Adding Vision to What You See in Markets

Strangely, I find that traders who describe themselves as visual--i.e., they make extensive use of chart displays of prices and indicators--are among those who trade with the least vision.  They make inferences from what they see; not from an understanding of what lies behind the displays.

Take VIX, the popular measure of volatility implied by options pricing, as an example.  We might make inferences about whether stocks will go up or down based upon VIX being stretched to the upside or downside.  What we know, however, is that VIX tends to move inversely with index price.  VIX also tends to move up or down with realized volatility.  So when we look at a display of VIX, are we truly seeing a reading of options-implied volatility or are we seeing a conglomeration of several correlated variables?

To illustrate the point, I built a simple model of VIX that eliminates the overlapping influence of previous price movement and recent realized volatility.  This adjusted VIX measure captures the degree to which implied volatility is high or low relative to what we would expect based upon previous price movement and realized volatility.  A high adjusted VIX means that options are pricing in more volatility than we would normally expect from the recent price movement; a low adjusted VIX means that options are pricing in less volatility that we would normally expect.

I went back to 2012 and divided the adjusted VIX into quartiles.  When the adjusted VIX was in its strongest quartile, the next five days in SPY averaged a gain of +.49%.  When the adjusted VIX was in its weakest quartile, the next five days in SPY averaged a gain of +.72%.  When the adjusted VIX was in its middle two quartiles (i.e., when VIX was pretty much in line with what we'd expect from recent price action), the next five days in SPY averaged a loss of -.01%.

In other words, all the market's gains since 2012 can be attributed to "mispricing" of VIX.  But you would never see that in a simple chart of VIX.  

Trading by sight does not always bring vision.

For those interested, the adjusted VIX is currently in its lowest quartile, understating the price movement we've seen recently.

Further Reading:  Pure Volatility
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Promising Ideas to Start the Trading Week

*  I've found it helpful to track the correlations among the various sectors of the SPX by using creating an overall correlation index from the sector ETFs.  What you typically find is that, as cycles top out, there is divergence among the sectors.  That shows up as a drop in correlation.  Conversely, at market lows, there tends to be a risk-off washout across sectors.  That results in a rise in correlation.  I went back to the start of 2014 and divided the sector correlation data into quartiles.  When correlation was in its highest quartile, the next 10 days in SPY averaged a gain of +1.87%.  All other occasions averaged a loss of -.01%.  In other words, periods of elevation in correlation have accounted for all of the market's gains over that time.  We're not in that highest quartile at present.

*  The techniques I'm currently working on for improving concentration, mood, and performance are ones that involve a major shift in states of consciousness.  When we are in radically different states, we can access new information (intuition) and fresh energy.  We can also break old, undesirable patterns of thought and behavior.  This post outlines the essence of the approach.

*   A great and simple crowdsourcing strategy for finding good ideas is simply to track the top clicks on the Abnormal Returns site each week.  I inevitably find something of value, such as the very interesting post on why pursuing yield might not be the wisest investment strategy.

*  Here's a great post on a great site:  combining value and momentum strategies, from Alpha Architect.

*  Thanks to a savvy manager for pointing out this very promising line of research from an excellent site:  what it means when returns on stocks and bonds are positively correlated, from MKTSTK.

Have a great start to the week!

Brett
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New Highs and Lows in the Stock Market and What They Tell Us

If you've followed the blog for a while, you know that tracking the number of stocks across all exchanges making fresh one- and three-month new highs versus lows is one of my favorite measures of broad stock market breadth.  Above we see the three-month new highs vs. lows (raw data from Barchart) going back to the start of 2014.  We can see that breadth improved recently, as small and mid-cap stocks outperformed large caps.  Even with that improvement, however, we still see fewer stocks registering new high vs. low strength relative to the end of 2014.  Contributing to recent weakness has been not just large caps, but also commodity-related shares.  I continue to view this as a rotational, range environment and most likely part of a broad topping pattern that will eventually lead to a meaningful correction.

Going back to 2012, the new high/low data have mattered.  If we just look at one-month new highs and divide the data with a median split, we see that when new highs have been high, the next five days in SPY have averaged a gain of +.11%.  When new highs have been low, the next five days in SPY have averaged a gain of +.55%.  It's yet another great example of how markets that look the best yield the worst returns on average.  The results are similar if we look at three-month new highs.  When those have been high, the next five days in SPY have averaged a gain of only +.01%.  When they have been low, the next five days in SPY have averaged a gain of +.64%.

