What Makes Good Traders Great Entrepreneurs

If you ask portfolio managers and traders what they like about what they do, often they'll mention the psychological benefits of working for themselves.  That is true even for traders working within firms, as they typically retain a high degree of autonomy in their decision-making.  In an important sense, successful traders are entrepreneurs:  they develop ideas for the deployment of their capital and compete in a marketplace to achieve outstanding returns.

So what kind of personality traits make for a successful entrepreneur.  In an insightful post, Leslie Fieger details 14 character traits that he has found among those who start their own successful businesses.  Among some of the most relevant to trading are:

*  An intense drive to succeed;
*  The ability to adapt to changing circumstances;
*  Decisiveness
*  Energy
*  Perseverance and determination
*  Risk tolerance
*  Strong self-confidence

One trait in Fieger's list particularly stood out:  a sense of personal destiny.  Entrepreneurship requires sustained hard work.  That is only possible for people who perceive a link between what they do and how well they will do.  An athlete won't spend years training for the Olympics unless he or she deeply believes that they are meant for great things.  The really successful entrepreneurs have begun with a vision--and they perceive the fulfillment of that vision as nothing short of their mission and destiny.

Research suggests that entrepreneurs are distinguished by having proactive personalities: they don't see themselves as being limited by external circumstances and instead take initiative to bring about change.  This "can-do" approach to life helps them persevere where others would give up.  It also proves infectious, as successful entrepreneurs find partners who share their vision.

I strongly suspect that it is this proactive component to personality that enables great entrepreneurs to adapt to changing circumstances.

So how would you rate yourself as a manager of your trading business?  How well are you leading your trading enterprise and sourcing new opportunities?  Good trading will make your day or week, but it takes entrepreneurship to make a trading career.

Further Reading:  The Trader as Entrepreneur

Why Don't I Trade My Plan When I Plan My Trade?

Nothing is quite so frustrating as planning a trade, not following the plan, and then seeing it work out--without you on board.

Why does that happen?

Kahneman's work on fast and slow thinking suggests that we have two information processing systems at work at all times.  The fast system is highly efficient and responds to immediate situations; it processes information automatically.  The slow system is effortful; it reflects, analyzes, and reasons.  If someone gave you a challenging math problem, the fast system might respond with, "Yuck!  I hate math!", while the slow system would go to work breaking the problem down.

When we plan an action, we engage our slow processing system.

When we are in the heat of battle, our fast processing kicks in.

Indeed, that fast processing can kick in when we are least aware, creating perceptual biases and shaping our behaviors.  

As Mike Tyson famously said, "Everyone has a plan until they get punched in the mouth."

Harder planning, better planning, more planning--none of that will work if we are in a different mind when it comes time to execute the plan.  That is why special forces teams rehearse maneuvers under simulated battle conditions; why pilots practice on realistic simulators rather than in an empty classroom.  The great advantage of mental rehearsal is that you can imagine challenging situations--and evoke the reactions of your fast system--while walking yourself through the right responses.  

Either you battle test your plans in rehearsal mode or they will be tested in actual battle.

Further Reading:  Visualization Techniques for Traders 

A Look at Some Interesting Market Relationships

Perhaps a bit too much to think on an early Saturday morning!  Anyway, here are a few of the more cogent thoughts:

*  One of the measures I track is something I call market "stability".  It basically looks at the uniformity vs. dispersion of correlation and volatility within the stock market.  I notice that stability has been breaking down in recent sessions.  The last time this happened was at the very end of February/very beginning of March, which preceded a market dip.  Indeed, since the start of 2012, the top quartile of stable markets have averaged a five-day gain of +.72%.  The bottom quartile of stable markets have averaged a five-day loss of -.02%.  In the middle quartiles, we've averaged five-day gains of +.52% and +.23%.  We're not at that bottom quartile presently, but we've moved out of the top half of the distribution. 

*  Interesting post from Paststat recently in which he builds on this blog's earlier observation and investigates the implications of underperformance of small caps.  Again, we can look by quartiles since the start of 2012 and it turns out that when smaller caps (IWM) have most underperformed the S&P 500 index (SPY) over a ten day period, the next five days in SPY have averaged a gain of +.85%.  The next three quartiles average, respectively, +.05%, +.09%, and +.53%.  Interestingly, we've seen momentum when small caps have meaningfully outperformed large caps and reversal when they've meaningfully underperformed.  

*   I don't see a similar relationship between SPY outcomes and the degree to which NASDAQ shares (QQQ) underperform.  Indeed, following the instances in the top quartile of QQQ underperformance over a 20-day period since 2012, the next 20 days in SPY average a gain of only +.60, compared with an average 20-day gain of 1.61% over the remainder of occasions.

