Sunday, May 31, 2015

Tracking Markets in Event Time

Here is a chart of the ES futures for the past month (blue line).  Each bar is not denominated in time units.  Rather, each bar is drawn after 500 price changes.  (Raw data from e-Signal).  Because there are fewer price changes in the overnight session and during midday hours, there are fewer bars drawn during those periods.  Busier early morning and end of trading day hours account for more bars on average.  Movement, not time, is treated as the market clock.

The red line represents price change over a moving 50-bar window as a short-term overbought/oversold measure.  In general, we've seen negative average returns over the subsequent 50-100 bars when we've been in the most overbought quartile of returns and positive average returns when we've been in the most oversold quartile.  I generally won't execute a longer-term trade unless we're oversold on the price-bar measure.  It's a nice way of buying dips/selling bounces, which saves money when trading rangy markets or choppy trends.

A psychological benefit of denominating markets in units other than time is that the charts slow down as markets slow down and pick up as markets pick up.  This is a helpful way of avoiding overtrading slow markets--and it is a nice heads up on when markets are slowing down and when they're picking up.  I also find the cyclical behavior of markets to be clearer when cycles are measured in movement rather than time.

The main takeaway is that if you look at markets in conventional ways, you'll generate conventional returns.  I consistently find that it's the creative ways of thinking about markets that hold the most promise for superior performance.

Further Reading:  Event Time

Saturday, May 30, 2015

Drawdown Diagnosis: Understanding Why You Are Losing Money

When you experience a drawdown in your profitability, the most important thing you can do is accurately diagnose what is going on.  There are three possibilities:

1)  Nothing is going on - The drawdown is normal and expectable for you and your trading approach.  Unless you have an insanely high Sharpe ratio historically (steady gains, modest losses), you can count on sequences of losing trades and losing days, weeks, and months.  You don't want to overreact to every losing period and continually change what you're doing; otherwise, you'd never build expertise in any particular trading modality.

2)  Market have changed - This is clearest when you identify shifts in market trends, volatility, and correlation over the period of your drawdown.  A recent Bloomberg article in which I was quoted makes this point very well:  young traders have not lived through rising rate regimes and could be surprised by changing market patterns (such as the correlation of stock and bond returns).  If your drawdown correlates with such a period of market change, some adaptation is in order.  Not all trading problems are psychological in origin.

3)  You are trading poorly - A dominant theme in my forthcoming book is the importance of knowing your best practices.  If you know what you do well when you are making money, you're most likely to be able to identify when you deviate from those strengths.  Poor trading can result from distraction, fatigue, frustration, and/or patterns of negative self-talk.  Until you address those factors, putting capital at risk undermines your trading business.

Markets continually challenge us, and that is what prods us to continually change.  Drawdowns are the market's way of telling us that we need to focus on our trading and not on screens.  Some of the greatest and most constructive changes in people's trading have been inspired by the most painful losses.

Further Reading:  Best Practices During Trading Slumps

Friday, May 29, 2015

When Coaching Is Not The Answer

Here are a few situations that I've encountered recently with traders:

*  A trader who showed talent but also tended to overtrade tried psychological exercises, journaling, reading books, and speaking with a coach.  Upon review, the trader appeared to have a lifelong pattern of poor attention.  A more formal evaluation did indeed find evidence of an attention deficit disorder.  The trader started on a new medication and has had far greater success with consistency in his trading.

*  A trader who made bad decisions during moody periods reported getting little joy from trading, despite working long hours.  A thorough evaluation found that he was experiencing little happiness overall, even in situations that normally would make a person happy.  He was evaluated for a form of depression known as dysthymia and started on a medication.  His sleeping, eating, and mood improved, as did his trading.

*  A trader who experienced unusual winning and losing streaks nearly blew up in his trading.  He described a pattern of past overuse of drugs and alcohol, as well as gambling binges.  He recently had been drinking to excess, especially after doing well in his trading.  He entered a program for addictions and began viewing his trading as part of an addictive pattern that he needed to change.

Check out the post on the greatest causes of trading problems that no one talks about.

Sometimes it's not about "controlling your emotions", "following your plan", or any of the well-intended advice given by mentors and coaches.

Sometimes an emotional problem is the result of a diagnosable disorder.   

It starts with a competent evaluation.

Make sure whomever you work with is competent to perform competent evaluations.

Coaches coach.  Mentors mentor.  Very often, they are not qualified to diagnose a disorder; nor are they financially incentivized to make referrals to medical and mental health professionals.  When all you have is a hammer, everything becomes a nail.  But not all problems that affect trading are trading problems.  And sometimes limitations are not just self-imposed beliefs, but very real disorders.

If you've been experiencing repeated problems and self-help has not been enough, reach out for qualified help.  It could make a huge difference in your life--and in your trading.

Further Reading:  Three Things That Can Improve Your Life Now

Thursday, May 28, 2015

A Look At Tomorrow's Trading Talent

The young people who will be tomorrow's Market Wizards are getting involved in financial markets right now.  What do tomorrow's stars look like?

