* We continue to see massive divergences among stock sectors, as nicely tracked by the Finviz site. This has created weakening breadth for stocks overall, as interest rate sensitive, US dollar strength sensitive, and commodity sensitive shares have significantly underperformed healthcare and growth-related sectors. It is difficult to imagine a resumed bull market with China/Asia/commodity weakness; it is also difficult to imagine a true bear market unless concerns over global growth start to hit U.S. growth-related shares. That has me watching the strongest and weakest sectors and their relative price performance going forward.
* If we truly treat our trading as a business, then it makes sense to look at ourselves not just as traders, but also as managers and leaders of our enterprise. Surprisingly, there's been little attention paid in trading psychology to this aspect of performance and success. My latest Forbes article covers a very important theme in the management literature: we best lead by creating standards of excellence and managing toward those. Many trading failures boil down to failures of leadership, and those boil down to shortcomings in managing ourselves, our resources, and our work processes.
* Two excellent conferences coming up this fall that I'll be participating in: 1) Traders4ACause in Las Vegas and 2) Stocktoberfest in Coronado, CA. Both promise a great lineup of speakers and plenty of opportunities for networking.
* One topic that recurs in my conversations with traders is refining the quality of their information networks. It's not at all common to read lots of things and come away with very little. Just as important as taking in information is synthesizing it into meaningful views. But those views will only be as good as the information we synthesize. For those with a bent toward numbers, good information via Twitter can be found by following @sentimentrader, @paststat, and @RyanDetrick. Broad perspectives can be found by following @dashofinsight, @abnormalreturns, and @Quantocracy. Trading perspectives can be found by following @crosshairtrader, the Stock Twits STUDY stream, @NewTraderU, @seeitmarket, and @ivanhoff. A good source for trading psychology ideas is #tradingpsychology. I'll have many more good links and follows to suggest shortly!
Have a great start to the week!
Brett
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A reader recently asked the question of why we so often don't trade our plans after we've gone to the trouble of planning our trades. The usual answer to this question is that emotion gets in the way, which naturally leads to strategies for yet more planning, "discipline", and the dampening of emotion. As an interesting article on motor sport makes clear, however, it may well be that we lose our plans when we lose our concentration. Instead of working to control emotions, it makes sense to cultivate expanded levels of focus. After all, an athlete can be fired up emotionally *and* wholly focused on the game: emotion can facilitate performance. Indeed, it's the football or basketball team that comes to the game "flat" that is apt to fall short in performance. Quite literally, their heads are just not in the game.
In the aforementioned article, the author speaks of "concentration styles". This is a very useful concept. Not all people focus in the same ways. For example, I work with extroverted traders who are very skilled at processing information interpersonally. When they are at the trading desk, sharing ideas with others, they are in their zone. Alternatively, I also work with more introverted traders who are very skilled at analyzing situations in markets. They concentrate best when they tune out chatter from others and place themselves in a quiet environment.
Concentration benefits from a distraction-free environment, but sources of distraction vary as a function of concentration style. If internal cues (stray thoughts and feelings) are distracting, staying socially focused can facilitate good decision-making. If external stimuli (sights, sounds) are distracting, staying in a neutral environment can be most helpful to performance. For a visually oriented trader, focusing on charts and other visual displays could yield superior information processing. That would not be the case for many quantitative traders.
In short, we fail to trade our plans when we lapse in our concentration, and we lapse in our concentration when we stray from our information processing strengths. When we exercise those strengths, we strengthen them further. In that sense, focused trading can become excellent training for our concentration. Conversely, when we approach trading in a haphazard manner, we fail to cultivate our ability to focus and become easily swayed emotionally. I've never known a trader operating "in the zone" who has complained about emotional disruption. Show me an Olympic champion and I'll show you someone emotionally charged *and* performance focused.