Overall, chasing new highs and stopping out of long positions on expansions of new lows has brought subnormal returns.  We have had a trending environment since 2012, but not a momentum environment.  Understanding that distinction has been crucial to stock market returns.

Further Reading:  VIX and Stock Market Returns
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Shifting From Negative Emotions to Positive Performance

A portfolio manager I recently met with was stressed out, frazzled from long--and frustrating--hours of following overseas markets.  He wasn't concerned, however.  He simply explained to me that he was going to engage in a vigorous workout in the gym--a rapid sequence of stretching, running, and lifting exercises.  By the time he was finished, he explained, he was so pumped up that the endorphins overcame any sense of stress or distress.

The light bulb went on in my head.  His key to overcoming pressure and fatigue wasn't to chill out.  Instead, he found a way of accessing a positive, pumped-up state that was more powerful than his state of stress.  What enabled him to move from negative emotions to positive performance was emotional transformation:  a gear-shift of experience that overwhelms negativity with positivity.

The problem most of us make is that we address negative states by attempting to reduce our negative thoughts, feelings, and actions.  That keeps us in our same form; it doesn't transform.  When we are sad, trying to reduce our sadness will not bring happiness.  When we are stressed and drained, trying to slow down will not re-energize.  Counting to ten when we're angry can be helpful, but it won't bring gratitude.

The key to self-mastery is to improve access to our most positive emotional states.  What gets a trader out of a frustrated funk after taking losses?  Doubling down on generating the next set of ideas and letting the excitement of discovery wash over the sense of frustration.  Once we learn from negative experience, we want to put that learning into practice--but that requires a shift to a new and constructive mindframe.  As the recent article suggests, we cannot access that mindframe from within our existing form; we need to transform.

Here are five gateways to transformation that I have found useful:

*  Meditation, imagery, using music to achieve a different sense of mind and body;
*  Vigorous physical activity, exercise
*  Social activity, having fun, connecting with others in a meaningful way
*  Generating fresh experiences, going to new places, pursuing new ideas
*  Reaching out to others, engaging in activities that are larger than oneself

The common ingredient is the creation of new experience that accesses new states of mind, body, and emotion.  Turning negative emotion into positive performance means that we become very good at operating the gear-shift of consciousness, where we determine the states we're in and don't simply allow them to determine our course.

Further Reading:  Building Emotional and Physical Health
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Making Your Trading Fist: Five Fingers of Preparation

Coach K has it right: a finger by itself is far less powerful than five fingers joined into a fist.  When a championship basketball team prepares for a game, it doesn't just work on one thing today, another tomorrow, and focus on something else another day.  Rather, it works on fundamental skills and strategies every single day of practice.  That way, each finger of preparation makes a fist of preparation for success.  Coaches know that if a team can't fire on all cylinders in practice, they won't be prepared to give their all at game time.

During my time at Duke, one of the preparation drills for the basketball team was the requirement to make 10 consecutive free throws at the end of practice.  In other words, you couldn't go to the locker room, take your nice hot shower, and get back to your dorm room until you made 10 consecutive shots from the line.  Think about that:  you're tired, sweaty, just wanting to get into that shower--and now you have to concentrate and nail 10 in a row.  Imagine the frustration of making five and clanging the sixth--and then starting over.  Imagine the frustration of seeing your teammates drain their 10th shot and you're still struggling on the line.  

It plays with your head.

And that was the purpose of the drill:  If you could pull it together and make those shots in a challenging practice situation, you'd be better prepared to make that key free throw down the stretch in the heat of a tournament game.  

*That* is preparation:  placing yourself in realistic, challenging situations and training yourself to perform at your highest.  Preparation is not simply writing in a journal or scanning a bunch of charts or reviewing various pieces of research.  Each one of those things is a finger.  Preparation joins the fingers into a fist through full-throttle practice.

Imagine that, after every day, week, or month of poor trading in markets, you had to replay those periods one time unit at a time, make new decisions, and keep replaying those markets until you made the right decisions for the right reasons.  You could not resume real time trading until you successfully relived the periods of bad trading and--in realistic simulation--corrected your errors.

Such an exercise would force you to stay in the right mindset; focus on the right pieces of information; follow the right trading rules; make the right decisions; and manage the positions the right way.  It would join those five fingers of preparation into a practice fist.  

It wouldn't be fun, but it would be a powerful way to ensure that bad trading doesn't turn into bad habits.

Further Reading:  NCAA and Trading Upsets
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Why Courage is Key to Trading Success

As we can see from the above chart, which tracks the five-day moving average of VIX versus the SPX for the past three years, important lows in markets have tended to see spikes in short-term implied volatility (credit to Index Indicators for the chart and data below).  

