Saturday, October 31, 2015

Every Great Trader Is A Player-Coach

There are two kinds of traders.

One views "coach" as a noun:  a person who can help them.

The other views "coach" as a verb:  something they regularly *do*.

Every great trader is a player-coach:  performing and working on performance.  How we coach ourselves helps determine how we improve our decision-making, how we adapt to changing markets, and how we grow our trading.  

I like the "STRIDE" model of coaching, because it starts with strengths and targets:  building on what is working and setting goals--and then focusing on the challenges that stand in the way of those positives.  

I also like the model because it calls attention to the difference between goal-setting (targets) and concrete planning to reach those goals (action steps).  A goal without action steps is a fantasy.

Finally, I like the model because actions are followed by evaluation.  We're always keeping score, always figuring out what's working and what's not, and using that information to feed future targets and actions.

Coaching yourself means finding your STRIDE:  turning learning into a routine, robust process.

But, wait:  what if we think of the STRIDE process as describing markets??

What's going well in markets?  What's working?
What market patterns could be traded better?
What are the obstacles to trading the patterns that the market is giving to us?
What ideas have we traded?  What ideas are markets paying out?
What will we do to get into sync with the patterns markets are trading here and now?
How will we evaluate the inevitable changes in market patterns?  Changes in our trading?

There are *two* learning curves in successful trading:

When we apply the learning process to ourselves, we act as our own COACH.

When we apply the learning process to markets, we act as our own MENTOR.

Many trading problems occur because we fail to sustain one or both of those learning curves:  we become so focused on trading that we stop coaching and mentoring ourselves.

Further Reading:  Mentoring and Coaching

Monday, October 26, 2015

Trading Notes: Week of October 26th

Friday, October 30th

*  Stocks continued their upside, hitting new highs for this leg even as we continued to see some continued lagging from small cap shares and from interest-rate and commodity-sensitive issues.  Still, with respect to the SPX, corrections are occurring in relatively flat fashion, creating launching pads for fresh moves higher.  As long as pullbacks are occurring at successively higher levels and we continue to make fresh price highs, buying weakness continues to be the favored strategy.

*  I recently compared cumulative upticks/downticks for the Dow stocks versus the NYSE Composite.  The Dow ticks have been powering to new highs, whereas the cumulative NYSE ticks have remained flat.  It's yet another indication that the bull move is most robust among large cap issues, with smaller cap issues lagging. 

Thursday, October 29th

*  Stocks began the day quite strong, with an NYSE TICK distribution skewed to the positive side.  When we get multiple readings > +800, it's generally an indication of institutional buying, particularly when accompanied by above normal volume.  That strength returned following the reflex selloff after a Fed announcement perceived as hawkish, with solid breadth and an expansion of strength to the small caps.  Once again it's a situation in which short-term pullbacks that take the majority of SPX shares below their short-term moving averages end up providing good long side entries.  Those pullbacks are also occurring at successively higher price lows which, as noted yesterday, gives the benefit of the doubt to the bulls.

*  I'm keeping an eye on the strong USD, as a firm Fed and an ECB and BOJ still in QE mode should contribute to further USD strength.  That puts pressure on EM countries tied to USD, essentially tightening their conditions even as their economies are slowing.  That could pose further challenges for China in particular.  Note overnight bearish price action in Asia today.

*  Tuesday saw 460 stocks touch fresh monthly lows; yesterday we had the strong price action and 306 lows.  If the rally truly is broadening, we should not return to these levels of new lows; that's something I'll be watching closely.

Wednesday, October 28th

*  I'll be tweeting from the QuantFest conference tomorrow; I like what InvestiQuant is doing with identifying edges at the intraday, overnight, and swing levels and look forward to having something to report this weekend.

*  Tuesday saw some further correction on further slow trading, with continued breadth divergences among larger and smaller cap stocks.  Looking at the data from Index Indicators, we can see that about 67% of Dow stocks closed above their five-day moving averages but only about 23% of small caps and 34% of midcaps.  Yesterday was the first recent day where more shares actually touched monthly lows than highs.  While I do think we could see further price strength from here (I give benefit of the doubt to the bulls when short-term oversold conditions are occurring at successively higher price lows), that strength is likely to be selective, accompanied by divergences.  

*  My working hypothesis is that we've entered a "Nifty Fifty" kind of environment where, amidst slowing global growth, investors seek safe large caps that offer prospects of growth and yield and avoid everything else.  Hence the strength in the Amazons and Googles and avoidance of retail, energy, and smaller cap shares.  I'm watching breadth closely to see if that hypothesis is supported over time.  In general, my leaning is to be long the large caps on short-term corrections and lighten up on short-term strength. 