Further Reading: The Key to Making Changes: Training the Brain for Performance
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Back in May, I wrote about an experiment I was conducting in my trading. Since that time, I've made mistakes and learned valuable lessons. Out of those has emerged a promising consistency in my profitability. I am quite confident that I have many more lessons to learn and mistakes to make. So far, however, those lessons have been constructive ones, so I thought I'd share the most important ones:
1) Since May, I have returned to my daytrading roots. In that May post, I outlined three patterns that anchored my trading. My trading consistency (hit rate) and profitability increased dramatically when my trading of those patterns was intraday. When I focused on the larger picture--patterns and price projections from those patterns--I lost my feel for the market and became ill-prepared for variations in price paths. When I used the patterns as context but focused on the moment to moment flow of market behavior, I could actually feel whether or not patterns were playing out. This has become important, not only in terms of managing risk proactively (exiting trades when the flow of volume is diminishing in my direction; not when prices have reversed and hit my stop), but also in terms of opportunity management (sizing up trades in which flows line up with the patterns). Fast pattern-recognition is my greatest cognitive strength as a trader. By focusing on longer-term market behavior and patterns, I was neglecting this strength and that led to trading that was not consistently profitable. It's been a great reminder for the psychologist: success comes from leveraging who we are at our best.
2) Since May, I have refined quantitative models that forecast ES prices 3-5 days forward. The greatest refinement has been to model non-linearities in the data: situations in which the relationships among predictors and outcomes are different at extremes of the distributions. For instance, it's not too unusual for average values of an indicator to be unrelated to future price action, but extreme values to have predictive significance. Modeling those non-linearities has led to better models. (They actually are quantifications of the patterns mentioned in the May post). Per the first point above, however, my trading has been best when these model forecasts act as background and context. The successful trading comes from seeing order/trade flow line up with the forecasts. Even the best forecasts predict only a modest fraction of total variation in forward prices; trading only when flows line up with forecasts has greatly improved the hit rate.
3) I review every trade and what I've done right and wrong. It is no exaggeration to say that I spend much more time reviewing trade results, reverse-engineering success and failure, and researching the lessons from those than actually trading. The intensity of this deliberate practice has greatly accelerated my learning curve. Increasing the selectivity of the trades I take (per the two points above) and maximizing my review process has been much more successful than spending a lot of time in front of the screen and less time in review.
4) The number one psychological predictor of the success of my trades is my cognitive state while putting the trades on. If I am highly focused and have a clear sense of both larger picture and moment-to-moment flows, the trade is much more likely to be successful than if I lack that quiet sense of understanding and mastery. A great example of a trade lacking that sense would be one where I am entering because I'm concerned about missing a move. Almost invariably, the timing on such a trade will be poor. It's in the quiet, focused state that the pattern recognition will kick in and I will have a much better feel for when flows are turning in the expected direction. Eliminating distractions while trading has been crucial for me.
5) Where I have the greatest progress to make from here is in proper trade sizing and position management. What I'm finding is that it is much better to limit the number of trades taken based upon the above four criteria and sizing those trades up, rather than taking more trades and sizing them moderately. I'm also finding it helpful to use this increased sizing to facilitate a scaling out of positions, so that the portfolio can benefit from both short-term price reversals and ongoing trend behavior. Because I only trade one instrument, my diversification comes from differentiating time frames. This requires separate planning and review for the short and longer trades, and that is a work in progress for me. The challenge is to ensure that the longer-term planning and trading process does not bleed over into the flexible management of the shorter-term positions mentioned above.
My hope is that this self-reflection can serve as a kind of model for your own trading. Your lessons will be different from mine, because you are different from me and your trading is different from mine. The overlap will be in the process sense: by treating your trading as a performance activity, learning from mistakes and successes, and feeding those lessons forward into your future trading, you can evolve dramatically. If you write a blog and thoughtfully review your lessons learned, by all means let me know and I will be happy to link in the spirit of mutual learning!
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* Above we see the daily average of 5, 20, and 100-day new highs versus new lows for all SPX stocks. (Raw data from the ever-helpful Index Indicators site). When this multiperiod breadth measure has been in its weakest quartile going back to 2014, the next five days in SPX have averaged a gain of +.64%. All other occasions have averaged a gain of only +.05%. Interestingly, when we look just two days out, the strongest breadth periods have led to an average gain of +.15% and the weakest periods have yielded an average gain of +.40%. All other occasions have averaged a two-day loss of -.02%. On short time horizons, returns have been a function of either strong upside momentum or mean reversion following broad weakness. When trading price patterns, it helps to know the context in which they're occurring.