We can get a start by looking at an unusual international club designed specifically for teen-aged up and coming market talent:  Leaders Investment Club.  I've met quite a few of the members and detect similarities that I believe will account for their future success:

1)  Talent, Motivation, Attitude - As the quote above suggests, having talent is not enough.  It's what you do with that talent and how you do it.  To a person, the up-and-coming trading talent displays a passion for markets and a strong can-do attitude.  Their optimism and energy level are infectious.  They don't hesitate to reach out and network.

2)  They Play a Different Game - This is very important.  An unusual number of the young, talented traders look at markets in unique ways and ask unique questions.  They are not reading the same old trading books and trading the same old patterns.  When I recently spent time with my grandson Ethan, who is not yet in high school, he eagerly asked questions about systems trading and showed me what he was doing to find replicable patterns in stocks.  He was asking questions I don't hear from much older traders.  Tomorrow's stars are raising questions that aren't being addressed today.

3)  They are Entrepreneurial - When you read the bios of the Leaders Club members, you can't help but be impressed with their initiative.  Many have started businesses, careers, and/or trading enterprises.  They enjoy a high degree of parental support for their efforts, and they display creativity in what they pursue.  I can easily believe that many of the Leaders Club members will not ultimately make their marks in markets, but will succeed in entrepreneurial ventures that express their underlying curiosity and drive.

4)  They Leverage Distinctive Strengths - The young stars are not good at everything, but tend to be distinctively good at something.  They draw upon strengths to express their interests in markets.  In the case of young Ethan, he was drawing upon math and analytical skills.  Within the Leaders group, one can find young people with unusual social and interpersonal strengths as well as those with canny pattern recognition and research competencies.  

Everywhere I see it:  talent is attracted to talent.  I've enjoyed organizing craft beer gatherings of successful traders and portfolio managers.  While our rising talent might be too young for those venues, perhaps they will accept my offer of a summer gathering in NYC to learn from one another.  Hats off to Julian Marchese and Austin Schwab for their early work in organizing the Leaders group.

Further Reading:  Blueprints for an Uncompromised Life:  Constancy of Purpose; Devotion to Development; Resilience; Enhancement of Perception; Multiplier Effects

Wednesday, May 27, 2015

Three Steps Toward Changing Our Lives

Sometimes we become stuck in unproductive patterns:  action patterns, thought patterns, patterns of relationships.  Although these do not bring us closer to our goals, they have been overlearned and thus take on a life of their own as habits.  Very often, today's unproductive pattern is one that was useful at an earlier phase of life.  If I grew up in an emotionally volatile household as a child, I may have learned ways of avoiding conflict.  That could have helped me maintain stability.  Now, as an adult, that same conflict avoidance may create problems in a developing romantic relationship.

There is always a three-step process to changing our patterns:

1)  Becoming aware of those patterns and their consequences - We generally don't sustain change efforts unless we are emotionally connected to the costs of our patterns.  Without that emotional connection, it is too easy to relapse into familiar routines.

2)  Making conscious efforts to modify the patterns - Change, initially, does not come automatically.  We are always unlearning one habit pattern and cultivating a new, positive one.  Research suggests that we are most likely to achieve and sustain change if we work on our patterns on a very regular basis.

3)  Rehearsing new patterns until they become new habits - In general, it's not too difficult to initiate change.  The challenge is sustaining change long enough to create constructive habit patterns.  Without efforts to sustain and consolidate initial changes, we again fall prey to relapse.

I was recently interviewed for an interesting article on the SciTech Now site.  The topic was the use of apps and online counseling/therapy for helping people make changes.  There is no question that apps and online interactions can be useful in a self-help context.  When it comes to changing ingrained patterns, however, the efficacy of online tools is less clear.

Research into psychotherapy process and outcome suggests that the quality of the helping relationship is the number one predictor of positive change.  We are more likely to achieve change if we can internalize something positive in a good working relationship.  Indeed, any form of counseling or coaching can be thought of as a leveraging of a caring relationship to achieve desired ends.  That relationship not only helps a person see their patterns and their costs in a more objective way.  It also creates a platform for sustaining the motivation to sustain and internalize change.

It's not always necessary to enter a therapeutic relationship to achieve life changes.  Think of parenting.  Think of personal trainers.  Think of mentors in career settings.  The right relationships are positive vehicles for change.  One of the best change strategies is to connect with someone who wants the best for you and make change efforts a shared project.  Some of the best therapy occurs in loving relationships.

Further Reading:  Creating the Right Life Mirrors

Tuesday, May 26, 2015

New Views for a Short Market Week

*  In one branch of my analytic work, I break the market down into five factors that potentially drive near-term returns: momentum, breadth, sentiment, correlation, and volatility.  The above regression model is derived from 2013 - present data and predicts next five-day returns in SPY.  Interestingly, volatility and momentum have been the significant drivers of the model.  While the other factors are correlated with future returns, they are not uniquely so--i.e., they overlap one another quite a bit.  I find it interesting that the model is more bearish now than at any time since the start of 2015 and has been deteriorating through the year.  When the model has been negative, the next five-day return in SPY has been a loss of -.25%.  When the model has been positive, the next five days have averaged a gain of +.57%.  That being said, the model accounts for far less than half of the total variance in forward prices, which means that there is more price movement *not* accounted for in the model than actually predicted.  This kind of work gives one a healthy respect for the role of randomness in near-term returns.