Tuesday, October 27th

*  Thanks to Michael Covel for a stimulating podcast interview.  I'll post the link once it's up.  His archive of 390 podcasts is an impressive body of work; very worth checking out.

*  Monday was an unusually narrow trading day, with volume in SPY slowing to its lowest level in weeks.  Given anticipation of a Fed announcement on Wednesday, we could see further standing aside in today's trade.  So far the market has been rising on superior volatility and volume and correcting on lesser volatility and volume, creating relatively flat corrections.  That, of course, is what helps sustain uptrends.  We have a good amount of economic data out this week, on top of the Fed and Bank of Japan meetings.  I don't expect the slow trade to continue throughout the week. 

*  I remain unimpressed with the action of small caps (IJR) and midcaps (MDY), as reflected in the recent failure of the Russell 2000 Index (IWM) to make fresh highs.  Note also the recent weakness in oil and in energy shares (XLE), as well as the weakness in retail shares (XRT).  I become concerned about the upside when the rising tide is not lifting all boats.

*  Here's an interesting statistic:  During 2015, when fewer than 30% of SPX stocks have traded above their five-day moving averages, the next five days in SPX have averaged a gain of +.76%.  All other occasions have averaged a five-day loss of -.21%.  (Raw data from the excellent Index Indicators site).  Waiting for short-term strength before entering on the long side has been a losing strategy, and waiting for short-term weakness to enter on the short side has also lost money.  That's a good reason why the trade based on fear of missing moves has been so deadly.

Monday, October 26th

*  If I were building long-term positions in companies as investments, I'd select companies that achieve a high degree of engagement with employees.  This is why.  If your trading is your business, you are both manager and employee.  Does your management truly engage you?  Vitally important topic.

Great list of takeaways from the recent Stocktoberfest conference from Howard Lindzon.

*  Stocks continued their strength on Friday, as we hit new highs for the recent upleg and fresh three-month highs expanded to 483, the highest since June.  This suggests that momentum continues strong and that increases the probability that we will ultimately see new highs in stocks as part of the current cycle.  We have pulled back from Friday highs in overnight trading and some short-term corrective activity can be expected after the recent strong performance.  So far, however, dips have been bought aggressively.  The last two occasions in which more than half of stocks dropped merely below their three-day moving averages have resulted in strong buying.

*  Ultimately two factors appear to be leading stocks higher:  solid earnings (most recently from large cap tech names) and very accommodative monetary policy globally.  That, combined with the perception that the Fed is unlikely to raise rates, has resumed the QE trade.  Of course, as financial conditions improve, the Fed becomes more likely to raise rates in December, so we could see interesting year-end dynamics.

*  During this most recent move higher, the measure of upticks/downticks that I track for all U.S. stocks (red line on chart below), not just NYSE issues, has remained relatively flat.  This is because we've seen recent relative weakness among small cap issues.  I will be watching that closely early this week, as an expansion of small cap strength would broaden out the rally and support the idea of a continued upside, whereas a broadening of weakness (larger caps following small caps lower) would signal more significant potential for correction. 


Sunday, October 25, 2015

Learning From Our Genius--And Our Idiocy

Sometimes, the best path to creative insights is a willingness to challenge one's premises.  Suppose, for example, we don't define genius by a fixed IQ level.  That, of course, implies that some people are geniuses and the majority are not.  If we begin with the premise of multiple, intersecting intelligences, it opens the door to the possibility that everyone is a genius in some respect.  I learned this vividly when I first began working with active daytraders in Chicago.  Many of the successful traders were not intellectual in the least, but they had a canny sense of rapid pattern recognition that I, with my Ph.D., could not touch.  Similarly, I have seen very successful money managers lead teams and make boneheaded decisions when it came to managing their team members.  Managing capital and managing human beings represent different skill sets; not all who are classically intelligent are emotionally or socially so.

There are two important implications of the "multiple geniuses" perspective.  The first is that we are most likely to find success if we know our strengths, hone our strengths, and play to our strengths.  Many thanks to Ivaylo Ivanov for picking up on this in his excellent summary of the Trading Psychology 2.0 book. One of the takeaways that he emphasized is that we never find success by discovering an edge and sticking to it religiously through life.  Rather, edges in markets continually evolve and, like all entrepreneurs, traders succeed by adapting to their evolving marketplaces.  The question of finding one's success as a trader (or remaking one's success) begins with a more fundamental question:  In what respects am I a genius?  What am I truly good at?  How can I leverage those strengths in the current market environment?  It's our strengths that will fuel strong performance, not our copying of others.  Perhaps the trader who feels stupid is like the fish judging itself on tree climbing.  No amount of efforts to improve climbing will help the fish; only the decision to get in the water and swim.