Interestingly, if we bought SPX when the five-day moving of VIX was less than 15, the next five days in SPX averaged a loss of -.04%.  That would have resulted in a cumulative loss of -3.42% during a period in which the market rose by almost 47%!

Conversely, if we bought SPX when the five-day moving average of VIX was greater than 15, the next five days in SPX averaged a gain of +.52%.  That would have resulted in a cumulative gain of nearly 41%, versus the buy-and-hold of 47%.  In other words, the vast majority of the market's gains have occurred during periods of elevated short-term volatility.

My point here is not to suggest a trading system, though it's not difficult to conceptualize one from the idea of relative volatility spikes.  Rather, the point is that comfortable markets--those with modest volatility--have yielded negative returns.  Uncomfortable markets have yielded the bulk of market returns.  

A trader's returns have been directly proportional to his or her ratio of courage to fear.  Buying ugly markets has made superior returns; stopping out of long positions on ugliness has led to negative timing alpha.  Buying stocks when fear is gone and markets are orderly has not paid off.  

If there's a formula for trading success, prudent courage is not a bad start.  If there's a formula for trading failure, acting on fear--fear of missing out, fear of losses--is also not a bad start.  It's amazing how ramping up trading risk/size and trading frequency can turn prudently courageous traders into fearful ones.  If there's a formula for risk-taking, trading the largest size that enables you to stay prudently courageous during times of ugliness is a good starting point.

Further Reading:  Why Success Lies on the Other Side of Fear
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The Three R's: Winning Practices of Successful Traders

For this post, I reflected on the traders I've worked with who have been particularly successful and some of their common practices.  Here are three practices that seem to distinguish the best from the rest:

1)  Reviewing and Learning - The best performers keep score.  They review their performance--good and bad--and they made dedicated efforts to learn from mistakes and best practices.  It's much more than keeping a journal.  The successful traders use their observations of performance to fuel specific goals that they then track relentlessly.  They are not always making money, but they are always learning.  That helps keep them constructively engaged when profits are not flowing.

2)  Rejuvenating - Trading is not an easy business.  Income is very uncertain and markets can change on a dime.  Working twice as hard does not guarantee success, but working half as hard pretty well ensures failure.  Average performance keeps you a job and a paycheck in many areas of life, but in trading it leads to bankruptcy.  Successful traders have strategies for staying happy and healthy through the ups and downs of performance.  My recent post outlines a four-fold scheme for staying happy and healthy.  Successful traders turn wellness into a positive habit pattern.

3)  Reflecting and Preparing - Perhaps the single best predictor of trading success that I've found is the ratio of time spent in preparation relative to the time spent actually trading.  Successful traders spend more time researching markets, observing markets, thinking about markets, and reflecting on their trading of markets than they spend placing orders and managing positions.  A very common pattern of trading failure is ramping up the frequency and sizing of trades, both of which tend to increase the proportion of time spent in a flight-or-fight state and decrease the proportion of time spent in planning and observing.  Successful traders are selective in risk-taking and use the time between trades to work on self and markets. 

So those are the three R's of trading success.  They are all about working on oneself in addition to working on markets.  It's what the trader is doing when not trading that contributes greatly to trading success.

Further Reading:  Traders' Checkup
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Best Practices in Trading: Conducting Video Reviews

One of the limitations of reviewing our trading and constructing plans based on our reviews is that our look back usually is tainted by what we recall and what we do not.  Particularly if we trade actively during a day, it's unlikely that we will recollect all the factors that went into good and poor trades.  We may even forget what specifically happened during a particular trade that might have made it work out or not.  Our memories are biased by our emotions, as well as hindsight and the factors that most stick out in our mind.  It is difficult to effectively review our trading if we can't accurately recall our trading!

The way sports teams get around that, of course, is by videorecording each play and examining the video in detail to spot best and worst practices.  Today's best practice is offered by reader Chris Britton, who video records his own trading and uses the review to work on his performance:

"I am a discretionary day trader and I trade the 10 year note and 30 year bond futures.  My pre-market analysis consists of identifying key support/resistance levels (yesterday's value area high, low, vpoc, etc).  For actual trading and getting a feel for the market action, I watch the depth of market with support from a chart to watch for emerging support/resistance levels.  