*  One consequence of the gender skew in trading:  Many of the traits we think are correlated with trading success actually predict sub-par performance and we fail to cultivate the traits that actually are associated with positive performance.

*  Ivanhoff Capital takes a look at a candidate to be the next Chipotle.

*  Changing your brain patterns and more great reads from Abnormal Returns.

*  Steve Burns on focusing on signal and tuning out noise.

*  See It Market tracks unusual options activity among stocks.

Have a great holiday-shortened week!


Monday, May 25, 2015

Three Steps In Overcoming Trading Fears

Many situations can be interpreted as threats.  That leads to an anxiety response and an activation of the body's fight-or-flight stress response.  Once we perceive something as a threat, we can either run from it or we can face it.  Facing a fear does not necessarily mean fighting or fleeing.  Sometimes facing a fear means refusing to act and choosing to not accept a situation as a genuine threat.  This is particularly the case when the source of threat comes, not so much from the present situation, but from past associations triggered by the present situation.  If I have taken a huge loss in a volatile market, the next time volatility rears its head, I might panic out of my position.  

Generally, there is no such thing as an "overreaction" to a situation.  Whenever something seems like an overreaction, it means that we are reacting to something in the past on top of what's happening in the present.  The extreme of this situation is traumatic stress, in which painful experiences in the past intrude in our perceptions of safety in the here and now.

As Mike Bellafiore's recent post points out, even positive events can be interpreted as threats.  If we've been stung when we've held onto winning positions, only to have them reverse and hand us losses, the next time we're up on a position, we might respond to winning as threat.  I've worked with many people who have been so hurt in relationships that they respond with an anxiety response any time a person tries to get close to them.  At such junctures, we often act in ways to reduce our anxiety--which may not be ways that are ideal for handling the situation at hand.

So how do we avoid the extremes of flight and fight and instead face our fears with a degree of realism?  Here are three important strategies:

1)  Slow Down - That fight or flight response speeds us up.  Under the influence of an adrenaline rush, our thoughts race, our bodies tense, and blood flows shift to the motor areas of our brains.  When we sit still, breathe deeply and slowly, and focus our attention, we slow down the body's fight or fight responses.  Cooling down when events heat up is a great way to stay mindful and planned.  The best way to cool panicky feelings is to keep the body in a chilled state incompatible with those feelings.

2) Treat Emotions As Information - Your emotions are either telling you about a genuine threat in the world or a perceived one.  The key is sorting those two out.  If you can stay mindful and use the emotion to trigger an analysis of the situation, you can either appropriately act on the threat or remind yourself that your reaction is more to the past than the present.  When you treat emotions as information, you go into information processing mode, not blind action mode.

3)  Rehearse To Perfection - Too often we step onto life's stage without proper rehearsal.  Any situation that generates a threat response can be mentally rehearsed through vivid visualization.  If we can keep ourselves chilled when we imagine stressful situations and visualize ourselves acting constructively, we create new mind-body connections that eventually carry over to real life.  If you conquer a fear 20 times in vivid mental rehearsals, it's much harder to overreact to the 21st situation that occurs in real life.

The recent Forbes article is an important one, not only because of the social issues it addresses in the trading world, but also because of its implications for the psychology of trading.  Research suggests that male traders are particularly prone to overconfidence bias.  Under greater illusions of control, they are more likely to overtrade.  This, in turn, creates more frequent losses--and more opportunity for subsequent emotional overreactions to loss.  It is not unusual to see traders swing between bold overconfidence and fearful underconfidence: the first sets up the second, especially when boldness leads to oversized losses.

The best antidote to fear is realism.  If we can turn fear into a stimulus for self-awareness and market awareness, we are most likely to face fears constructively.  Realistic trading expectations, including emotional preparation for inevitable periods of drawdown, are powerful tools in proactively addressing trading anxiety.

Further Reading:  The Naomi Principle: Overcoming Trauma

Sunday, May 24, 2015

How To Improve Your Trading Business

Think of your trading as a business.

Think of yourself as a business leader.

It's time to analyze your trading business.

Break down your business into the strategies you trade:  the patterns, setups, themes, asset classes, types of trades, and/or relationships.

Break down your profit/loss by strategy.  How much have you made on each strategy?  What is the variability of returns within each strategy?  How are the returns of each strategy correlated with one another?  Under which conditions do your strategies perform best and worst?

Now revamp your money management across strategies.  Allocate less risk to the strategies with the most volatile returns; most risk to the strategies with the best risk-adjusted returns.  Allocate less total capital to strategies that are highly correlated with other strategies; more capital to strategies that produce positive returns with low correlation.