That brings us to the second--and perhaps more provocative--implication of the multiple geniuses view.  If all of us are geniuses in some respect, all of us are also idiots in some fashion.  We have our blind spots, our weaknesses, our flaws.  If it's our strengths that fuel our success, it's our weaknesses that can derail us.  Indeed, sometimes it's excessive reliance on our strengths that makes us idiots!  I recall one occasion in which a very bright friend proceeded to respond to his partner's distress by offering a detailed analysis of the situation.  It was an insightful explanation--and it was idiotic in the context of the partner's need for caring and reassurance.

It's not by coincidence that the subtitle of Ivanov's blog is "Reaction to news is more important than the news itself".  Our own genius and idiocy is parallel to the wisdom and madness of crowds.  The markets do forecast future economic developments--and they do so quite imperfectly.  The tech bubble around the turn of the millennium was a great case in point.  It was an idiotic overreaction--and it correctly anticipated a revolution in computing and online communications.  Observing reactions to news and other events and parsing out what is wisdom and what is idiocy is essential to investors and traders alike.  Trend trading and countertrend trading are flip sides of a single coin, in which market movements begin with insight and end with blindness.

Further Reading:  Emotional Volatility and Market Returns

Saturday, October 24, 2015

Three Best Practices of Best Traders

Here are three best practices that I observe among the best traders I know and work with:

*  Increase your exposure to new and different ideas - The worst traders are caught in confirmation bias: they seek views that bolster their own.  The best traders I know are intellectually curious: they seek out fresh perspectives, and that helps them generate fresh trading ideas.  After all, you can't expand your mind without challenging your mind.  What is your daily and weekly process for mind expansion?  A great way to increase your exposure to new and different ideas is to talk with new and different people and read/listen to different online offerings.  Check out The Enterprising Investor site from CFA and its menu of resources from different authors.  Check out the podcast links, longform links, and research links via Abnormal Returns.  There are a lot of smart people represented on those sites that can help feed your brain.

*  Spend as much time learning from your trading as you actually spend trading - The ratio of practice time to performance time is a great predictor of elite performance, whether among Olympic athletes or chess champions.  If you lose in your trading, was it because of getting ideas wrong or was it because you traded sound ideas poorly?  Either alternative leads to useful corrective action:  looking at new information that can help you get ideas right and developing trading best practices that help you optimally implement your ideas.  Experience itself is not a teacher; we learn only by actively reviewing and reflecting on experience.  If your trading is not teaching you specific lessons that you concretely implement, you are not on a learning curve that can lead to elite performance.  A big part of the Trading Psychology 2.0  book is devoted to learning from winning as well as losing performance: that's what uncovers the best practices that lead to best processes.

*  Manage yourself, not just your risk and your positions - An insightful trader this week took a hard look at his recent trading and came to the conclusion that he was not trading at his best because he was not keeping himself at his best.  What he found is that he performs at his peak when he is emotionally and physically conditioning himself for peak performance.  That's what creates the intensity of focus that picks up the next great idea; it's also what generates the energy needed to stay resilient in a drawdown.  Do you have a game plan each day and week for making the most of your energy level, your relationships, and your state of mind and body?  The work we do on ourselves is work that helps us become better performers; very often our trading slides when our self management slides.

Notice how those three best practices combine to create a comprehensive training program.  It's when we intensively train for success that we create the life mirrors that help us internalize confidence and resilience.  

Further Reading:  Training For Success

Monday, October 19, 2015

Trading Notes: Week of October 19th

Friday, October 23rd

*  The combination of prospects of further QE from the ECB and positive earnings news breathed fresh life into the market, as we rose on substantially increased volume.  The increased volume told us that fresh participants were coming into the market; the positive skew of the NYSE TICK told us that the participation was dominantly to the buy side.  Picking up those cues early in the trading day is an essential part of short-term trading.  Thursday's action was further confirmation of the base case outlined yesterday, though I'm certainly open to the possibility that, with the renewed buying, a momentum peak lies ahead of us.

*   Below is an interesting chart that tracks "relative volume":  how volume at each minute of the day compares with the average volume for that minute in SPY.  A value of 1.0 means that volume is average for that time of day.  A value of 2.0 is a full standard deviation above average; 3.0 is two standard deviations above average; etc.  Note in the chart how volume yesterday was well above average, particularly when the market was rising.  Great tell.

