from work.  The right activities will generate positive experience--indeed, they are positive ways of experiencing yourself differently.  The wrong activities--being with the wrong people, engaging in meaningless routines--are poor fuel for the soul and ultimately fail to catalyze our best life efforts.

A personal tradition is to start each morning with meaningful experiences as a way of setting the tone for the entire day.  Today I woke up around 3:30 AM--not an atypical start.  How did I start the day?  Not with looking at or trading markets, not with checking my mail, not with glancing at overnight news.  Eventually I get to all of those things.  But I started today by saying good morning to my four cats, who wake up with me.  They hang out together in our great room (see above) and each morning I pet them, greet them, feed them, fetch them fresh water, and clean their litter.  It is my way of welcoming the day by making an emotional connection and by tapping into a bit of servant leadership.  It is difficult to feel too important or too full of yourself when you are serving animals and cleaning their litter boxes.  But it's precisely connectedness and leading-by-serving that make me who I am as a psychologist and trading coach.  That gets me up and going early in the morning, fueling the day ahead; not any alarm clock.

Everything in life is a mirror:  a way of experiencing ourselves.  Some experiences reflect the best within us; others fail to connect.  Our work time is a key component of life success.  What fuels work time, however, are the mirroring experiences that remind us of who we are and what we're capable of becoming.

Further Reading:  How to Change Yourself

Tuesday, February 18, 2014

How Developing Traders Can Build A Track Record

One of the great challenges for people trying to break into the trading world is building a track record.  After all, you need to have money to trade and that's not easy when you're in paying-back-student-loan mode!  

In my book on building trading performance, I wrote about the value of simulated trading.  Paper trading is not the same as having money on the line, but it's a great way to get the deliberate practice hours in and build those pattern recognition and risk management skills.

Since that book, a number of fresh options for building skills through simulated trading have emerged.  One of the most promising is Zolio.  What makes Zolio unique is that serves two roles: 1) it is a trading platform that provides traders with real time data and tracks their trades and performance, and 2) it is an educational platform that helps developing traders learn from their experience via articles, webinars, and collected performance data.

Users can make use of Zolio in a couple of ways.  Beginners can simply try out new markets and trading strategies and keep score to see how well they perform with different approaches.  They can also try out different ways of managing risk, entering positions, etc.  The simulation mode is a great way to make lots of mistakes and learn from them without depleting trading capital.  The webinars cover such topics as risk management and stockpicking. 

More advanced developing traders can use a platform like Zolio to build a real time trading track record, which Zolio then can help shop to trading firms.  This is a great way to demonstrate market experience and trading skills.  The data that the platform collects provides much more detailed information on trading style, risk management, and overall performance than one could ever convey in a normal interview.

One of the unique aspects of Zolio is that they require participants to keep trading journals and document the reasons for their trading decisions.  Those journals become excellent review and learning tools.  Zolio also conducts personality testing with its traders, so that they can see their strengths and make use of that information in developing their trading styles.  The idea is to use the platform to learn more about who you are and how you can succeed in financial markets.

I notice that Zolio is sponsoring a trading competition with prizes and an opportunity to stand out in performance.  I like the fact that the largest prize goes to the person who achieves the best risk-adjusted returns, not just the person who takes the most risk and happens to make a lucky strike.  It could be a nice opportunity for developing traders to enter the competitive trading world, test their skills, and learn about themselves.

FURTHER READING:  The role of simulation in supercharging learning

Note:  I will occasionally highlight resources for traders via the blog.  My strict policy is to never accept compensation of any kind for such mentions.  I don't mention a service unless I've had personal experience with it and with the people running it.

Useful Trading Tools - Part One: NYSE TICK

Suppose you could follow every single stock listed on the NYSE and track every few seconds how many of the stocks were trading on upticks versus how many were trading on downticks.  What would that information tell you?

A buyer who wants to own shares aggressively will execute with a degree of urgency and will pay up for those shares.  Such lifting of offers will cause stocks to trade on upticks.

Conversely, a seller who wants out of shares aggressively will also execute with urgency and will accept the bid price.  This hitting of bids causes stocks to trade on downticks.

By calculating the number of stocks trading on upticks minus those trading on downticks every few seconds, the NYSE TICK ($TICK on eSignal feed) is an immediate, real time sentiment survey.  It is based on the actual transactions in a broad stock universe and thus represents what traders are actually doing, not just what they say they'll do in a survey.

One application of NYSE TICK is to take the intraday readings and create a cumulative line, similar to an advance-decline line.  As you can see above, that cumulative line has been making fresh bull market highs.  That tells me that market participants remain net buyers.  Note how selling pressure was restrained during the most recent market tumble.  That was a great tell that the down move was a correction in a rising market, not the start of a bear market.