* Management and leadership concepts don't just pertain to corporations; they are vital to the running of any trading business. If there's no vision to running your business, you're running blind. And if you're not running your trading like a business, do you really have any business trading?
* A broad array of worthy reads from Abnormal Returns, including posts on health, fitness, and more.
* Interesting post from Price Action Lab: Why moving average systems lack intelligence. It's tough to not find good reads via Quantocracy.
* Great overview of the week ahead from Dash of Insight, including a look at how domestic stocks behave during times of international turmoil.
* From NewTraderU: Character matters: how would you trade if you traded like a Boy Scout?
Have a great start to the market week!
Brett
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Promiscuity and trading: admittedly not the most common of topics in trading psychology, but I think it's quite relevant.
Alvarez makes a good point: on important matters in which we feel commitment, there is no promiscuity. If you're committed to physical health and being in peak conditioning, you won't be promiscuous in what you eat. If you're committed to a marriage, you won't be sexually promiscuous. If you're committed to career or a religious faith, you will necessarily be selective in what you pursue.
The problem with promiscuity is that the pursuit of breadth allows for no cultivation of depth. If I roam from one job to another each year, I never build a career--and never accumulate a career's worth of achievements. If I flit from one romantic relationship to another each week, I will never experience the depth of relationship that comes from a lifelong commitment. Once we make a commitment to something, we opt for selectivity. The pursuit of all things reflects a lack of commitment to anything.
It is common to attribute the breaking of trading rules to a lapse in discipline. Perhaps, however, those undisciplined occasions reflect an absence of commitment. Look at it this way: if you developed your own approach to trading; tested it well, historically and in your own experience; and knew deep down that it possessed unique value, you would feel a degree of commitment to that approach. You would trade it consistently, not because you impose a discipline upon yourself, but because you believe in it deeply. An artist doesn't flit from style to style, one painting to the next. Why? Because underneath that style is a vision--and that artistic vision expresses an emotional commitment.
When traders flit from one type of trade to another, their promiscuity reflects an absence of such artistry and commitment. They have not found their trading vision. Often, their ideas are borrowed from others and not tested and made their own. One more journal entry or checklist will no more help such traders than they would help the bored overeater. If you want to eat healthy, you must be committed to an ideal of physical conditioning. If you want to trade healthy, your trading must be connected to a greater purpose and commitment.
I will make a bet:
If we were to cut the types of trades that we take by two-thirds and focus solely on the one or two that reflect our greatest edge in markets and our greatest trading strengths--and if we were to meaningfully increase the size/risk taken for each of those trades--our overall profitability and risk-adjusted returns would rise significantly.
In other words, if trading becomes an expression of a commitment to a particular approach that is ours, many of the problems of trading psychology melt away. In trading, as in any career, dedication is the most durable source of discipline.
Further Reading: Solution-Focused Performance
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Here are some good self-assessment questions:
* How purposeful are you in getting the sleep you need to function at your best?
* How purposeful are you in getting the exercise you need to function with maximum energy?
* How purposeful are you in eating the right foods to sustain your health and well-being?
* How purposeful are you in organizing your time so that you're spending your highest quality time on your most important priorities?
* How purposeful are you in cultivating the quality of time with the people who matter most in your life?
* How purposeful are you in ensuring that, each day, you are accomplishing something meaningful in your life?
Can we really expect to achieve our life's purposes if we are not living our days purposefully?
Can we trade with intention and discipline if we don't live the rest of our lives intentionally?
Everything in life can be approached with intention and purpose or it can be approached mindlessly and routinely. In carrying out daily activities with self-direction, we strengthen our ability to stay mindful and purposeful for life's greater goals.
Life is one great gymnasium, but we only develop if we recognize the equipment and conduct our workouts.