*  Interestingly, new highs *and* new lows expanded in yesterday's trade, and small caps continue to lag large caps.  I'm watching that relationship closely, as well as the new highs/lows.

Thursday, October 22nd

*  Weakness in small caps noted earlier contributed to a sell off in stocks through much of the day Wednesday.  My measure of buying vs. selling pressure, interestingly, did not show a great surplus of selling.  This continues to look to me like a correction of the recent strength, not bear market behavior.  With fewer than half of stocks now trading above their three and five-day moving averages, the risk/reward looks a bit better and I am open to buying weakness that holds above the overnight lows.  I do note, however, that the number of stocks making fresh monthly lows has expanded beyond the level seen last week.  Continued expansion of that number would make me more concerned regarding the market's downside.  

*  In short, my base case is that the August/September lows were significant ones; that we began a new market cycle off those September lows; and that the cycle has hit a potential momentum peak but has further to run on the upside.  Waning breadth, especially among small cap stocks, and waning relative strength among EM shares concerns me about this base case, however, so I'm cautious and updating views day by day.

*  A tell for market weakness prior to the August drop was that we were persistently seeing more shares trading below their lower Bollinger Bands than above their higher bands.  At present, we've been seeing the opposite: more stocks trading above their upper bands (see chart below).  I'm watching that balance closely as yet a different kind of breadth measure that captures the relative breadth of strength vs. weakness.


Wednesday, October 21st

*  Stocks showed continued resilience on Tuesday, with pullbacks limited, ultimately leading to higher daily lows and higher highs.  We also expanded the number of stocks making fresh monthly highs, rising to 812 from 698.  Interestingly, VIX rose, but realized volatility and volume continued low.  We're seeing strength in overnight trade, after late day weakness yesterday--that continues the grind higher.

*  We've seen a drop in one of my measures of breadth volatility, which tracks the variation in the number of stocks making new highs and lows.  Going back to 2010, when breadth volatility has been high, the next five days in SPX have averaged a gain of +.52%.  When breadth volatility has been low, as at present, the next five days in SPX have averaged a gain of only +.03%.  I continue to view the risk/reward in the market as not particularly appealing for multi-day positions and instead lean toward shorter-term tactical trading of intraday swings.

*  I am continuing to watch small cap and mid cap issues to see if we can expand breadth or whether relative weakness in those groups can expand to other segments of the market.  The Cumulative NYSE TICK has been rising in recent sessions; buying strength has been moderate, but selling strength has been low.  I don't expect a major market decline until we see a reemergence of sellers, and that's not occurring so far.

Tuesday, October 20th

*  The topping behavior referenced yesterday was evident in Monday's trade, as we ground higher in SPX.  I continue to note relative weakness among small caps, which is contributing to breadth divergences.  We saw 698 new monthly highs on Monday against 166 lows.  That is against over 1000 new highs on the 7th through the 9th.  That being said, breadth divergences in rising markets normally don't signal major reversals until we see expanding numbers of shares making fresh lows and overtaking new highs.  During topping processes, it's more of a rotation trade than a trending one, with volatility, volume, and momentum coming down.  That makes it an opportunistic trading environment, as the lower volatility means that moves extend far less than they had when VIX exceeded 20.

*  One of the big mistakes traders make in low volume/low volatility environments is looking for the next big move, rather than planning for the lack of movement.  To accomplish that planning, traders either need to trade short term swings opportunistically (intraday swings) or extend their holding periods to seek larger moves that ride out the shorter swings.  I find that pullbacks and bounces in NYSE TICK intraday help to identify those shorter-term swings.

*  Should we see small caps and midcaps catch up to the large caps in performance and move to fresh highs, that would be a worthwhile clue that the upside has further to go.  I'd want to see other market sectors underperform before taking a longer-term bearish stance.

Monday, October 19th

*  I'll be tweeting from Stocktoberfest the next couple of days.  My latest Forbes article highlights a topic I'll be addressing in my Stocktoberfest presentation:  how we can make the transition from being good traders to becoming great ones.  That means that repeated experience is not enough; we actually have to undertake directed training.  The Forbes piece describes how we can use psychology to sustain training efforts.

*  Here's a simple way you can know if you're truly engaged in a process of expertise development:  Are there *specific* things you're working on in today's trading; are you keeping score to see if you are truly making progress; and are you making ongoing corrective efforts with continued scorekeeping if you're not making progress?  If you're not intensively engaged in the above, you are not on a course of peak performance development.