You are starting to make the transition from being a trader to being a portfolio manager.  As a portfolio manager, your trading business is a diversified one, and you manage the allocation of resources across distinct opportunity sets.

There is still much to be done to be a great leader of your trading business.  There is research and the development of new opportunities.  There is also work to be done to improve efficiencies within each strategy:  how you express the views of your strategy; how you enter and exit positions; and how you scale into or out of positions.

Then, of course, there is self-management:  managing your life so that you're in the best possible shape to run your business effectively.

Your goal is to run the kind of trading business that you would invest in if someone was raising capital and doing exactly what you're doing.  

Further Reading:  Leading Your Trading Business

Saturday, May 23, 2015

Trading, Backwards

A shoutout to Bruss Bowman for pointing out this truly insightful video on backward bicycle riding.  Engineers made a simple change to a bicycle, such that turning the handle bars made the bike move opposite the expected direction.  Sure enough, that made the bike impossible to ride.  The video demonstrates this with humor and insight.  It turns out that it doesn't take much to disrupt the algorithms in our brains!

A somewhat similar experiment was conducted in the 1950's by Ivan Kohler, who had subjects wear prism glasses that distorted their vision.  Since that time, prism adaptation has become a well-studied phenomenon.  There is typically a period of disorientation, in which subjects wearing prism glasses cannot execute simple hand-eye coordination tasks.  Then, gradually, they adapt to the changed world and can function with the glasses.  When the glasses are removed, however, they return to a short period of disrupted functioning.  

Fascinatingly, people who wear the glasses but do not interact with the world during that period do not adapt to the new perceptual world.  It takes repeated experience to learn from errors and recalibrate one's perception.

Think about ever-changing financial markets.  Markets change in their patterns of volatility, sometimes moving a great deal, sometimes quite little.  Market shift in their patterns of correlation, sometimes moving in concert with other markets and other times moving more idiosyncratically.  Markets change their directional behavior, sometimes reversing moves within ranges, sometimes extending ranges within trends.

It is as if the market's handlebars continually change; as if traders constantly put on new glasses with different prisms.

If that is the case, then we would expect disorientation to be a natural part of the adaptation process.  We would also expect losses to be a natural part of adaptation.  Traders *can* adapt to changing markets, but only after a period of interaction with those markets.  

Anticipating those periods of disorientation is helpful to trading psychology:  one need not take them as threats if they are part of adapting to changing conditions.

Anticipating periods of disorientation is also helpful to risk management.  If we know that markets will change, we can keep bet sizes small enough to weather those periods when markets trade with backward handlebars. 

Not long after we seem to master markets, we become students again:  expertise over time is a function, not just of learning, but the capacity to relearn.

Further Reading:  Adapting by Becoming a Better Thinker

Friday, May 22, 2015

The Power of Apprenticeship in Trading

The recent post discussed how we can turn our defeats into development.  Since writing that, I received an email from an accomplished prop trader who leads a group within the larger organization.  That trader had just sustained the worst losing day of his career.  So what did he do to address the situation?

He stayed constructive.  He wrote a detailed analysis of what he did wrong and how he will learn from the mistakes going forward.  His focus was on making sure this doesn't happen again, not on blaming external forces for his drawdown.  He took responsibility, but didn't stay mired in self-blame.

He reached out.  He sent his analysis to me and to the heads of his trading shop.  His commitment to improvement and learning from the setback thus became public.  He asked for a phone chat with me.  Done.  You can tell the workhorses from the show horses, because show horses will never show you their ugly side.

He role modeled.  This is the best part of all.  He sent his analysis to the members of his team.  He used his setback to help his teammates learn.  Instead of trying to look like a guru, he showed them how to handle loss.  That is a lesson far more powerfully delivered than in any textbook or blog post.

I predict this trader will be a rock star.  By turning his loss into learning for all, he showed leadership, not just management.  And, of course, that could never have happened if his firm did not promote team building, learning at the desk, and apprenticeship.

At one hedge fund where I work, portfolio managers are encouraged to build out teams by hiring junior professionals who have particular areas of experience and knowledge.  Those developing managers add value to their teams and learn the skills of trading and portfolio management at the desk.  The hit rate on their success is unusually high.  Why?  Because they learn through apprenticeship, not through a classroom or through unguided experience in front of a screen.

When you have a team and can learn from the successes and failures of others, your learning curve is multiplied.  Whether you work at a trading firm or independently, a key to success is surrounding yourself with others who are capable of turning losses into lessons.  Sharing your experiences with others transforms those lessons into commitments.

Further Reading:  Managing and Leading Your Trading Business

Thursday, May 21, 2015

Assessing Demand and Supply in the Stock Market

By now readers are aware that measures I track closely are buying pressure (demand) in the market versus selling pressure (supply).  My measures are derived from a decomposition of the NYSE TICK, which is issued by the New York Stock exchange.  The TICK is a running total, updated many times per minute, of the number of stocks trading on upticks versus the number trading on downticks.  My buying pressure and selling pressure measures separate upticking from downticking in the time series, treating strength and weakness as distinct variables.  While demand and supply are reasonably well correlated in the short-run, that is not the case over a period of days.  Any given period can show high amounts of buying and high amounts of selling; high amounts of buying and low amounts of selling; low amounts of buying and low amounts of selling; and low amounts of buying and high amounts of selling.  Indeed, the interplay among buying and selling pressure is a useful way of tracking phases of intermediate-term market cycles.