Further Reading: Therapy For The Mentally Well
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* Above we can see that we're coming off an unusually oversold level on the composite indicator that I've created from two technical measures. What we're looking at is a ten-day moving average of daily buy signals versus sell signals for every NYSE stock for two indicators: Bollinger Bands and Parabolic SAR. (Raw data from the excellent Stock Charts site). Going back to June, 2014, when I began collecting these data, if we divide the signals into quartiles, we find that the strongest composite indicator readings have led to a next 10-day return of +.32%. The weakest composite indicator readings have led to a next 10-day return of +.42%. All other readings have averaged a next 10-day return of only +.08%. In other words, most of the recent price action is attributable to short-term momentum and mean reversion. There has not been much of an edge trading middle-level market strength.
* The key to making the most from setbacks and failures in your trading.
* Taking a fresh and skeptical look at bonds and more good reading for the market week from Abnormal Returns.
* The How of Trading takes a look at the importance of trade planning.
* Perspectives on Greece and other timely topics from The Reformed Broker.
* Why keeping a journal is a great psychological tool.
* Excellent perspective from Barry Ritholtz: We've had large intra-year corrections on average, but the great majority of the last 35 years have finished with positive performance in stocks.
Have a great start to the trading week!
Brett
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Shoutout to @BrianTracy for the graphic and message. It speaks to what I call a mission-based mindset. Think of the Special Forces team embarking on a mission to rescue their colleagues from enemy capture. Every one of those soldiers will be mission-focused. They will have drilled and prepared; their goals--and the actions they will take to reach those goals--are front and center.
When people live with a mission-based mindset, they are like those elite troops. Their thoughts, feelings, and actions are directed toward what they should be doing in life. Most of all, they immerse themselves in worthy missions, and those make life a challenge and adventure.
Here are three follow up questions pertaining to the personal sense of mission:
* How many people do you know--and regularly interact with--that convey the sense that they are on earth to do something special with their lives? If you're not regularly interacting with people who have a mission-based mindset, what is mirrored to you, and what will you internalize over time?
* If you continue doing precisely what you've been doing in your life, what goals will you reach? What mission will you have accomplished? What special thing will you have done with your life?
* How many people have you recently inspired with your mission? If you're not routinely inspiring others, is it reasonable to assume that you will sustain inspiration?
We lose a mission-based mindset when we become so immersed in life's immediate demands that our priority becomes coping rather than achieving. If we move from one crisis to another--one to-do item on a list to the next one--then events control us. When there is no mission, there is only getting by.
And how about trading? Is your pursuit of financial markets part of an overarching life mission, or is trading your escape from the responsibility of crafting a life purpose? The answer to that question lies in what you pursue outside of normal market hours. From the Special Forces team to the religious missionary to the startup entrepreneur, there are no life missions that operate on abbreviated work schedules.
But then again, when in a mission-based mindset, work does not feel like work. It feels like service: service devoted to a noble cause.
Further Reading: Changing Our Lives
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* There are many ways to achieve, but I know of none that does not involve a willingness to tolerate discomfort. Our boundaries are what make us feel comfortable; pushing our boundaries is what achievement requires. In life as in the gym, if you're not breaking a sweat, you're not building your fitness. If you want to develop a part of yourself, that development requires regular workouts.
* I'm not sure people can make positive changes in their lives without first changing their internal dialogues. Can we really sustain new patterns of behavior if we're sustaining the same old thought patterns? As noted in the recent article, keeping a journal can be a structured method for changing our self-talk. Not many traders actually use journals that way. But we really can reprogram ourselves. We eat well, sleep well, exercise--do a lot of things to maintain our hardware. That won't get us where we want, however, if we're running faulty software.
* Keep trading simple and don't overthink things. I've worked with many successful traders and portfolio managers. None has ever held that view. Seriously. None.
* What traders mean when they say a market is choppy is that it is not following a linear price path. They assume, therefore, that price action is random and untradeable. Suppose, however, that choppy markets are simply ones in which non-linear (cyclical) price influences dominate linear (trending) ones. A choppy market could be a very tradeable one if there is a stable pattern of cyclical behavior. If one has no method for testing for non-linear regularities, however, trading success would be limited to trading straight lines. Not all trading failures can be attributed to psychology.