*  Friday's trading continued the bounce from the short-term oversold situation noted last week.  We once again are at a juncture where I'm not enamored of the risk/reward situation here.  Intermediate-term measures are stretched to the upside; put/call ratios have come down; and we continue to see fewer stocks make fresh new highs despite new highs for this move in the broad indices.  My pure volatility measure is at levels associated with subnormal forward returns over a several day basis.  All this is consistent with my overall perspective that we've seen a momentum peak for this market cycle and are now involved in a topping process.  That process can extend for a while before we see an ultimate price peak and eventual bear phase. 

*  An uptrend is sustained when we are able to register higher price highs and higher price lows across multiple short-term cycles.  So far, that is what we've been doing.  Until that pattern changes, I'm reluctant to take short positions for anything more than short-term trades.

Sunday, October 18, 2015

Why So Many Traders Lose

Here are a few observations on why so many traders fail.  It's not because of psychology:

1)  The majority of traders think directionally, and they think linearly.  That has them trading momentum and that has them trading trends.  Even the traders who look for reversals look for momentum and trend, just in a different direction.

2)  Market behavior can be described as a combination of cyclical and linear (trend) components over any particular time frame.  As markets become more crowded, cyclical components dominate over time, reducing the Sharpe ratio of those markets.

3)  Traders fail because they are thinking in straight lines when they should be thinking in cycles.  They think of cycles as sources of choppiness and noise, not as sources of signals that are different from linear, trending ones.

4)  Any market cycle consists of mean-reverting behavior at cycle peaks and troughs and trending behavior between peaks and troughs.  This ensures that any single approach to trading markets (looking for trend/momentum; looking for reversal/mean reversion) will draw down substantially over many cycles.

5)  When the Earth was found to be round and not flat, that opened the door to exploration and development of new lands.  When markets are viewed as cyclical and not linear, that opens the door to promising trading strategies.

6)  A great deal of the emotional frustration and disruption of trading that traders encounter is the result of trying to fit markets into a preferred framework, rather than discovering the framework that best describes market behavior.  

7)  Becoming more disciplined in applying inappropriate models to markets leads to greater consistency in losing.  If a ladder is leaning against the wrong building, becoming a better climber won't get you to your destination.

In short, traders lose, not because they're bad at the game, but because they are playing the wrong game.

Further Reading:  Finding Opportunity in Cycles

Saturday, October 17, 2015

The Greatest Mistake Losing Traders Make

One of the greatest mistakes traders make is to allow their thought processes to get noisier as they lose money.  They double down in their thinking about the market; they scan even harder for winning trades; they vent emotions about their losses.  In short, they turn up the volume on their cognitive processes.

The core issue here is whether your trading is a performance skill like golf or a knowledge skill like mathematics.  If I'm encountering difficulty with a math problem, I want to think harder and more creatively about finding the solution.  Math requires explicit knowledge and problem solving.  Golf, on the other hand, is more of an implicit learning skill where thinking more and harder frequently interferes with what the body knows.  That creates the "yips".  

If my trading is completely rule-governed and mathematical, a period of bad trading results probably means that market regimes have changed.  In that case, I want to double down on my market analysis and see where patterns of trend, volatility, correlation, etc. have shifted.  Analysis in that situation facilitates adaptation.

If my trading is intuitive and based upon pattern recognition, a period of bad trading results also could mean that market regimes have changed.  Doubling down on analysis, however, facilitates paralysis; explicit processing interferes with implicit performance skill.  Thinking harder about why your audience is not responding to the speech you're delivering will only interfere with your delivery and make the situation much worse.  

My theory is that investment is an explicit performance domain.  Trading is based on implicit learning and performance.

When traders encounter problems and shift into the cognitive mode of investors, they lose touch with their implicit, pattern-recognition skills.  It's not simply that they overthink.  They shift to the wrong information processing mode.  In a literal, cognitive sense, they are out of their right minds.

Here's a great article for you:  it's about teaching golf through implicit learning.  The article cites a study in which two groups were taught putting skills.  One group was given detailed instruction; the other group was given ample practice and left to figure out what to do on their own.  When tested, the first group displayed greater knowledge of putting, but in subsequent performance, the first group did not outperform the second group.  Indeed, in pressure situations, the group that was taught how to putt was more likely to choke than the group that learned through experience.  

Why was that?