*   Sentiment matters.  Since 2012, the top quartile of days based on single day stock index put-call ratios have averaged a next 20-day gain of 2.22%.  The bottom quartile of days (lowest index put/call ratios) have averaged a next 20-day gain of .78%.  The top quartile of days based on single day single equity put-call ratios have averaged a next 20-day gain of 2.11%.  The bottom quartile of days have averaged a gain of .81%. 

*  Volatility matters as well.  Since 2012, the lowest quartile of VIX days have averaged a next five-day gain of only .03%.  The highest quartile of VIX days have averaged a next five-day gain of .87%.

*  Divergences?  The good news is that SPY has been only about 2% off its all-time highs during the past three trading sessions.  The bad news is that stocks making new monthly highs fell short of those making fresh monthly lows by 376 to 993 three days ago; by 212 to 1461 two days ago; and by 328 to 646 yesterday.  There has been much more weakness than the large cap indexes suggest.

Further Reading:  A Different Way of Looking at New High and Low Data    
 

Connecting the Dots: How to Become More Cognitively Flexible

Steve Jobs made a great point:  We're more likely to connect the dots and perceive new relationships among things if we have more dots to connect.  Having more and different experiences provides a richer palette from which you can paint the world.

Research suggests that there is value in cultivating experiences that are outside our routines--and even downright weird.  It is the unusual experience that is most likely to give us new dots to connect.  Last year I took on a psychology research project that was out of my wheelhouse.  The project forced me to learn data analysis techniques that I had never before utilized and got me looking at data in wholly new ways.  I was totally overwhelmed, then I was fascinated.  I learned a tremendous amount and what I learned has provided the backbone for my most recent modeling of equity index price movement.  At the time I took on the project, I had no idea that it could be relevant for markets, but the fresh dots led to novel connections.

The key is that involvement in diversifying activities has to be active, not vicarious, to generate enhanced cognitive flexibility.  Listening to new and interesting music can be stimulating; tackling the playing of a musical instrument can be diversifying.  We can read about different cultures, but it's visiting them that provides us with a different view of our own ways of life.

There is much to be said for process and routine in trading, but it's the experiences beyond the routine that provide us with the cognitive flexibility to see markets from different angles and adapt quickly when markets shift.  Stubbornness in trading is really a form of cognitive rigidity.  It's difficult to believe we can be flexible traders while living inflexible lives.

Further Reading:  Flexibility vs. Sticking to Trading Plans

What Makes a Trader a Peak Performer

What turns any activity into a peak performance activity is keeping score--and then using the scores to work on improvement.  Once you begin to track how well you're doing, you have a baseline of success from which you can gauge further growth.  Keeping score also keeps a trader accountable to themselves:  are you really improving over time?  

What prompted this topic was a visit to The Night Owl Trader site.  Two things jumped out at me when I looked over recent entries.  The first was that the author is attempting to call market direction for the next day.  The most recent forecast was "uncertain".  I love that.  Having created and recreated more regression forecasts of markets than I care to count, I know that sometimes the output says, "uncertain".  That is not as appealing to some as making a table-pounding, high-conviction bullish or bearish call, but it is intellectually honest.  Sometimes the evidence is balanced, and sometimes there isn't a distinctive directional edge.

The second thing that I liked was using the daily forecasts to keep score:  how often the author was right and wrong on market direction.  Keeping score publicly can be a particularly strong form of accountability.  Over time, it can lead to useful reviews:  what were the highest batting average periods?  The lowest ones?  What types of markets were most forecastable and which were least?  How could the forecasts improve for the least predictable markets?

A while back a trader contacted me about working together.  He didn't attempt to convince me of his passion for trading or his grand insights.  Rather, he sent his multi-year track record, performance statistics, and a very well laid out description of his trading methodology.  The message he sent was, in essence, "Here's what I do; here's how well I do it; I want to get to the next level."  His track record wasn't perfect, but it was his willingness to keep score, stay intellectually honest--warts and all--, and open the kimono in the search for peak performance that made me strongly suspect he'll get to that next level--and beyond.  

Those are the traders you want in your network:  they will bring out the best in you through their devotion to achieving the best within them.

Further Reading: Keeping Score, Religiously 

Heavy Concerns About (Covenant) Lite Loans

Thanks to Jason at SentimenTrader for returning the issue of covenant-lite loan issuance to the front burner and shout out to Steve Han at SMB Capital for the heads up.  Cov-lite loans are ones that are made with fewer protections in place for lenders.  That raises fears of a repeat of low down payment mortgages back in the day.  Zero Hedge brought the issue to attention late last year; Forbes had a piece on the topic earlier that year. Just recently, FT discussed the growth of cov-lite loans in Europe.

Oppenheimer points out that cov-lite loans are not covenant free and do have protections in place.  Meanwhile, leveraged loans are off last year's pace but continue hot.  The issue of search for yield resulting in a reach for lower credit quality as a function of the low interest rate policies of central banks is an important one:  I'll be keeping an eye on how lite loan portfolios get.