* If you desire success in markets and have developed no unique, concrete way of achieving it, you aren't pursuing your dream; you're pursuing a fantasy. Successful traders talk about markets and trading. Wannabees talk about themselves and their "passion" for trading. Is there any more powerful confession of incompetence than a longstanding passion devoid of achievement?
* The hardest lesson I have learned as a trader is to understand and accept what I do best in markets. There are traders and there are investors: fast thinkers good at pattern recognition and slow, deep thinkers good at analysis. There are aggressive risk takers who achieve absolute returns and there are balanced risk takers who achieve superior risk-adjusted returns. These are fundamental differences of cognitive and personality style. Great traders are rarely, rarely great at all styles. We find our success by leveraging our distinctive strengths. But that means we must truly understand and embrace our strengths.
* The people I know who are really good at networking with trading colleagues are those who have something of value to share, not those who are focused on their need to learn from others. There's something to be said for being a sponge when you're learning, but there's nothing quite so deadly as a room full of sponges. That's why I put out my challenge for the September T4AC conference event.
Further Reading: Trading Psychology Articles
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In my recent post, I talked about some of the common ingredients of successful traders. It turns out that many of those traders will be attending September's Traders4ACause event in Las Vegas. In addition, the charity event will include such noteworthy speakers as Jack Schwager, Peter Brandt, Jim Dalton, Terry Liberman, and Mark Minervini. Two of the traders featured in the upcoming book I mentioned in my post will also present: Bao Nguyen (@Modern_Rock) and Nate Michaud (@InvestorsLive).
My presentation for the Traders4ACause event will focus on solid research in psychology and what it teaches us about best trading practices. I will be sharing specific best practices that I have observed among successful traders over the years and ways you can adapt those practices to your trading. The theme of the presentation is that there is much more to successful trading processes than simply controlling emotions and staying disciplined. Those are necessary for success, but not sufficient.
Perhaps most important of all, such a charity event is a way of giving back--and a way of giving to one another. It's great to connect with other traders online, but nothing beats face to face interaction, sharing ideas and experiences, and building an active, helpful, and supportive network.
In the spirit of networking and mutual learning, I will be bringing to the September event a one-page writeup of a specific trading practice (not psychology; an actual trading method) that I have found to be a best practice in my own trading. I will give that handout to anyone who also brings their own trading-oriented one-pager describing their best trading method. Nothing in the handouts should be stupid or generic; rather, each will describe something unique in trading practice that has had value for you. Bottom line: I give you my insight; you give me yours.
Now suppose--just suppose--all the participants at the conference bring their one-pagers and everyone shares with everyone else. You'll go to the meeting and receive literally hundreds of promising ideas. Even if only 10% of them have specific promise for you, that's a great return on your attendance and sharing. Giving to charity is great; we can also make giving to one another part of our cause.
Hope to see you in Las Vegas!
Brett
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We often hear that traders, to be successful, should "follow their process." But what really goes into trading processes? The recent post described a few common elements of successful trading. One of those was selectivity. Faced with an infinite number of possible trades and times to trade, even the active trader must find some way of filtering out the majority of possibilities and focusing on the smaller number that offer distinctive opportunity.
How does such selectivity work? I would argue that every successful trader and portfolio manager filters trades by three criteria:
1) An Idea - The trading idea expresses the underlying logic of the trade. It is what gives the trade a potential positive expected return. The idea could be that risk assets will rise when the rate of change among a host of macroeconomic indicators is positive; the idea could also be that a company's shares will fall if they experience a parabolic rise because of promotion not grounded in fundamentals. The trading idea defines the field of opportunity.
2) An Expression - Any trading idea can be expressed in a variety of ways, and those expressions ultimately determine the risk/reward of the trade. For example, daytraders might run several scans of stocks in the premarket to identify promising "pump and dump" candidates. Portfolio managers might express a view in currencies, equities, and/or rates, depending upon the positioning in those assets and how they might fit together in a portfolio. An expression could be in options, in a relative value trade, or in an outright long or short cash position. Each brings different risks, different rewards.