There are many other applications of TICK as well.  For instance, since 2012, individual readings that exceed about +900 or fall below -900 represent two full standard deviations from average.  That tells us that there is significant buying or selling pressure across the broad stock universe.  Note that such buying or selling has to be broad based, as you can only get those extreme readings if stocks beyond the S&P 500 list are lifting or selling off.  

To get those extreme TICK readings where so many stocks are upticking or downticking simultaneously, we need to see institutional participants aggressively buying or selling baskets of shares.  That is an excellent sentiment clue.

For instance, after early selling that took TICK to the -740 area during Friday's session, buyers entered in force and drove TICK above +1000.  From that point forward, more stocks traded on upticks than downticks.  That was a nice tell for the coming upward trend day.

And what if NYSE TICK readings stay pretty much between +500 and -500 for the day?  That is often a good indication that institutions are not participating aggressively and that there is little directional demand or supply for shares.  That can be a good clue alerting us to slower, rangebound trade.

So much of successful short-term trading boils down to rapid pattern recognition, derived from plenty of observation.  I have archived one- and five-minute TICK readings for years and studied their nuances.  For me, it's been a great tool for identifying who is in the market and which way they're leaning.

Further Reading:  Interpreting Markets With NYSE TICK

Monday, February 17, 2014

Adapting to Change: The Greatest Challenge in Trading

Here's why I'm writing a new book on trading psychology:

The status quo says that problems in trading performance are the result of emotional disruption, lapses of discipline, and failure to consistently act upon one's edge in markets.

That analysis simply does not match my experience, either as a coach or as a trader.

Successful traders don't suddenly morph into inconsistent basket cases.  And when you see multiple talented traders lose money at the same time, it's impossible to believe that an epidemic of lapsed discipline has suddenly struck the trading community.

Rather, what happens is that the edge that had been present in markets no longer exists.  Markets continually change--they shift in their patterns of trend, volatility, correlation, etc.--so that what once worked no longer yields reliable results.  The momentum trader makes money until volatility shrinks and we move into choppy, rangebound trade.  That brings frustration and emotional disruption, but the cause of the negative emotions is a failure of adaptation to markets--not a failure of discipline or rule-following.  Indeed, doubling down on following rules that no longer work can only cement further losses and frustration.

To be sure, once emotional upset enters the trader's experience, it can interfere with future decisions.  But no amount of psychological stress management will create needed adaptations to changed markets.  That can only be accomplished by treating losses as potential sources of information--as signals that alert us to altered market regimes.  

Once you view drawdowns as information--not merely as failures or as stresses--the door opens to a deeper understanding of markets and ways in which we can take our trading to that proverbial next level.  The challenge is not simply to learn trading; it's also to unlearn and relearn it when markets present different, fresh opportunity sets.

Market Structure and Adapting to Change

Links and Thinks to Start the Week

Well, with that uplifting risk management poster, let's see what inspirations we can find for the coming week!

*  My regression model for SPX remains moderately bullish 5-10 days out, though not as aggressively bullish as it had been last week.  The Cumulative NYSE TICK line is making all-time new highs and my sentiment measures based on ETF buying/selling pressure have jumped higher the last several days, but are not at a frothy extreme.  Per the recent post, upcoming posts will describe a few new measures that I use to track market strength and weakness.

*  Abnormal Returns continues to do a great job of curating the financial web and finding valuable nuggets.

*  Bella from SMB touches on a topic near and dear to my heart:  using data to improve the decision making of discretionary traders. 

*  Some good quant work on Rob Hanna's Quantifiable Edges site, including a recent look at stretched volatility readings.

*  A wealth of information on Rennie Yang's Market Tells service; another site I like for unique market analytics is Decision Point, which has recently merged with the Stock Charts service.

*  Charles Kirk on the value of wiping the slate clean and when it makes sense to read less.

Have a great week--

Tackling the Challenge of Daytrading

If I were starting a business, I would not seek a field in which opportunity is shrinking and one where competition is increasing.  With regularity, however, I see new traders pursue daytrading in the most crowded instruments, especially the S&P 500 Index. 

Let's look at a few stats:

*  Since 2010, the average volume in SPY has been almost 172 million shares.  Since 2012, that average volume has dropped by more than 25% to 122 million shares. 

*  Less volume means more domination of electronic market makers and less participation by directional speculators.  Since 2010, the average daily range in SPY has been almost 1.15%.  Since 2012, the average daily range has dropped by more than 25% to .83%.

*  With recent crises in Europe and Asia, an increasing proportion of market moves are occurring outside of U.S. hours.  Since 2010, SPY has gained over 72 points.  Only 39 of those were made during U.S. hours; the rest occurred during the overnight hours.  Those limited to the day time frame missed out on nearly half of all directional opportunity.