Under stress, the explicit learning group went back to their instruction and focused on what they should be doing.  That shift to explicit thinking interfered with the performance skill and led to the choking.  Amplifying the volume on their cognitive processes provided interference, not inspiration.  The implicit learning group had no lessons to focus on and were more likely to rely on muscle memory, reducing the likelihood of choking.

The big takeaway from all this is that, if your trading is based on pattern recognition and a feel for markets, you want to become quieter when you encounter problems, not noisier.  In finding the quiet beneath our 50,000 daily thoughts, we can apprehend the new patterns being displayed by markets and pick up a feel for them.  

The worse you perform, the quieter you want to become.  If you're a trader, not an investor, never let your thinking interfere with your information processing.

Further Reading:

Implicit Learning and Performance

Implicit Learning and Self Regulation

Monday, October 12, 2015

Trading Notes: Week of October 12th

Friday, October 16th

*  Yesterday's sharp rally and new high close for this move fits with the "buy weakness, sell strength" idea from yesterday's posting and is consistent with the idea of a market that may have topped in upside momentum, but not price.  It was interesting to see that we had 609 stocks make fresh monthly highs yesterday, down from the 1274 new highs last Friday.  Such breadth divergences can be expected to continue if we indeed have made a momentum peak for this cycle.  It's when we see significant expansion of stocks/sectors making fresh short-term lows that we need to seriously consider the market's downside.

*  Meanwhile, volatility continues to be crushed with VIX closing around 16, down from around 27 late in September.  My pure volatility measure also hit new lows and is getting close to levels that are associated with subnormal upside returns.  It has been challenging for traders to adapt to the reduced volatility, which punishes trading on momentum and rewards patient, counter-trend entry execution and quick, tactical profit-taking.

*  A project I will begin this weekend is gauging the expectable size and duration of moves based upon volatility regimes.  My sense is that such an approach could help making trading far more flexible and adaptive than it currently is for many traders.

Thursday, October 15th

*  So here's my question of the day:  Why do so many bastions of capitalism pursue change via centralized planning?  From large corporations to finance firms, capitalist enterprises increasingly rely on central planning as they grow.  Indeed, if countries ran their economies the way many companies run their businesses, we'd view them as communist/socialist bureaucracies hopelessly out of date.  We extol "leadership" in corporations and large organizations; perhaps that's how dictators think of themselves in centrally planned economies.

*  A good buy trade early in the day reversed on the WalMart news and stocks traded off through much of the session yesterday, though they've recovered in overnight trading.  This back and forth is what we'd expect if we recently hit a momentum peak for the current cycle and now are engaged in a topping process.  In that scenario, buying weakness and selling strength makes sense.  Yesterday closed with further weakness, as we had 348 stocks make new monthly highs and 261 register fresh monthly lows.  That new lows figure is the highest we've seen since October 2nd.

*  The weak retail sales number and WalMart news highlights what seems to be a changed story:  instead of economic growth justifying a Fed hike, there's increasing talk of economic weakness and no hike this year.  If the topping out scenario holds, then we're seeing a cycle peak cresting below the prior peak, volatility bottom at higher levels, and increasing concerns of recession--all bearish on a longer time frame.  I will continue to monitor breadth measures to see if this scenario is playing out.

*  I've heard from multiple sources that this has been a difficult trading environment, with poor P/L, for many traders.  Per yesterday's entry, we're seeing reduced volatility in stocks and reduced volatility of volatility.  In such an environment, movement fails to extend--and becomes more consistent in failing to extend.  That kind of reversal mode is difficult for traders wanting to trade momentum or trend.  I'm not sure many traders explicitly work on adapting to changes in volatility regimes.  In such cases, sticking to a process is actually a failure to adapt.

Wednesday, October 14th

*  Per yesterday's post we indeed saw price consolidation in Tuesday's session and we've now worked off the short-term overbought conditions.  According to the Index Indicators stats, at Tuesday's close we had under 19% of SPX stocks close above their three-day moving averages and under 32% close above their five-day averages.  In general, particularly as uptrends mature, I like to be a buyer when the majority of shares fall below their short-term moving averages and lighten up when the majority are short-term stretched and rolling over.  My leaning is toward the buy side if we see selling dry up above the overnight price lows.