What I find helpful in doing trade reviews is recording my trading session (using Camtasia or the like).  At the end of the day, I cut down the video to the important parts that consists of trades that I make and trades that I missed or whatever I feel may make an important point.  Then I add in notes on the video that point out interesting clues that I keyed in on or missed.  The finished video is anywhere from 10 to 30 minutes long depending on how many trades I make.  The key points in the video present the context of the price action, the order flow on the depth of market that show why I entered (or did not enter), and, in some cases, why I exited when I did.

How does this help me?  First, the recording helps me identify strengths and weaknesses in my ability to correctly read the order flow.  From that, I have built a library of my own "best setups" or "avoidable pitfalls".  For example, I can review trades that had a successful breakout at some resistance level and compare the order flow from those to trades that had a failed breakout.  The key element is spotting what the order flow was doing that made the difference between the two.  If my skills can't explain it, then at least I have the library to review in the future for when my order flow reading skills will be improved.  

Second, the trade reviews at the end of the day are actually enjoyable.  Even if a trade is a loser, I enjoy watching the video.  That is because in some way, I improve my depth of market reading skills. Before I was making recordings, I dreaded the losing trade reviews and trying to remember what I did wrong.  That opened the door for bias to creep in which make learning from the mistakes harder.  With the recording, I learned that I can't escape my own accountability in making errors.  

Finally, play back reviews during slow periods or on the weekends actually help keep my mind sharp and prepare me for the next trading session.  I have found that while watching these reviews, the dialogue in my mind takes on an instructor type role where I try to explain the play by play action."

I particularly like Chris' observation at the end, where he notes that watching reviews places him in an instructor role.  That reflects the impact of self-coaching.  When Chris watches the videos, he is like a coach reviewing game film with players.  Going to specific portions of the video, reviewing the elements of performance in detail, and noting what could be done differently adds a level of detail to review that is impossible to replicate with a retrospective journal.  As Chris notes, the reviews become enjoyable, because they are constructive--they teach--and don't simply point out negatives.  

If pattern recognition is a function of cognitive focus and amount of exposure to those patterns, then a focused, video-based review is a great way to accelerate a trader's learning curve.  The trader who has watched markets during the trading session and then focused on patterns in post-market review simply has more learning experience per unit of time than the trader who fails to conduct review.  The video review is a powerful tool for learning and self-coaching.

Further Reading:  Viewing and Reviewing Your Performance

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New Perspectives for a Market Monday

*  Above we see a chart of the total number of SPX stocks making 5, 20, and 100-day new highs vs. new lows each day.  Note the tendency of this multiperiod breadth measure to top ahead of price during intermediate-term market cycles.  The measure has remained strong recently.  Interestingly, going back to 2012, when the multiperiod measure has been positive (more stocks making new highs than lows), the next five days in SPX have averaged a gain of +.15%.  When the measure has been negative, the next five days in SPX have averaged a gain of +.71%.  Yet another example of how momentum trading (buying strength and selling weakness) has not worked for stock index traders in recent years.

*  Fascinating research on how we can live longer lives, which is also how we can live happier and more successful lives.  Very important topic:  sacrificing quality of life ends up sacrificing life.

*  Trading when you have a full-time job and other valuable insights from Abnormal Returns.

*  Great post from WindoTrader on the importance of preparation in the success of elite performers.

*  Interesting cross currents in the volatility market from Volatility Made Simple.

*  Crosshairs Trader on the psychology behind three types of traders.

*  Valuable trading lessons from SMB.

Have a great start to the week!

Brett

Best Practices in Trading: Maximizing Your Information Processing

The typical trader works from multiple screens and each of the screens carries multiple pieces of information updated in real time.  Some screens update charts; some update news; some are for messaging; some track quotes across many markets.  No trader wants to miss a fast-breaking development, so the temptation is to add screens and add more data to each screen.  Can traders really process all that information in real time?  How much of what appears on our screens truly is information--and how much is distraction?

Today's best practice comes from Terry Liberman from WindoTrader.  He emphasizes the importance of understanding and owning your trading information processing system.  Years of experience in developing effective trading platforms have taught Terry quite a bit about how traders process information.  His key point is that we cannot maximize our processing of market information unless we understand our information processing strengths and play to those.  One of the unusual features of WindoTrader is the ability to overlay information displays on one another, so that the trader can visualize price action on several time frames simultaneously.  For a highly visual information processor, this can provide a significant cognitive efficiency.

As Terry points out, the best practice of streamlining information to fit your processing style is increasingly important, given the explosion of data available to traders:

"As we know, there is no shortage of information because this is the Era of Information Overload on Steroids.  The important thing for those of us who trade is to be able to quickly and easily find the information that meets our requirements as to relevance, usefulness, applicability, and fit.  