When Small Cap Stocks Underperform

For the first time since early February, smaller cap Russell 2000 stocks (IWM) have underperformed larger cap S&P 500 stocks (SPY) by a full percentage point or more over 5, 10, 20, and 50 day periods.  That's pretty unusual in bull markets.  Indeed, if we look at those occasions when VIX has also been below 20 (a nice bull market filter), we only find 14 non-overlapping instances since 2006.  Over those 14 instances, SPY has been up 20 days later twelve times and only down twice, for an average 20-day gain of 2.23%.  All other instances have averaged a 20-day gain of .50%.  

(Story for another day:  When IWM has outperformed SPY by over 1% over 5-50 day periods, the average next 20-day change in SPY has been a loss:  -.31%.)

All this tells us is how stocks have behaved in the past.  Our job is to read how the market is behaving now and continually update our estimates of past patterns playing out in the present.  Could we be entering a whole new regime of small cap underperforance?  It's possible, especially given the higher valuation of small caps and concerns over the potential end of QE.

Should we show signs of basing, however, with further selling unable to push the broad list of shares lower, we could have a nice setup for bargain hunters.

Becoming Evidence-Based in Your Trading Business

Here's a business article I particularly like, covering the importance of continual innovation, but also the continual measurement of the outcomes from that innovation.  By becoming evidence-based, traders ground their development in objective results.  The example in the article of the health food store owner making ongoing changes in his business processes and measuring results--right on down to how and where his food product were displayed--provides a nice example of an evidence-based approach to improvement.

Conversely, take a look at this article about how psychotherapy has been on the decline in recent years.  One theme that dominates is the failure of therapists to embrace the research base of their field.  For instance, there is strong evidence that certain, behavioral approaches to the treatment of anxiety disorders are more effective than generic talk therapies.  Many therapists, however, wedded to the more subjective and relationship-based aspects of their work, do not employ those methods and instead offer the services that are most subjectively gratifying for them.

I fear that many traders are more like these therapists than the health food store owner.  They fail to innovate and, even when they try something new, they are not rigorous about tying process changes to changes in trading outcomes.  The evidence-based trader keeps score and grounds trading methods in carefully observed and tested approaches.  Before we can "do more of what works", we have to measure what works.  If we don't keep score, markets will keep score for us.

If you're running your trading business well, you're breaking it down into component processes and examining how well each process is working for you.  It is out of those observations and measurements that you arrive at focused innovations and effective ways of executing those.  How to break your trading business down and make evidence-based changes will be the focus of an upcoming post.

Further Reading:  Sustaining Innovation  

Finding an Effective Trading Coach: What to Look For

The recent post on seeking a trading coach suggested that many times a coach is not the ideal solution for trading-related concerns.  Many problems that traders face are a subset of performance anxiety/pressure concerns that impact people in various situations, from exam-taking to public speaking.  Those issues can be addressed quite effectively by experienced, well-trained psychologists.  The advantage of finding such a psychologist is that they are likely to be local and hence more accessible and more affordable than most trading coach specialists.

That local consideration is an important one.  Research in counseling and therapy finds that the most consistent ingredient of success is the quality of the relationship between the person helping and the person receiving help.  It is easier to build and sustain that relationship with face-to-face meetings that can be scheduled with regularity.

Whether you end up working with a counselor, mentor, or coach, other ingredients of success include:  1) a concrete focus for change; 2) active work between meetings to make changes; and 3) the ability of the helper to provide fresh perspectives--and new directions--for the change process.  In other words, change is most likely to occur when you specifically spell out the desired change, work actively and consistently to achieve that change, and receive useful and insightful guidance from the person you're working with. 

But my experience is that one success factor trumps all others:  great helpers care greatly about helping.  They are personally invested in your success and go the extra mile to make the coaching or mentorship work.  With the less effective helpers, you have the nagging sense that the meter is always running, that they're in the business of generating billings.  Effective helpers plan for the end of helping: they want you to be independent and reach the point of helping yourself.  Less effective helpers want to milk the cash cow: they invent endless ways to keep the coaching or counseling going. 

By the end of a couple of meetings, you generally know if the process of mentoring, coaching, or counseling shows promise and whether there is a positive chemistry.  Don't be hesitant to shop around: amazingly, people will travel from store to store to find the right outfit, but won't put a fraction of that effort into finding the right physician or psychologist.

Outcome research suggests that brief approaches to counseling can be highly effective for people who don't have long-standing, severe personality problems.  When you're ready to make changes in your personal or professional lives, the right helper can be a valuable catalyst.

Further Reading:  Three Considerations in Selecting a Trading Coach

Quantifying Money Flows in U.S. Equity Sector ETFs

I recently looked at money flows into the SPY ETF and found that there have been net outflows since the start of 2014. 
Above, we can see that net outflows in 2014 have been particularly pronounced among consumer-related shares:  discretionary issues (XLY) and staples (XLP).  (All are indexed to a value of 100 at the start of the year).