*  Below is an interesting chart that looks at the volatility of the pure volatility measure that I track, with the chart going back to August 17th.  Notice how the volatility of volatility spiked during the August decline and has since returned near levels seen prior to the market's drop.  Vol of vol tells us something about the stability of price action, which in turn tells us something about the participation of market makers.  If a market is dominated by market makers, we oscillate between bid and offer and volume cannot move price a great deal.  If market makers pull back and the order book becomes more sparse, a given unit of volume can impact price much more greatly.  Interestingly, when vol of vol is in its highest quartile since late 2013, the next four days in the ES futures average a gain of +.34%.  When vol of vol is in its lowest quartile, the next four days average a loss of -.05%.  As market cycles mature, we tend to see a crushing of vol but also of vol of vol.  I believe we're seeing a maturation of the present market cycle; if that's the case, we should begin to see breadth divergences on further strength.  Yesterday's weakness among small caps might be the start of that pattern.

Tuesday, October 13th

Last week's punchy post on why we trade emotionally seems to have struck a chord.  The hits on the post have been about 4x average and it's already become one of the top ten TraderFeed posts in terms of hits.  One reader took offense to the language and style of the post, and I sympathize with that view.  One of the things I've learned as both psychologist and parent is that how you deliver a message has as much impact as the message itself.  But part of that impact is saving the punchy style for the most important messages.

*  We had a slow holiday trade yesterday, with rangebound action.  One measure that helped my trading yesterday was looking at the extremes in the NYSE TICK.  (I typically look at one- and five-minute readings during the day).  If we don't have many positive or negative extremes, it means that institutions simply are not active in the market.  It takes large, basket executions to get TICK above +800 or below -800.  If you don't get those extremes early in the morning, you can anticipate a slow day and often a rangy one.

*  As my intermediate term strength chart below shows, we continue to be stretched to the upside.  This measure is a five-day moving average of 5, 20, and 100-day highs vs. lows among SPX stocks.  (Raw data from Index Indicators).  In a strong cycle, this will top out ahead of price.  I noted yesterday that I wasn't thrilled with risk/reward and indeed we've pulled back in overnight trade.  I would not be surprised to see further consolidation near-term, but am not expecting an outright bear move.


Monday, October 12th

The weekend article on "flourishing" is, in my view, one of the most important topics in psychology broadly and trading psychology specifically.  By and large, traders do a decent job of keeping themselves out of damaging, negative states of mind and body.  They don't necessarily make special efforts to keep themselves in optimal states.  As a result, we never truly experience how well we could perform across many areas of life, including trading.

*  This past week's entries have focused on strong market breadth and the favorable implications of high buying strength.  That has led to buy-the-dips trading and has done well to this point.  Breadth continued strong on Friday with 1274 new monthly highs, the highest figure in a week.  (Raw data from the Barchart site).  We generally see significant corrections after a period of waning breadth.  That just hasn't been occurring to this point.

*  That being said, I'm not enamored of the risk/reward right here.  As the chart below depicts, we have come down quite a bit on the Pure Volatility measure (volatility per unit of volume in the ES futures), and that has historically led to subnormal returns.  We're also stretched to the upside on many of my indicators, which in the past has occurred near momentum peaks (not necessarily price peaks).  The put/call ratios have come down; all that leads me to believe we could get some consolidation early in the week.  

*  Should we get some pullback this week, my leaning would be to resume the buying strategy.  Good short-term pullbacks would be ones in which a majority of shares close below their three and five-day moving averages and where we see more stocks give sell signals vs. buy signals on the technical measures I follow, such as Bollinger Bands, Parabolic/SAR, and CCI.  The past few days we've seen many more buy signals than sells on those measures, but the number of buy signals tailed off on Friday.

Sunday, October 11, 2015

What Is Your Emotional P&L?

You know a person's dreams are dying when they become solely focused on ways to not lose money in trading.  Risk management is a necessary component of success, but it's how we manage opportunities that ultimately puts points on the board.  Too many traders cut off the right tails of their return distributions when they trim the left tails.  They are quick to get out of losing trades, quick to avoid winners from becoming losers, and ultimately neither win nor lose all that much.  Sometimes we become so focused on staying in the game that we forget about winning the game.

Think about your emotional returns from trading.  What is your emotional P/L?  My recent Forbes post is an important read in this context; it focuses on flourishing.  Flourishing means making the most of the returns from your life's activities; it reflects the degree to which we are emotionally profiting from what we're doing in life.

Over time, can we expect trading to provide us with financial profitability if it is draining our emotional account?  Our emotional P/L reflects the balance between fulfillment and frustration.  When we are playing to our strengths, we get stronger and that is reflected in our levels of happiness and life satisfaction, as well as the quality of our relationships and the state of our physical functioning.  