One way to think about information processing is to recognize that data are not information and must first be converted into information through your filters of relevance, importance, and applicability.  Once they become information and meet your criteria as information, you now have knowledge and some understanding of it so you can make some decisions about it.  And then, once it meets your requirements, decide how you're going to act on it in alignment with your performance criteria.

To increase your ability to collect the information your require and process it, begin with the information you need, why you need it, and the benefit it will specifically provide you at this moment in time.  Next, determine both the context and the content of the information as well as its validity overall and its validity for you.  And finally, plan the specifics for using it and gaining the most from it in your pursuit of achieving your goal or goals.  To read something fun as well as thought provoking, check out Information Anxiety."

Terry makes a very important point:  trading is, at root, a cognitive process.  It is all about taking in data, assembling data into information and insight, and making decisions based upon the ongoing streams of information and insight.  How much of what is on our screens is truly essential to our decision making?  How many screens would we employ and how cluttered would each screen be if we only focused on the data most relevant to our trading decisions?

Streamlining our information processing forces us to think about our thinking and follow our chains of reasoning in generating sound trading decisions.  Terry's best practice is not just optimizing our screens; it's optimizing our thought processes and then adapting our screens to the best of our processing.  More is not better; many times it's fast information processing that is as important to trading as deep information processing.  By carefully organizing what is on our screens and how it is displayed, we can improve the efficiency as well as the effectiveness of our thought processes.

Further Reading:  What Trading Teaches Us About Life
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Best Practices in Trading: Breaking Your Cycles

The first step in changing any damaging behavior pattern is interrupting it.  When we interrupt a pattern, we necessarily stand apart from that pattern.  We control it and refuse to let it control us.  When our patterns show up during trading--patterns of negative thinking or patterns of poor trading--a surprisingly powerful response is to simply pause what you're doing, identify the negative pattern, and refuse to let it control you.

One implementation of this idea comes from reader Eldad Nahmnay, a daytrader who shares his five minute rule:

"After reviewing my trading, I saw that I had a lot of repetitive trades.  By this I mean that less than five minutes after I had closed a trade, I was back in a new one.  Usually this occurred after a losing trade.  This made me realize that I hadn't accepted the loss completely and was looking for a sort of revenge.  After understanding this, I added the five minute rule:  after a trade, I close the system for five minutes when I ask myself the following questions:  What have I done well for this trade?  What can I take away to help with later trades?  Do I have any open emotions that can affect me later?  Did I do anything that violated my trading rules?  

After answering these questions, I take a minute or two away from the screen to come back fresh.  The number of poor trades that I took was reduced by more than 70% after I implemented this rule."

Notice this Eldad's rule is really a routine to develop mindfulness in the middle of the trading day.  By taking a break after closing each trade, he is able to stand apart from markets (and his reactions to markets) and ask himself key process questions.  The five minute break interrupts any negative patterns that may have leaked into his trading and helps ensure that a single bad trade doesn't become a series of bad trades.  By instituting the break after every trade, the trader turns mindfulness--and the breaking of negative cycles--into a positive habit pattern that gives both perspective and control.

Further Reading:  Brief Therapy and Becoming Your Own Trading Coach
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Best Practices in Trading: Creating Checkups for Your Trading

There's a lot to be said for a periodic checkup from the neck up.  It is easy to talk ourselves into trades, veering from our edge in markets.  How do we know if we're truly aligned with our best practices?  That's where checklists and checkups can be very helpful.

Today's best practice comes from Mike Bellafiore and Steve Spencer from SMB Capital.  They describe a twice-weekly checkup that helps ensure that junior traders are truly rigorous in their selection of trading ideas.  They describe the process that occurs on their trading floor:

"Each Tuesday and Thursday at 1:30 PM EST we meet in our firm training room in midtown Manhattan for...The PlayBook Checkup.  The PlayBook Checkup?  What, is someone sick?  No, there are no doctors or nurses present; just traders and developing traders.  This is a best practice that has helped our traders identify and maximize their trading edge.

Here's how it works.  A junior trader on our desk prepares a trade in template form--an SMB PlayBook trade--of a setup that makes sense to him or her.  Then, he/she presents this trade to other traders in our training room.  I host this learning session with tough questions to the trader regarding stock selection, a trade catalyst of lack thereof, preparation or lack thereof, thinking, and execution.  Here I 'checkup' on the favorite trades of our new traders--their edge.