On the other hand, we have seen net inflows into financial (XLF) and commodity-related (XLB, XLE) ETFs during 2014 and strong recent outflows from technology (XLK).

I'll be tracking these data on the blog to identify shifts in sector rotation and where funds are flowing.  If you take a look at the sector performance graphics from FinViz, you'll see that returns have been very different depending on sector exposure.

Other interesting possibilities crop up with these data:  historical queries based upon money flows; sector-based pair trading ideas based on flows; tracking divergences among flows for signs of market turning points; etc.

One of my personal disciplines is to always have a market research project ongoing.  Those projects always have a quantifiable component, so that I can objectively gauge their promise--and their limitations.

From pharmaceutical firms to technology enterprises:  companies adapt to changing markets with continual research and development.  It's not a bad model for traders looking to build long-term careers in markets.

Further Reading:  Creativity in Trading

Should I Seek a Trading Coach?

I receive quite a few inquiries about the coaching of traders.  I enjoy working with traders and have been privileged to share many ups and downs with skilled market participants.  That being said, I'm not convinced that seeking a coach is the answer for many market-related woes.  Here are a few questions to ask yourself before considering engaging a coach:

1)  Do I need a coach or do I need a mentor?  A mentor is one who teaches markets and trading: who has experience in markets that you can learn from.  Many coaches are not active in markets and don't trade.  Many times struggling traders need role modeling and learning, not psychological assistance.  Problems in your trading are just as likely to cause emotional upset as the reverse. 

2)  Do I need a dedicated trading coach?  Many times, an experienced psychologist can address the psychological issues facing someone in a performance field.  If, for example, you find that stress is interfering with your decision making, a therapist experienced in techniques for dealing with performance anxiety can help you every bit as much as a trading coach.  This is especially the case when personal issues that affect your life outside of trading contribute to your trading challenges.

3)  Can I do it on my own?  There are quite a few good self-help resources available on the web and in book form.  I wrote my most recent trading book precisely to help traders coach themselves.  You may also find that networking with experienced traders can set you on the right path.  

Only after you've addressed those three issues should you take steps toward finding a coach.  In an upcoming post, I'll address what to look for if you do take those steps.

Further Reading:  Succeeding as Your Own Trading Coach

A Look at Stock Market Money Flows

Punch up a chart of SPY and you'll see that, even with yesterday's drop, we're not far off the market highs and above the level at which we finished 2013.  (My flow index for the chart starts 2013 at a level of 100).

If, however, we look at the money flows in SPY--the product of the share price times the shares outstanding--we see a different story.  Money flows for SPY came off hard during the late January and early February decline and have only bounced partially back.  We remain well off the end of year highs.  

I like sentiment measures that reflect what real traders and investors are doing, not what survey respondents are saying.  You can see that market participants were gobbling up shares toward the end of 2013: prices kept rising and the shares outstanding kept expanding, reflecting strong demand.  A lot of that bullishness came off early in 2014, leading to the recent bounce.  Flows in SPY have stalled during the last few sessions.

The money flow concept is a handy one for assessing sector-specific ETFs as well.  Is money flowing into some sectors but not others?  Which ones are seeing sentiment extremes?  In an upcoming post, I'll take a look at a couple of interesting sector flows.

Further Reading:  Divergences in Money Flows

Positive Divergences Amidst the Negative Ones

Saturday's post looked at divergences in the new high/low data among U.S. stocks.  When hundreds of shares are posting fresh one-month lows despite market averages hovering near their highs, you know there's weakness under the surface.

With today's drop in stocks, we touched a five-day intraday low in the major U.S. indexes.  I can't help but notice, however, that we failed to print five-day lows in many emerging markets (EEM), including China (FXI), Brazil (EWZ), and India (PIN).  Until recently, EM equities have been downside leaders.  Should that dynamic change, we could see some fresh growth stories--and asset reallocations--on the horizon.

And, speaking of divergences, we've seen net redemptions in the shares of many U.S. equity ETFs since the start of the year, including SPY.  During the most recent weakness, however, we have not seen net redemptions.  What would it take to get institutional investors back to gobbling up equity ETFs?  Perhaps a global growth story, sparked by fresh EM interest, would do the trick.

On the radar for now--

Further Reading:  Five Ways to Improve Your Trading

Facing the Execution Gap: Running Your Trading Business

It is common for portfolio managers and traders to refer to their work as their business.  And, after all, why manage money if we're not in the business of achieving superior risk-adjusted returns?

It's interesting, therefore, that market participants don't make greater use of organizational psychology in maximizing their businesses.

It is easy for a trader to imagine that psychological issues are interfering with best trading practices.  Less commonly acknowledged is that one's trading is not well organized as a business.