As you can see from the charts above, we've recently made fresh highs in SPY.  During that period, we've seen below average buying pressure (the zero level is average) and more than average selling pressure (values below zero show heavier selling).  That suggests that more stocks have been trading on downticks than upticks, even as the broad market average has risen to new highs.  This is the first divergence we've seen in the cumulative NYSE TICK in many months.

This excess of supply pressures over demand helps account for the weak breadth of the recent rally.  Interestingly, yesterday we hovered at new highs in the index, but only 500 stocks across all exchanges traded at fresh one-month highs, while 389 touched fresh one-month lows.  Volume in SPY has also been unusually low during the past several sessions.  Since 2013, when SPY volume has been in its lowest quartile, the next ten days in SPY have averaged a loss of -.08%.  When volume has been in its highest quartile, the next ten days in SPY have averaged a gain of 1.41%.

A break to new highs on expanded volume and breadth would clearly violate the pattern of weakness noted above.  Until that point, I don't see an edge in chasing the upside.  More on this topic at this evening's gathering.

Further Reading:  Tracking Market Dynamics

Wednesday, May 20, 2015

Randomness and Returns: A Market Lesson From Peter L. Brandt

I'm looking forward to being part of a very special trader's conference in September featuring Jim Dalton, Jack Schwager, and Peter Brandt.  Details on the conference will be coming shortly.  In upcoming posts, I'd like to highlight a few things I've learned from these seasoned professionals.

One of the best posts on trading that I've encountered in years is Brandt's analysis of how randomness affects trading profitability.  The same exact trading methodology can yield winning or losing outcomes over a limited time horizon simply due to the random strings of winning and losing trades.  This is demonstrated extremely well by Brandt's post, where he assumes a given win rate and ratio of average winning size to losing size and then shows how those metrics can lead to profitability or unprofitability over a run of 100 trades.  

There are two important implications of Brandt's analysis:

1)  If you ramp up your trading size, the increased risk over a random series of losing trades can devastate your account.  Your trading size should not be a function of some high target return that you hope to make, but rather a function of the random strings of losers that you can survive.

2)  Just because you're going through a losing period doesn't mean you're trading a losing methodology.  Changing sound methods in the middle of a random string of losing trades would be like a batter changing his swing after striking out a few times.  That is what helps turn normal setbacks into prolonged mental and performance slumps.

The bottom line is that we can read far too much into short-term trading outcomes.  Losing trades don't necessarily mean we're trading poorly and winning trades don't necessarily suggest that we have a hot hand.  We can gain knowledge from analytical mistakes and creative insights, but it's also important to retain the wisdom that sometimes we will trade well and lose and other times we can trade poorly and win.  

Not every move--of markets, or of profit/loss--is meaningful.

Further Reading:  Lessons From a Successful Trader

Tuesday, May 19, 2015

Thursday TraderFeed Gathering in NYC

Well, I have a choice.  I can either go through my emails (all 16,606) or I can post to the blog a reminder about Thursday's get together for daytraders and other assorted dubious characters.  Not one of life's more difficult choices...

We'll convene at 5 PM in NYC at the tasting room of the Whole Foods at Columbus Circle (lower level of the shops at 59th and 8th Ave.)  Hope to talk about trading, markets, craft beer, and of course craft beer.  Look forward to seeing some of my good colleagues at SMB there as well as a good friend who's quite an experienced prop trader.

Now to those emails...

Joining a Prop Group or Hedge Fund

I frequently hear from two groups of traders interested in affiliating with trading firms:  early career traders interested in experience, learning, and access to capital and experienced traders looking to grow themselves.  Two of the types of firms they most often consider for affiliation are proprietary trading groups and hedge funds.  Since I've held full-time jobs at both types of trading firms and been involved in the hiring process, I can offer a few perspectives for those contemplating those career directions.

What are the differences between prop groups and hedge funds?

Prop groups trade the (proprietary) capital of the firm's owners.  Historically, prop groups evolved from market making functions.  As algorithmic trading has taken over much of the true market making, most prop firms have retained their short-term roots and trade short-term (largely intra-day) opportunities, making use of significant leverage.  Prop firms can operate in futures markets or stocks; occasionally both. 

Hedge funds trade the capital of investors, some of whom may be owners/partners in the firm and others who will be high net worth individuals and/or institutional investors.  Hedge funds traditionally invest, not trade.  They run portfolios of positions, rather than trade in and out of a limited number of instruments daily.  Hedge funds trade a wide variety of strategies and often will run different strategies within a single fund to achieve diversification for investors.