The junior trader breaks down a favorite trade into five variables for their presentation (the SMB PlayBook Template):

a.  The Big Picture
b.  Intraday Fundamentals
c.  Technical Analysis
d.  Reading the Tape
e.  Intuition

Each day our new traders archive a setup that made the most sense to them before they leave the trading floor.  From these PlayBook trades they choose one to present under the pressure of constructive scrutiny during the PlayBook Checkup.  They know to choose wisely and be ready to defend their trade.

Some phrases heard in our training room during these sessions:

*  Yeah, don't make that trade again.  You are not going to make money trading plays like that.
*  Where could you have been bigger in that trade?
*  How the heck did we allow a Boston Red Sox fan into this firm?
*  You have to be bigger in this trade.  You are leaving money on the table by not being bigger.
*  If you are not going to properly prepare for a trade, what makes you think the market will let you succeed?
*  This is exactly the type of trade you can build a career around.

Here's what the PlayBook Checkup helps traders accomplish:

1.  Define their favorite setups
2.  Eliminate setups not worth their intellectual, financial, and emotional capital
3.  Guide traders to internalize their trading edge with their PlayBook
4.  Helps traders learn good risk/reward trades from their peers
5.  Offers them a trade review by a trading partner with a deep dive into a specific trade setup
6.  Provides a forum where standards of quality trades for our desk are set
7.  Teaches them how to think through their setups like a pro
8.  Builds an opportunity for us to bond, joke, and share a common learning experience"

This is a great example of how trading can become an effective team sport.  Steve and Mike institute the checkup as part of their training program, but in fact this is a process that any trader could implement with one or more trading buddies.  It enables traders to think about their thinking, hone their edges, and learn from each other.  The cumulative impact of engaging in such checkup review each week is significant.

Further Reading:  The Power of Teamwork in Trading
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Why Endurance is the Key to Trading Success

There is no characteristic more important to long-term trading success than the ability to weather setbacks and turn them into successes.   It 's not just that successful people endure longer; it's that they gain energy--they derive challenge--from the endurance.

Think about this:  losers are motivated by winning.  They need to win to thrive.  When they don't win, they lose their motivation, and that keeps them from winning.  Winners are motivated by losing.  Their struggles develop their strengths, and that contributes to future wins.

Yesterday was a kick in the teeth for some traders.  Anticipating a prompt pace of Fed normalization of rates, they were expecting a strong dollar and higher rates.  We got just the opposite.

The winners are those reassessing monetary policy, reassessing views and positions, reviewing what they might have missed, adapting to the new information, and learning from the experience.  When trades don't go their way, they may pull back their risk-taking, but they double down on effort, preparation, and the generation of ideas.  

It is that determination to gain from loss that gives the competitor a second wind.  When we're focused on losses, we get winded.  When we're focused on using struggles to better ourselves, we find our wind.  It's tough to finish a marathon race without accessing that second wind.

Further Reading:  Peak Performance Articles
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Tracking the Breadth of Market Strength and Weakness

I thought I would share a continuing work in progress.  This is composite index of all NYSE stocks giving buy vs. sell signals for two different technical systems:  Wilder's Parabolic SAR and Bollinger Bands (raw data from Stock Charts).  The chart above tracks a 10-day moving average of the index.  The index provides a general sense of "overbought" and "oversold".  Interestingly, the overbought readings do not lead to reversal on average.  Rather, if we look at the strongest half of signals since June, 2014 (when I began assembling these data), the next three days in SPY have averaged a gain of +.24%.  When we look at the weakest half of signals, the next three days in SPY have averaged a gain of only +.01%.  When many stocks are producing buy signals, there tends to be short-term upside momentum.  When many stocks are producing sell signals, on the other hand, we want to be on the lookout for potential reversal.

Note that we've been seeing overbought and oversold levels in the index at successively higher price levels.  That is what we would expect in an uptrend.  Where I've found the index to be particularly useful is in identifying momentum peaks that tend to precede price peaks during intermediate-term cycles.  The index has also been useful in identifying when we are getting buying interest coming out of oversold levels.  That is what we've been seeing most recently.  I like these kinds of measures, because they tell you how much distinctive strength and weakness we're seeing across the broad range of stocks.

Further Reading:  Identifying Trend Days
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Best Practices in Trading: Organizing Your Daily Routines

There aren't many hard and fast formulas for success in trading, but one that comes close is taking your best practices--what you do when you are successful--and turning those into positive habit patterns.  The way this is accomplished is through the creation of routines.  When we establish a routine--and then make it routine--we take our strengths and make them automatic.