What the graphic refers to as "execution gap"--the difference between what you intend to do and what you actually accomplish--is often a function of disorganization.  This is not necessarily the result of personality problems and emotional upheaval.  Rather, it is the understandable consequence of trying to keep one's eye on markets and opportunities and at the same time on one's trading business.

What if what you needed to best improve your trading was an improvement in the running of your trading business?

Here's a little exercise:

Think of yourself as a business organization.  There is you the trader, but there are also a number of others within your organization who you manage.  Those include the people you talk with about markets, the sources of information that you access, and even the people in your personal life who impact your energy and focus.  Every person and every resource that can influence your trading performance is part of your organization, your trading business.

Now, with that organizational mindset firmly implanted, read the article on 4 Disciplines of Business Execution.  In that article, Sean Covey summarizes ideas from his book of that name and explains four ways in which successful organizations narrow their execution gaps.  Ask yourself how you would score if you were to grade yourself on each of these disciplines.

As Covey notes:  "...if you want to achieve goals you've never achieved before, you have to do things you've never done before."

If you're looking inside yourself for your answers, you may be neglecting the running of your business.  It's great to work on discipline and trading your plans, but your plans are apt to be suboptimal if you're not properly harnessing and managing the resources of your business.

Imagine a restaurant owner who is so busy cooking meals and serving customers that he never adapts his menus  to changing customer tastes.  He is hard working and disciplined--and he goes out of business.  

Great money managers aren't necessarily great business managers--and yet it takes both to sustain a successful trading career.  Researching and trading markets is half the battle: the other half is charting our business direction and executing on that strategy.

Further Reading:  Questions for Your Trading Business

Readings and Resources for Starting the Week

Reading really is amazing...how else could we benefit from the ideas and inspirations from people all over the world at all periods of written history?

Here are some good readings and resources for starting the week:

*  Here's a blog from the PriceSquawk site on the advantages of hearing price action rather than watching it.

*  Quantifiable Edges on how the market would be trading now if it weren't for Fed meetings.

*  A look at the relative performance of financial shares and lots more financial links from Abnormal Returns.

*  Upcoming Battle of the Quants program and a worthwhile session on avoiding overfitting data.

*  Nice visualization of commodity performance for the week from FinViz.

*  Interesting trading strategies tested out by MarketSci.

*  Quite a compilation of quant-oriented posts from The Whole Street.

The Psychology of Quantitative Analysis

Early this morning I began my weekly routine of model building.

As a thought experiment, imagine taking every technical indicator out there and conducting a big factor analysis.  The factor analysis would reduce the number of indicators to a smaller cluster of factors that are relatively uncorrelated.  

This is important because it turns out that many indicators, from a purely mathematical vantage point, are measuring the same thing.  A 14-day RSI, for instance, may correlate very highly with a 14-day rate of change and a 14-day stochastics.  If you look at all three indicators, you're really looking at one variable measured three ways, not three unique variables.

What you really want are unique variables that are significantly correlated with forward price movement.

The bad news is that the many technical indicators out there really just boil down to a handful of unique variables.  The good news is that, overall, these unique variables do possess statistically significant predictive validity with respect to the prospective movement of stock index prices.  The challenging news is that even this significant predictive value leaves the lion's share of the future movement of stock index prices unexplained.

So imagine I identify a handful of unique predictive variables from among the large array of technical indicators and I identify the expressions of those variables that minimize their overlap.  From these few variables--it's important to reduce the likelihood of overfitting the data--I conduct a regression analysis and arrive at a statistically predictive model over an identified market regime.

Over the regime, let's say the model has been 65% accurate in forecasting the direction of S&P 500 Index prices over the next three trading sessions.  When the model has given its strongest signals (top quartile of forecasts), the average three-day gain in SPY has been .64%.  When the model has given its weakest signals (bottom quartile of forecasts), the average three-day loss in SPY has been -.28%.  This performance has held up well in out-of-sample testing.

Is this a good model?  It possesses a statistically significant "edge" and yet its R-squared, the amount of variance accounted for in future index prices, leaves about 90% of future action unpredicted.  A full 35% of the time, the model has been wrong in identifying future price direction.  And yet, a model that gets market direction right two-thirds of the time is better than throwing darts, assuming that we remain in the stationary regime that we backtested (an important assumption).

What quantitative work accomplishes for me psychologically is that it clearly identifies what is known and what is unknown.  It gives me a sense for when there is an objective edge and it provides a sense for the fragility of that edge.

Does quant modeling "take emotion out of trading"?  No, but it does something more important.  It replaces the emotions associated with overconfidence and confirmation biases with a different set of emotions: the humble respect for what is unknown, the desire to expand the frontier of the known, and the felt imperative to quickly adapt to what Victor Niederhoffer calls "ever-changing market cycles". 

Further Reading:   
Predictability as a Market Variable

Quant Reading:
See publications section of Marcos Lopez de Prado's site

A Quick Look at the Market Tide

My chief market analyst is a bit cautious on the stock market.