A hybrid structure is known as the "family office".  This is an organization that manages money like a hedge fund, but trades only the capital of the friends and family of the founder.  Very high net worth individuals may establish family offices to avoid the regulation of hedge funds while retaining the practical benefits of hiring portfolio managers.

What are the advantages of affiliating with prop groups or hedge funds?

Access to capital.  This can be significant, as many early career traders simply lack the capital to earn significant dollar returns.

Access to other skilled traders.  This varies greatly from firm to firm and requires due diligence.

Access to superior tools and equipment.  Larger firms can afford to invest in software and trading platforms that help traders find opportunities and better manage risk.

Access to structured learning experiences.  This varies wildly across firms.  Some run actual training programs, some offer mentoring within groups, some offer little if any training.  This requires particular due diligence.

Access to markets.  Prop firms and hedge funds can open access to markets that might be too expensive or difficult for traders to trade on their own.  A prop firm that is a member of an exchange can pass along a favorable commission structure to its traders.  A hedge fund with strong relationships with prime brokers can meaningfully expand a trader's access to global markets.

What are the pitfalls of affiliating with prop groups or hedge funds?

Fees - Sometimes these can be onerous.  There are some bad players out there that make their money more from the commissions and seat fees they charge traders than from facilitating the success of their traders.  If you're paying high commissions, you are a customer of the firm you work for, not an employee.  Caveat emptor.

Payouts - If you trade on your own, you keep 100% of your profits before expenses.  If you trade at a prop firm, that payout may be closer to 50%.  If you trade at a hedge fund, it will typically be below 20%.  That isn't a problem if you have significant access to capital and if you're getting value in return for the profit-share.  But you want to make sure that's the case.

Job Security - If you cannot sustain profitability, these firms will not retain you.  That can make it difficult to find a new position.  One limitation of making trading a career is that it doesn't readily prepare or position you for alternate careers.  This is an important consideration to think through if you're contemplating raising a family and need a measure of stability in your career.

How do I break into a prop group or hedge fund?

Build your own trading track record - Even if it's with small capital, you can demonstrate good decision making, sound risk management, and trading skills.

Develop knowledge and skills that make you valuable to a firm - There is always a need for quantitative talent, programming experience, and specialized knowledge of specific markets or regions.

Join an existing group within a firm - This is my favorite way for young professionals to join a hedge fund, but it takes networking and that development of specialized knowledge and skills.  Increasingly, we're seeing prop firms build out groups as a way of leveraging their talent and offering ongoing mentoring of developing traders. 

Affiliating with a trading firm is definitely not for everyone.  You may not want to make trading your career, and you may have sufficient access to capital and other resources to build your own trading business.  One structure that is interesting is known as "arcades", where traders bring their own capital, enjoy higher payouts, but share office space and resources.  That can be a nice blend of affiliation and independence for experienced traders.

If you do decide to look into affiliating with a firm, watch for those sketchy players that take advantage of the hopes and dreams of unwitting early career traders.  If a group claims to offer education and training, get the details about their curriculum.  If the firm offers great payouts, check out the (hidden) fees and commissions.  If the firm promises access to capital, find out exactly how much access their experienced traders have.

Finally, culture matters.  Some trading firms care a lot more about their traders--and are much more devoted to growing them--than others.  Talking with traders already working within the firms is a great way to learn about the culture and the opportunities and pitfalls of affiliation.

Bottom line:  If you want to join a top firm, learn some top skills and get some specialized experience that will make you an asset to the company.  Going with no track record and no specialized skills and loudly proclaiming your "passion" for trading is a great way of failing to distinguish yourself to any solid organization.

Further Reading:  Joining a Prop Firm

Monday, May 18, 2015

Thoughts and Ideas Going Into a New Week

*  Interest rate volatility has not been friendly to the stock market over the last few years.  Since 2012, when 20-day realized volatility in TLT has been in its highest quartile, the next 20 days in SPY have averaged a gain of +.35%.  That contrasts with an average 20-day gain of +1.35% for the remainder of the sample.  A weaker dollar, rising gold prices, a steepening of the yield curve, disappointing economic data releases:  are we seeing beginning concerns over stagflation?

*  We are all in the business of living; our success hinges on our self-management and leadership.

*  Ivanhoff Capital on the role of luck in success.  I would say that success is the result of putting yourself in enough promising situations where good luck can eventually come your way and staying out of enough unpromising situations that you can avoid bad luck.  This is why holding losers and selling winners quickly is so damaging:  it minimizes the odds of good luck and maximizes the odds of bad luck.   

*  Good book recommendations from Abnormal Returns.  I particularly like Ratey's book on exercise and the brain.

*  On the topic of books, I was pleased to host a craft beer gathering of portfolio managers last week with Maria Konnikova.  I will be posting on important topics from her excellent book Mastermind: How to Think Like Sherlock Holmes.  She also spoke about her upcoming book, The Confidence Game, which takes us inside the heads of con artists and their victims.  A worthwhile related topic: how we can con ourselves.       