Today's best practice comes from money manager @MPortfolios, who describes his process as blocks of routines:

"I've found a very beneficial component to the workday is having an organized routine, or blocks of routines, synced to the priorities of managing my practice.

I have an end of day routine that is investment management focused, where I perform a scan of all positions vs. their various 'by rule' stop levels to determine if any have triggered, if any have risen above maximum allocation levels, etc. and determine if replacement positions are indicated and what they will be.  This routine sets up the following morning's initial actions.

I start my day [second routine if I did have market open transactions to complete] by:  1. Checking notifications and scan prior day's transactions (dividends, inflows, withdrawals) to know what's on my plate from an administrative standpoint; and 2. Looking at macro spread charts of asset classes, regions, and market sectors for signs of underlying changes in the landscape.  (I use relative strength as a basis for a large part of my approach).

I've found that a really helpful byproduct of this, besides the obvious benefit of being organized, is that it fosters calm, systematic decision making."

I like the idea of blocks of routines, where to-do items are clustered based on their mutual relevance and then placed in sequence to aid the running of the trading business.  In my own work, one block of routines would capture my morning workout; another would describe my review of markets; another would involve trade planning; etc.  Each of those blocks, in turn, captures very specific activities that I have found to be useful in preparation and trading.

@MPortfolios observes that this organization is a psychological tool as well as an aid to work flow.  When we are grounded in sound routines, we can work efficiently and effectively, allowing us to devote our attention to the special situations that markets always seem to present.

Further Reading:  Turning Goals Into Habit Patterns
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Revisioning Trading Psychology: Building on Your Best

I completed the manuscript for my new book this past weekend and sent it to the publisher.  As has been the case with all my books, the final version is different from what I planned.  Researching and writing has a way of not only expressing ideas but developing and deepening them.  Part of the joy of writing is discovering what comes out of the process.

It was my hope that the book would help move trading psychology beyond the usual themes ("You have to be disciplined to succeed"; "Successful traders control their emotions") by drawing upon new research in psychology that is relevant to elite performance.  

The main themes of the text follow an A-B-C-D mnemonic:

*  A - Adapting to changing markets;
*  B - Building on your strengths
*  C - Cultivating creativity
*  D - Developing best practices and turning them into best processes

Years of working with traders and portfolio managers have taught me that it is not enough to find an edge in markets and stick to that edge unswervingly.  Markets are ever-changing, which means that long-term success depends upon finding ever new sources of edge.  That is not so different from succeeding in fast-paced industries, such as technology.  The edge that the laptop once shared vis a vis desktop computers is no longer a distinctive edge in the world of tablets and smartphones; the advantages of big box retailing are no longer as compelling in a world of online commerce.  In a competitive world, edges never remain static; the winners are those that can adapt.

That means that successful traders not only need to handle the stresses of trading, but also build on their cognitive and personality strengths to creatively find opportunities within markets.  Traders need research and development processes every bit as much as pharmaceutical and tech firms.  But we can't look at fresh things or view old things in fresh ways if we ourselves are not fresh.  Creativity is the new discipline:  success requires that having processes to stick to our edges always must coexist with rigorous processes for discovering new sources of edge.

Reverse engineering our successes enables us to identify best practices at each phase of the trading process.  It is when we link those best practices that we develop best processes that guide decision making.  Yes, it is important to learn from and correct mistakes.  Success also requires that we identify and leverage what we do well in markets.   

How many traders truly understand their distinctive strengths and have specific methods for applying those strengths to markets?  At times it seems as though half the trading world doesn't so much as keep a journal; the other half keeps a journal and writes down all the problems they're having.  Who systematically studies their successes and develops processes for learning from them and extending them?  That's where tomorrow's edge lies.

There are many exciting frontiers in trading psychology.  Once you realize that success comes from growth and adaptation, then it's easy to see that developing yourself as a trader and developing yourself as a person are one and the same.  We need routine to stay consistent as traders; we need to cultivate new routines to stay profitable as traders. 

Further Reading:  Solution Focused Links 
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Best Practices in Trading: Balancing Your Job With Your Trading Career

What if you want to develop yourself as a trader, but you need to bring in income right here, right now?  In that case, you may very well work a day job while you learn the ropes as a trader.  Balancing your job with your hoped-for career can be a challenge, but it can be done.  