The chart tracks all common stocks making fresh three-month highs minus those making three-month lows.  Back in mid-January, I became cautious on stocks because we were hovering at then-price highs and yet many fewer shares were participating in the strength.  That preceded the market tumble into early February.  

Now we see much the same thing happening.  On Friday we touched a price high in SPY and yet 847stocks made fresh three-month highs and 466 touched fresh three-month lows.  By way of comparison, we had 1626 new three-month highs on March 4th and only 101 three-month lows. 

Friday's high price in SPY was not confirmed by consumer discretionary shares (XLY); S&P 400 Midcap shares (MDY); homebuilder stocks (XHB); retail stocks (XRT); raw materials shares (XLB); consumer staples stocks (XLP); and healthcare stocks (XLV).  

NRK likes rising tides that lift all boats.  When she sees many boats not rising, she tends to question the tide.

Enhancing Your Information Processing

Yesterday afternoon I had the pleasure of speaking with Terry Liberman and Eric Cassidy from WindoTrader, a software platform that offers unique chart displays grounded in the Market Profile framework.

Notice the unique chart display above.  The entire period is captured at left in a profile view, displaying the prices with the greatest volume (far left) and the prices arrayed by time period (traditional profile).  The chart then segments the session into 14 large bars, with traditional bars inside the larger bars to show how price moved within the large bar period.  The large bars are color coded to show whether we are building value higher (green) or lower (red).  Notice the large rectangular bar that is arrayed horizontally across the center of the screen.  That is the session's value area.

The chart nicely shows how the market tried to establish value lower early in the session only to probe the opposite extreme of the value area. 

Notice how much information can be conveyed in a single display.  To be sure, any novel display takes time to learn and feel comfortable with.  With practice, however, traders can pick up on patterns that otherwise would go undetected with a traditional chart--particularly if they are guided by tested relationships derived from sound theory.

While on the topic of WindoTrader, check out their video series and especially the video detailing the concept of developing your "anchor trade".  That video nicely illustrates the value of looking at markets uniquely and developing bread-and-butter trades from your distinctive way of making sense of markets.  It's difficult to imagine you could achieve consistently better results than others by looking at the same information they do and processing it in similar ways.

Further Reading:  Countering Information Processing Biases in Markets

Creating the Right Trading Displays

In upcoming posts, I'll be showing a few ways of displaying information on charts that I find useful.

Much of short-term trading boils down to pattern recognition.  How information is displayed very much impacts the patterns that are perceived--and those that are missed.

What is important is that the chart clearly reflect the information most utilized by a trader in making decisions.

One piece of information I find crucial is perspective or context:  I want to see how the immediate, short-term action is related to the longer-term market auction.

A simple context is provided by the blue bars along the left axis.  Those display the total volume traded at each market price over the week's trade.  As you can see, we made fresh highs for the week this morning only to stall out.  It was helpful to see where volume had been distributed over the past few days, as that helps define what Market Profile traders call the "value area".  

A market that can't break out of a range is unable to establish value higher or lower.  The rejection of price above value in the morning led to the retreat back into the value range of the longer-term auction.

Markets continually establish value, reset value, and return to value.  Many of the day's best trades come from recognizing when a move away from value is gaining acceptance or finding rejection.

Further Reading:  Markets in Profile

The Limits of Self Belief

At most places where I have worked as a trading coach, I have been involved in the hiring process.  That has given me a fair amount of experience with interviews and interviewees.

What I can tell you is that the correlation between a candidate's self-professed passion for trading and the actual time/effort they spend understanding markets is close to zero.

The correlation between a candidate's stated confidence in their trading and trading methodology and their actual results is also about zero.

The most confident candidates I've encountered--those who target returns not achieved by even the most successful portfolio managers I work with--almost never can objectively document consistently good returns.

Candidates who come in with their actual, verifiable results, document their risk-adjusted returns, and clearly outline the limits as well as the promise of their methods are very often the ones who excel.

Promising candidates detail their trading processes, not their promise.

As outlined by recent research, it all seems as though confidence doesn't necessarily breed success.  Interestingly, the self-reported writing skills of college freshmen has been going up over decades, while actual writing ability has dropped.  Students rate themselves much higher in drive to succeed now than two or three decades ago, but the average time they spend studying has dropped meaningfully.

Whereas modesty was a common norm decades ago, it is now understood that successful people have to project confidence and tremendous self-belief.  This has led to a kind of ambition inflation, in which--crazily--above 75% of students rate themselves as "above average" in their drive to succeed.  One wonders whether that proportion really exhibits either drive or success.

Genuine confidence comes from hard work and hard experience: putting in the time and effort to achieve mastery and getting knocked down enough times to know--deep in your soul--that you have what it takes to succeed.  It springs from that "grit" factor described by Duckworth.  Stated confidence without the hard work, without the experience, and without the demonstrated grit is self-promotion at best, delusion at worst.