The point of this post is not that you shouldn't be a daytrader.  Rather, the point is that, if you're going to be a daytrader, you have to approach markets very differently from the herd.  You either need to be in non-crowded instruments that possess unique directional opportunities or you need to approach crowded markets in unique ways that find profitable opportunities in the reactions and overreactions of the herd.

Suppose you took a look at every NYSE stock trading on Friday and whether it was making a new high price or a new low price just for that day's session.  If you plotted the new highs minus the new lows at every minute of the trading day, the chart above is what you would have seen.  You would have noticed that, once we got past the first half hour of trade, the new highs dominated the new lows.  You would have also seen that, past that first half hour, the majority of stocks consistently traded above their day's volume weighted average prices.

But if you were trading off the charts that everyone else looks at, you quite likely wouldn't have seen the underlying strength across shares.  That would have made it difficult to identify the likely trend day early in the session.

Daytrading indeed has become more challenging.  It is hard to imagine achieving unique results without a distinct informational edge.  All the coaching, discipline, and psychological insight in the world won't help a person trade the market if they don't see the market.  Upcoming posts will focus on some tools for seeing the market better.

Keys to Daytrading Success and Why So Few Get There

Sunday, February 16, 2014

Quality of Life and the Pursuit of Trading Excellence

Yes, I know, it's cruel to post a picture of a warm Mykonos beach when it seems that everyone is buried under polar vortex snow, but I promise there's a point to it!

Responding to the recent post on David Blaine and the development of expertise, reader David Ayer posed the following questions:

If trading as a mission is the only path to excellence, what about balance with the rest of things in life such as quality downtime or giving full attention to important others? Do these get sacrificed? If so are there mental health concerns?

I think these insightful questions reflect important concerns, but also misunderstandings.   

What we know about creativity is that it is at least a two-step process consisting of:  1) a period of immersion in a domain, where people absorb all they can about the world; and 2) a period of stepping back, where people can reflect upon what they've learned and put their observations together into new views of the world.  

It's a bit of a simplification, but I refer to the first process as analysis and the second as synthesis.  Creativity starts with a wealth of raw materials derived from intensive observation but doesn't blossom until there is an opportunity to synthesize what you've analyzed into a fresh perspective.

If you don't do the deep dives, analyze the charts, study the companies, put in the screen time, observe markets, research patterns, etc, you won't have the raw materials for synthesis.  There's nothing to synthesize if you haven't made the initial observations.  It's the immersion in observation that enables us to see what others don't--that gives us the rare and valuable raw materials.

But at some point people burn out if all they do is stare at a screen or conduct one deep dive after another.  It's the emergence from immersion that puts the mind in synthesis mode.  That's why so many of our choice insights come when we least expect them:  on walks, in the shower, or in dreams.

After a period of unusually intensive analysis, I took a vacation with Margie to Europe and we spent time in Mykonos.  It was a fresh setting, a beautiful locale, and a getting away from routine in every possible sense.  While photographing a picture-perfect sunset, a startling idea came to me based on everything I had been analyzing.  The essence of the idea was that all technical indicators boil down to a handful of variables, such as momentum and volatility.  The key is to distill all chart patterns and indicators into the smallest possible set of non-correlated variables, find optimal expressions for those variables, and then identify which of the variables are driving price action during particular market regimes.

It was a bit disorienting, as this undid much of my previous work, but it was also exhilarating.  The perspective seemed crystal clear--there was a "rightness" to it based on my recent observations.  I threw myself into pursuing the vision when I returned home and continue to refine the idea to this day.  The regression modeling that now is central to my daily market preparation leans heavily upon this structural, technical view.

So now let's revisit Mr. Ayer's challenging questions.  If you create a dichotomy between work and quality downtime, you'll always be a divided human being.  Creative productivity requires intensive work and quality downtime.  Indeed, from my perspective, one of the greatest performance problems traders face is both a lack of intensive, quality analysis time and a lack of quality downtime.  Traders stare at screens and flit from chat to chat without truly doing the deep analytic dives.  At the same time, they tell themselves that dedication to trading requires that they not take too much time away from markets.  As a result, their analyses and syntheses are lacking.

Analysis without synthesis is drudgery.  Synthesis without analysis is empty theorizing.  It is the combination of passionate immersion in markets and quality experiences away from markets that brings out our creative best.  What is the quality of your market time?  What is the quality of your time away from markets?  How efficient are you as a creativity machine?  As a generator of inspiration?  We can only find the right answers if we ask the right questions.

Greatness, Creativity, and Trading Success