Today's best practice comes from Sam Awad, who describes--tongue firmly in cheek--some of the strategies that help traders who have to make ends meet from 9 to 5:

"In my mind, the real unsung heroes of the trading world are people like me:  people who love markets, are invigorated by the intellectual pursuit of extracting money from the market; people who are willing to put up their hard earned capital against Ivy Leaguers, former Division 1 athletes, Ph.D. mathematicians and computer scientists; and who are just nutty enough to do it--while at work.

That's right.  We're the guys who work 8 hours a day, every day.  And when do those 8 hours occur every day?  Oh yeah, at the exact same time as market hours.  And yet for the love of the game and the dream of a new, free life, we persevere...Over the years, I've become an expert at this.  I have faded liquidity spikes while yawning through Monday morning meetings; navigated Fed speeches and pylons during fork lift training; caught a lucky bounce off a morning support level during a conference call; and given it all back rolling the dice on Non-Farms on casual Friday.

Through it all, I've compiled quite a few methods by which to achieve Trading at Work mastery:

1)   Negotiate an earlier starting time:  arriving at work before your co-workers may seem like an opportune time to work on company work, since you will spend the rest of the day trading, but really you'll use this time to research and generate your day's trading ideas;

2)  Volunteer for special projects:  this is the best way to ensure you always have an excuse for not getting day to day work done, and you look like a hero volunteering.  What do you do when those special projects come due?  Don't concern yourself with that right now.  When that day comes let Future You curse Present-Day, Money-Making You.  It'll be worth it.

3)  And this is the piece de resistance.  If at all possible, find a software program that looks similar to your trading platform.  It could be software that charts productivity analytics, or sales, or in my case, temperature and humidity monitoring.  Just get everyone in your office used to seeing those nice red and blue bars on your monitor and boom!  You've just bought yourself valuable screen time!

Sam's advice may not work well for job longevity, but it captures a challenge that many people face when they are first learning how to trade.  When I began trading regularly, I was teaching and running a student counseling program at a medical school.  Fortunately, students were engaged in courses during morning hours, which allowed me to follow markets early in the trading day.  I developed a trading approach that only traded opening setups.  To this day, if I trade intraday, my feel is best at and near the market open.

This, however, is where simulated trading and the ability to replay the market day can be extremely useful.  Once I finished work, I could practice trading with real prices and gain a feel for markets without jeopardizing my work during the day, which I loved.  I was also able to use evening hours to print and review charts, observe market patterns, and learn valuable lessons that have stuck with me to this day.  My current work extends from early in the morning to evenings, which has prodded me to learn to trade longer time frames.

Creatively integrating the work you do to bring in a paycheck with the work you do to learn markets is a best practice.  If you're creative, there are ways of having your cake and eating it too!

Further Reading:  Living the Purposeful Life
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Best Practices in Trading: Priming the Mind for Performance

One of the challenges of preparation is ensuring that what you've drilled when you're in practice mode will actually stick in the mind when you're in the heat of battle.  It is not at all uncommon for students to prepare hard for big tests, only to have the material they studied fly out of their heads during the exam.  What we process in a calm, focused manner and what we can access when we are hypercharged in flight or fight mode can be very different things.  That is why processing information more frequently and deeply (encountering the information in different ways) is essential to cognitive performance.  What we need to know if most likely to stick if we rehearse it well.

Today's best practice comes from reader Daniel Martin Schulz from Hamburg.  He describes a cognitive priming strategy that he has found effective in his trading preparation:

"Thinking back to high school and university times, one technique that often provided me with a welcome boost before important tests the next morning was to review particularly important material right before going to sleep (and I mean right before the head hits the pillow, virtually the last thing before sleeping, except maybe kissing your significant other good night). It continues to amaze me how the material thus reviewed “sticks”. It must be something about how our brain consolidates information and learned content during sleep (I am sure others have written about it but I have no link or article ready).

I do not review a huge amount of charts – only a handful of print outs of the markets I followed very closely during the day, that I traded and/or that I intend to trade the next session. I use 4 time frames for each market (daily, hourly, 15 min, 5 min – but these details are unimportant and the time frames will vary from trader to trader). What will not vary is that we can "seed" our unconscious/sleeping brains with something to work with during the night that way. A small advantage for sure – but ours is a business of hunting the ever so slight edge."

Daniel's review strategy is effective because it reduces the impact of interference from the processing of subsequent events.  Research suggests that an important part of creativity is an incubation process in which we relax our focus following intensive immersion in a problem.  Daniel uses sleep as that incubation period, achieving a kind of seeding of the mind.  This might aid both the recall of information studied and the integration of that information into fresh trading ideas.

Further Reading:  Paying the Tuition for Intuition
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