The old pros know: it's when you think you're special that markets are most poised to prove you wrong.

Further Reading:  The Power of Uncertainty

Small Steps, Large Changes

In the recent post on why changing oneself is so difficult, I drew on the work of Kegan and Lahey, who emphasize that our "competing commitments" can make us immune to change.  They make the point that our "big assumptions"--our deeply-held beliefs about ourselves and the world--can stand in the way of implementing desired (and desirable) changes.

If I hold a deeply held belief that everything I do is destined for failure, then it's understandable that part of me would hold back from taking risks even though another part of me wants to take a calculated leap.  If my belief is that it is selfish to make money and focus on success, it's not surprising that I won't sustain the drive to achieve in business or in markets.

Amazingly, Kegan points out, people can be told that they need to take pills or else risk death--and yet a majority won't comply with doctors' orders.  That's not because they don't want to live.  It's because a competing drive makes it difficult to change their behavior.  

I had the honor and pleasure this afternoon of speaking with a wise rabbi from Beth Medrash Govoha in Lakewood, NJ. BMG, if you don't know about it, is a very unusual place, where students gather to study in self-organized groups and select their leaders--a place where the entire goal is learning for learning's sake.

The rabbi and I discussed change and he made an excellent point:  You can look at an ideal behavior--or someone who is ideal--and that can be inspiring.  But most of us are far from ideal and need to change one action at a time.  If you want to be a more generous person, you start by doing one generous thing each day.  No big change--just a step in the right direction.

Now it turns out that this is how people overcome many forms of anxiety, such as phobias and PTSD.  They very gradually, but very steadily, face the thing they are afraid of and build one successful experience after another.  Each step is not a large one, but after a while people are facing things they could never have tolerated earlier.

If you're not working on change daily, you're not working on change.  And if you try to accomplish massive changes in one day, you run the risk of activating competing motivations and derailing your efforts.

When change is each day in small ways, you gradually experience yourself in new ways...and soon that experience becomes part of your identity.  Most people are not immune to change.  They are immune to big changes.  The key to remaking yourself is to find the small steps that add to big changes without setting off alarms.

Further Reading:  Creating the Right Life Mirrors

What We Can Learn From Correlations Among Stock Market Sectors

As we saw in the post on Julian's video, we can gather a great deal of information from patterns of correlation.

Above is a measure of rolling correlations among major U.S. stock sectors that I track daily.  Basically it's a moving average of a composite of the correlations of each sector with every other sector.

Correlation has been percolating higher of late, but is not yet at levels that have been associated with recent market bottoms and snap-backs.

Since 2013, I notice that the average five-day return in SPY has been about .25%.  When the correlation among sectors has been above .80, the average five-day return has been .49%.  When the composite correlation has been below .80, the average five-day return has been .06%.

When stocks peak, they tend to move their own ways as sector rotation sets in and strong shares stay high while weak ones begin their declines.  When stocks fall, they tend to fall in unison--and then often bounce back in unison.  

It's not just about how stock indexes move; it's also about how stocks move relative to one another.

Further Reading:  Intraday Correlations Among Stock Sectors

Changing Your Self: Why Change is So Difficult

Making changes in life--and in trading--can be scary.  Every change is a voyage from the more known to the less known.  The pull of habit and safety can become a weighty anchor, grounding us when we long to soar.

This morning, a wise trader suggested to me that people don't fail to make changes because they lack motivation or because they have some need for self-sabotage.  Rather, people long to make changes and still can't sustain change because they have other, hidden commitments.

When you desire to change your trading or your lifestyle or your relationships but find yourself stuck re-reading old life chapters, it is because something in those chapters pulls you back.  Disrupting your overt motivation to change is a hidden motivation that has been operating in the background all along.

The trader who cannot bring themselves to take more risk has a hidden commitment, perhaps for safety.  Until that hidden commitment is actively engaged and addressed, it will work at cross-purposes with the desired goal.

How do you happily integrate hidden commitments with personal goals?  The first step is to become aware of those commitments--and to recognize that they are there for a (usually good) reason.  In the next posts in this series, we'll examine the change process and how traders can bring their real selves closer to their ideals.

Further Reading:  The Importance of Discrepancy in Change

Getting More By Giving More: Creating Positive Spirals

Overnight I received an email from my son Macrae.

Crae *never* emails.  We text, we talk on the phone, but no email for this millenial dude.

But Crae emailed overnight and expressed a heartfelt interest in connecting with his siblings and their kids via Skype.  His reasoning was impeccable:  we have large family reunions annually, but this way we could be more connected by the time we actually connect in person.

Now you have to understand, Crae is in the middle of a challenging job hunt and has a fair amount on his plate.  But out of the blue he emails and thinks about connecting with those he cares about.

It turns out that people all around the world have similar stories to tell about reaching out, caring, and giving.  Check out the "stories" page on the I Like Giving site.  It's all about people feeling good about doing good.