3) An Implementation - To a surprising degree, the way in which a trade expression is implemented impacts its ultimate profitability. Two traders could have the same trading idea and decide to express it with a long stocks trade. One trader predicates entry execution on strength, buying when there is upside price confirmation and then adding to the position on strength. Another predicates entry execution on weakness, buying pullbacks in price and scaling out on strength. The profitability curves for the two traders over time will look radically different. Indeed, for the ES futures, the former implementation strategy could have easily led to flat to negative returns even in the recent bull market! Placement of stops, sizing of trades--all of these greatly impact trading outcomes.
I would propose that a truly process-driven trader has studied each of the three areas above, so that all three contribute to an overall trading edge. The process-driven trader should be able to justify the trade on all three criteria, and the process-driven trader should be able to review performance across the criteria to determine where improvements can be made. There is much more to profitable trading than arriving at good ideas, and there is much trading of randomness in the place of good ideas. Not all who follow routines are process-driven.
There are also psychological processes underlying success across performance domains. Further Reading: Feeding Your Head And Developing Your Self
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I recently wrote a foreword for a very interesting book of interviews with successful daytraders that will be coming out shortly. Among the excellent contributors were @modernrock, @OzarkTrades, @InvestorsLive, @lx21, @offshorehunters, @elkwood66, @kroyrunner89, @DerrickJLeon, @johnwelshtrades, and @TomKellyLV, Although my trading is different from theirs--and theirs is quite different from that of portfolio managers I work with--I notice three broad areas of overlap. These seem to be common elements of what makes traders successful:
1) Resilience - Successful traders take risk. Successful traders are sometimes wrong. Successful traders take hits. Successful traders learn from the hits, get up, and move on. They are resilient. They succeed, as Churchill observes, by moving from failure to failure with enthusiasm.
2) Selectivity - Successful traders have clear criteria for what makes good trade ideas. They also have separate criteria for what turns good ideas into good trades. They don't watch everything, and they certainly don't trade everything. They wait for good ideas to become good trades.
3) Calling - Successful traders have an uncanny sense that this is what they're meant to be doing. It's not a job, and it's not a career for them. It's a calling. That's the only thing that can keep people searching and re-searching, banging away for good ideas and good trades. And it's the only thing that enables them to gain the immersive pattern recognition experience that separates them from average traders.
To be sure, there are other success ingredients, from discipline to creativity. What I see among the traders listed above, as well as those I work with, is an unusual combination of these three factors. It's a pleasure and a true education to study successful people. There is much more to success than avoiding failure.
Further Reading: The Real Source of Trading Success
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It's good advice: the right foods can be the right medicine. I recently met with someone who was experiencing feelings of depression and a loss of energy. Those, in turn, affected his concentration and that interfered with his trading. It turned out that he had gained significant weight. His weight gain influenced his sleep quality, as he began snoring and experiencing interruptions of sleep (apnea). The disrupted sleep prevented him from entering the deeper, restorative stages of sleep, which left him tired and run down by the morning. On the advice of his physician, he changed his diet, lost weight, stopped snoring, slept better, and regained his energy and concentration. Had he resorted to sleeping pills and antidepressant medications instead of diet, he could have compounded his problems.
In the recent Forbes article, I make the case for a different kind of diet. Our daily experience is what we process each day, and that is what we internalize--for better or for worse. The work we perform, the people we interact with, the activities we engage in: that provides our psychological diet. What we do in life and who we do it with shapes our experience--and our experience shapes how we view ourselves. I recently spoke with a young trader who aspired to doing great things in markets. My first questions asked about the great things he was doing each day. Can we really expect extraordinary results from a series of ordinary days?
Ask yourself to define the ideal you: how you would like to be as a person, as a romantic partner, as a trader. Then identify those specific things in your daily diet of experience that will lead you to move consistently toward those ideals. If you're not progressing toward your goals and find yourself dreaming of ideals but not achieving them, perhaps it's time for a diet.
Further Reading: Role Modeling and Mirrors
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