*  Concerns over demographics in China and questions over its true growth rate;

*  The consensus for a Fed rate hike has shifted from June to September.  Interesting that 70% of economists think the Fed will wait too long to raise rates, not raise them too soon.  Is the rise of rates on the long end expressing that fear?

We're nearing a critical period for Greece and the possibility of default on its debt; some worthwhile tweets from @MrTopStep.   

Have a great start to the week!

Sunday, May 17, 2015

Volatility, Correlation, and What Makes For Good Trading

I'll be talking more about this topic at Thursday's NYC trader gathering:  how market volatility and correlation are related to forward price movement in the broad indexes.  The above chart tracks an index that I created that combines volatility and correlation across the major stock market sectors.  The bars represent average forward 10-day price change since 2012 when the volatility/correlation index has been in its various quartiles.  In general, we see subnormal returns when volatility and correlation are low and unusually strong returns when the two are high.  It is in the latter situation that we have seen selloffs, with everything taken down in a risk-off mode.  When volume and volatility are low and some sectors are showing strength and others not (weak breadth), that's when we've seen punk near-term returns.

We currently reside in the lowest quartile:  low volatility and low correlation.

The division of forward returns into quartiles based upon a candidate predictor is the start of market analysis, not an end point.  At least two further issues remain:

1)  What is the variability around the returns in the quartiles?  We're looking at averages, but perhaps these are skewed by a relative handful of very low or very high values.  Strong differences of means are far more significant when there is little variability around the means than when individual values are all over the place.  In practical terms, a given mean difference in returns may not be helpful if pursuing the difference exposes you to large drawdowns.

2)  Is your candidate predictor truly unique?  Maybe volatility and correlation are low and high simply because the prior X days have demonstrated a strong or weak return.  Just because you have a promising variable doesn't mean that the variable is *uniquely* predictive of forward returns.  A simple procedure is to construct a stepwise multiple regression where past price change is the first variable entered to see if it is predictive of the next X-day change in index prices.  Then add your candidate variable in the second step and see if this accounts for significant further variance in predicting the next X-day change.

Even if we pass the above two criteria, what we have left is a hypothesis, not a conclusion.  Any historical analysis assumes that the patterns of the past will play themselves out in the immediate future.  As a quantitatively informed discretionary trader, I will then look for evidence in the day's session that the predicted pattern is or isn't playing itself out.  When price action and market behavior lines up with what the model is predicting, there's the possibility of a trade.  When they don't line up, it means that something unique is happening in today's trading session, such that a historical pattern is not playing out.

That, too, is information to a flexibly minded discretionary trader.

Good trading occurs at the intersection of rigorous analysis and keen pattern recognition.

To be continued...

Further Reading:  My Recent Trading Experiment

Saturday, May 16, 2015

Going From Managing to Leading Your Trading Business

There are few topics more important than that of self-leadership: how we guide and manage our lives.  This is particularly true when the business of life also includes a business as a trader or investor.  Managing our trading means that we are deploying our capital efficiently and effectively:  finding the right balance of risk and reward over time.  Leading our trading business is something different altogether.  When we are the leader of our trading enterprise, we determine whether we are pursuing the right risks and rewards.  Markets change; opportunity sets change:  do we change with them?  That is a question of leadership.

A major pitfall for active traders is that they spend so much time managing risk and opportunity that they fail to properly lead.  They work hard, but struggle to succeed if they're pursuing unfruitful directions.

But if you're an investor or trader, you're more than a manager and more than a leader.  You are also a venture capitalist.  You are funding your trading enterprise.

Here's a great exercise:

Put together a pitchbook proposal as if you're actually pursuing venture capital.  Your pitchbook will consist of four sections:

1)  Your background, history, and experience that qualify you for an investment of capital;
2)  Your core strategy or strategies and what, specifically, gives them a distinctive edge in markets;
3)  Your track record, including monthly profit/loss, drawdowns, and overall risk-adjusted returns;
4)  A detailed description of your trading process, from the generation of ideas to the management of risk, along with sample trades that illustrate the process in action.

Once you assemble the pitchbook, set it aside for a day or two and then read it with a fresh set of eyes, imagining that you're an investor being asked to invest in this trading business.

Would you make an investment?  Would you feel comfortable asking others to read your pitchbook and consider making an investment?  Would a savvy trader or investor invest in your business?

If not, what improvements and changes would you need to implement to justify an investment?

The answer to that question takes you from management to leadership.

Further Reading:  Self-Leadership and Success

Friday, May 15, 2015

Turning Your Defeats Into Your Development

One of the interesting commonalities among the Market Wizards interviewed by Jack Schwager is that many suffered blow ups early in their careers.  Those implosions turned into important lessons that shaped their future success.  Their success came, not just from winning, but from turning the downs in their trading into ups.  Without the failures, they would not have achieved their successes.

I find this is true in relationships as well.  It sometimes takes a seriously failed relationship to teach a person what they truly need in a good relationship.  Many a happy marriage has been preceded by an unhappy prior relationship.  The same is often found in career development.  One doesn't find the right direction until pursuing some wrong ones.  The downs in life provide fuel for the ups.  That is part of being alive.