In Barbara Fredrickson's research, she found that people who practiced lovingkindness meditation daily experienced physiological benefits in terms of greater heart rate variability and psychological benefits in terms of greater well-being.     

But here's the catch:  practicing lovingkindness meditation actually led to a greater number of loving experiences in subsequent daily life--which then *added* to well-being and physiological benefit.

In other words, reaching out to others in thought led to reaching out in action, which led to more good feelings and more reaching out:  a positive spiral.

How many traders, consumed by the challenges of their profits and losses, stay isolated in front of their screens, thus facing a negative spiral?

Instinctively, Macrae realized that to overcome personal challenge you have to look beyond personal challenge and broaden your universe.  It's one of psychology's great paradoxes:  When you're not getting enough from life, it's time to start giving.

Further Reading:  Giving Thanks

Succeeding at Trading Through Innovation

One of the distinguishing features I've found among successful traders is that they innovate.  They don't look at the same markets in the usual ways.  They find new ways of viewing and trading markets.

Here is an excellent video from high school senior Julian Marchese, who is one of the founders of the Leaders Group mentioned in an earlier post.  He demonstrates how he uses a correlation workbook in Excel to identify potential "relative value" or "mean reversion" trades.  The workbook also shows which macro markets are moving with others, highlighting particular themes that are dominating the macro trade.

When I first met Julian, he had no particular experience with quantitative analysis or Excel programming.  He taught himself the relevant skills so that he could become multifaceted in his views of markets.  His key insight is that markets don't move in isolation:  many times they move thematically, in response to macroeconomic developments.  By tracking the correlated movement of assets, it is possible to read the themes that are driving market action and bet either on the continuation of those themes or their reversal.

Further Reading:  Pain and Gain in a Trader's Development
 

The Psychology of Trading Edge

We saw a nice thrust upward in stocks yesterday, as we went from a situation in which fewer than 30% of stocks traded above their three-day moving averages to one in which over 80% closed above that benchmark.  (Kudos to Index Indicators for the chart and data). 

So what has happened historically after a situation in which the difference between stocks trading above their three-day averages moves 50+% in a single day?  By definition, that captures a move in which we start with most stocks below their short-term moving averages and finish with most of them above.

Going back to mid-2006, when I first began archiving these data, this has occurred 39 times in a VIX environment < 20.  Over the next five trading sessions, SPX has been up 24 times, down 15 times for an average loss of -.26%.  Winners have been more common than losers, but the average size of losers has exceeded that of winners handily.

No edge in that particular pattern.

Which can be information.

But suppose I *need* to find an edge.  I keep running historical queries until something "significant" pops out.  Perhaps I even fall prey to confirmation bias and keep running the studies until something supports my preexisting market view.  If we run 20 studies, we've got a decent shot at finding the one in 20 that meets a significance criterion at the .05 level!

Confirmation bias is an understandable challenge in a field where confidence is needed to put on trades.  Running studies until something looks good--or cherry picking the charts to look at--is an understandable bias when traders are seeking confidence.

Sometimes, however, the answer is that there is no meaningful directional edge in a given market.  It's like drawing a poor hand at the poker table.  The pros know when to play and when to muck their hand.  There is an important difference between the motivation to trade and the motivation to make money.

Further Reading:  Avoiding Confirmation Bias

The Real Reason Traders Struggle With Discipline

If there's a single theme that dominates discussions of trading psychology, it's discipline.

Traders are routinely encouraged to control their emotions, stick to their processes, keep journals, whatever.  If you lapse in your trading, it's because you're not sufficiently disciplined.  Call it the puritanical approach to trading: if you don't stick to the straight and narrow, yours is a failure of willpower and commitment.

Research provides us with a different picture, however.

Willpower is a limited resource, tied to glucose levels in the brain.  When we exercise willpower in one set of circumstances, we can become depleted for the next ones.  Spending hours in front of a screen is an activity tailor-made to deplete willpower.  Overtrading and breaking one's trading rules, from that perspective, is less about self-sabotaging and more about the limits of our capacities for self-regulation.

The good news is that willpower really is like a muscle, in that it can be built over time.  Until your willpower muscles are of bodybuilding quality, however, an important trading practice is simply getting away from screens and renewing one's energy and focus.  Quick exercise, a drink of lemonade, a power nap--all are ways of restoring discipline.

Ironically, it's often the most driven performers who drive their willpower into the ground, leaving themselves frustrated with themselves and their performance.  It helps to think of trading more as a distance race and less as a sprint: pacing oneself is key to finishing the race.

And how far can one train one's willpower?  Check out the feats of David Blaine or watch the Penn and Teller movie "Tim's Vermeer".  It may well be the case that the reason passion for one's work is essential to success is that only such passion provides the gym time needed to build world class willpower muscles.

Further Reading:  Discipline: Cause or Effect of Trading Problems?