Here's a great exercise for your trading journal.  Divide the page into three columns:

In the first column of the journal entry, identify your greatest trading failure during the past week.  Was it a missed opportunity that your process should have picked up?  Was it a trade taken that truly lacked an edge?  Was it poor implementation of a good idea or an idea that you simply took from the crowd?  

In the second column, assess the consequences of that trading failure?  How much did that failure cost you?  In actual losses?  In lost opportunity?  In your mood or focus?  In subsequent bad trading?  We don't change our patterns unless we sustain awareness of their costs.  When we emotionally recognize the consequences of our actions, we find the motivation to make changes.

In the third column, clearly formulate a plan of action for correcting that trading failure over the coming week.  This becomes your mandate, your overarching goal for the week.  You will assess the success of the week based upon your ability to turn trading defeats into your development as a trader.

Imagine sustaining such a journal project for an entire year.

Imagine a parallel project for improving yourself as a spouse, as a parent, or as a professional in your work.

Turning failure into success fuels growth.  Continuously turning failure into success fuels resilience.  This journal exercise, over time, builds the spirit as well as the performance.

Further Reading:  Five Features of Great Traders

Thursday, May 14, 2015

The Personal Side of Trading Performance

A worthwhile exercise for your trading journal:

Track physical variables, including sleep (quality and amount); exercise (amount and type); eating/drinking (amount and type); and overall energy level.

Track your daily productivity (amount of work you get done; quality of the work you get done); quality of your idea generation (how well you're seeing markets and generating trade ideas); quality of your trading (making right decisions at the right time); and quality of your learning from your trading (journaling, work on yourself).

Does better work lead to better attention to those physical variables?  Does more attention to the body lead to better performance in trading?  

How are you behaving during your best periods of trading?  Your worst?  How consistent is your lifestyle relative to optimal performance?

Are you like an athlete in training or do you lack training?

Further Reading:  The Performance Benefits of Exercise

Wednesday, May 13, 2015

Preparing for Trading and a NYC Trader Gathering

As posted earlier, I am organizing a craft beer get-together for NYC area traders a week from Thursday (May 21st) at 5:00 PM.  We will meet up at the tasting room of the Whole Foods on Columbus Circle (59th Street and 8th Avenue) in midtown Manhattan.  I'll be joined by the good folks at SMB, who will share a few perspectives from the front lines of the prop trading world.  This is not a formal talk or presentation and I guarantee there will be no sales pitches.  Rather it's an opportunity to meet other traders, share perspectives, and hopefully make some contacts that can enrich and inform.

I'll be sharing some perspectives regarding the trading experiment I've been conducting. One of the more interesting early findings is that spending much more time in preparing for trades (research, personal preparation) and greatly limiting actual trades to well tested patterns has already improved my hit rate, profitability, and overall trading experience.  Active use of Evernote as a journaling tool has been important to the process.  I find it is very different planning a trade in my head versus writing out everything that goes into a trade.  When trades are in your head, they're intended.  When they're written out and elaborated, they're planned.  There's an important difference.

Look forward to meeting up.  If you can't make it, don't worry; there will be other events as we move toward summer!  

Tuesday, May 12, 2015

Where is Weakness Coming From in the Stock Market?

It's interesting to note that, according to the excellent screening tools at FinViz, the three U.S. stock market sectors that have been down over the prior two quarters have been Conglomerates, Basic Materials, and Utilities (top chart).  Those are also the highest yielding sectors (bottom chart); the ones most sensitive to movements in interest rates.

With bonds down recently (rates higher), recent weakness we've seen in stocks has been pronounced among rate-sensitive issues.  The three sectors down most over the past week are--you guessed it!--Conglomerates, Utilities, and Basic Materials.

Yesterday, we came within a few points of an all time high in the ES futures.  We closed with 387 stocks across all exchanges making fresh monthly highs and 374 making fresh monthly lows.  Much of the breadth weakness in stocks is related to the recent backup in yields.

Further Reading:  A Different Way of Tracking Stock Market Strength

Monday, May 11, 2015

Preparing for the New Market Week

*  As we hover near new highs in SPY (blue line above), we see that stocks making fresh three-month new highs versus lows continue to lag.  I will be watching this measure closely to handicap the odds of further strength morphing into a fresh bull leg.  If that is in the cards, we should see a meaningful expansion of breadth.  Small caps were relatively weak after Friday's lift off, so not seeing breadth expansion yet.

*  If you train yourself for persistence and resilience in other areas of life, you build the capacity in trading.

Top readings from the past week from Abnormal Returns, including a look at divergences and possible growth scare in the economy.

Great demonstration of how easy it is to overfit backtests.  Also check out these seminal papers in financial mathematics.

What the Commitment of Traders report is telling us about positioning across asset classes from SeeItMarket.

Ten facts about SPY from New Trader U.

Four performance metrics worth tracking from Tradeciety.

Have a great start to the trading week!