An important implication of the recent post is that the times in which we feel most fulfilled in our trading reveal to us many of the things we need to be doing to sustain success in markets.  Fulfillment is more than just being happy with making money; it is that sense in life that we are on the right path, doing what we're meant to be doing.  Our emotional P/L is a source of crucial information; it is our most immediate confirmation as to whether or not we're playing to our strengths.  It also provides us with the fuel we'll need to get through inevitable periods of drawdown.

You know markets are controlling you when your trading P/L determines your emotional P/L.  Long-term success in trading means being able to sustain a positive emotional P/L even when the trading P/L is waning.  It starts by figuring out--each day--the psychological returns you'll be targeting and how you'll achieve those.  In other words, we need to toss out our daily to-do lists and appointment books and start generating daily plans for flourishing.  But that takes big dreams--and a visionary sense about how truly fulfilled we could be in life.

Further Reading:  A Key to Building Great Relationships

Saturday, October 10, 2015

The Real Reason We Trade Emotionally

OK, so here comes one of my best posts.  


I'll give you a view you won't hear from any mentor, coach, guru, or furu.

Why do so many traders talk about trading being a mental game and making bad trades because of emotions?  Why do you find yourself making the same mistakes again and again, making money only to lose it?

Is it because you lack discipline?  Is it because you cannot control your emotions?  Is it because you don't stick with a trading process?


You have emotional problems in markets because you're the market's bitch.

You heard me right, Mr. Independent Trader who doesn't want a 9 to 5 job and wants to only work for himself.  You're the market's bitch.

From open to close, you're hanging on every market tick, letting it sway your thoughts and feelings.

When the market treats you well, you feel good.  When it treats you poorly, you feel like crap.  When the market's not moving, you don't know what to do.

If you behaved that way in any relationship--with your boss at work or your spouse at home--everyone would see that you're someone else's bitch.  But with markets, you tell yourself it's dedication, it's a passion for trading.

Bullshit.  You the market's bitch.  

You have a relationship with the market and anytime you're controlled in a relationship, you're the bitch.

The only way to have an even relationship with the market is to control when you play, so that you don't get played.

That takes rules, that takes finding and sticking to edges--and it takes the willingness to not play when your edges aren't screamingly apparent.

What you got ain't passion for trading; it's a need to play.

If you need to play, you're going to get played.  You're going to be controlled by market behavior.  You're going to be the market's bitch.  

Further Reading:  Life Lessons From the Trading Trenches

Monday, October 05, 2015

Trading Notes: Week of October 5th

Friday, October 9th

*  Morning selling pressure yesterday could not breach overnight and prior day lows, continuing the flat correction.  In general, when overnight and prior day lows/highs hold on early day selling/buying, it's worth thinking about buying the dip/selling the bounce to exploit the potential pattern of higher lows/lower highs.  With the Fed minutes, significant buying flows once again returned to stocks and we again made new highs for this move, with an expansion in the number of shares registering fresh highs.  A total of 242 SPX stocks registered fresh 20-day highs vs. lows, the highest since August 17th (raw data from Index Indicators).  As emphasized yesterday, I'm not seeing the kinds of divergences that would normally precede a substantial correction. We're once again stretched on a multi-day basis, so that leaves me in the mode of buying pullbacks.

*  Earlier entries mentioned the very strong buying pressure during this rise.  On a five-day basis, we've seen buying strength that has only been present on 9 prior occasions since 2012.  Ten days later, SPX was up 8 times, down once for an average gain of about +3.0%.  Once again, this highlights the momentum effect once institutions dominate on the buying side.

*  Volatility continues to decline, with VIX now below 18.  If this is like past strong buying cycles, we will see modest pullbacks and further grind higher on lower volatility until breadth divergences begin to appear. 

Thursday, October 8th

*  Buying dips indeed proved to be a useful strategy in Wednesday's session, as we closed once again with strength.  Across all exchanges, we saw over 1000 stocks register fresh monthly highs, a new high for this upleg.  In general I don't become overly concerned about sustained downmoves unless we see a preceding period of time in which fewer stocks participate in the strength.  Thus far, the participation has been solid, with the buying pressure mentioned yesterday continuing strong.  We're quite extended in the short run, so the consolidation we're seeing in overnight trading is not unusual.  My leaning is to allow this consolidation to run its course before resuming long positions.  Even in healthy uptrends, it's not unusual to get a pullback in which the majority of shares trade below their 3 and 5-day moving averages.  I'd look at such a pullback as a potential buying opportunity; I'd also be interested in buying any flattish correction that stays above the 1960-ish level.

*  Note that VIX continues lower and continues to stay below 20.  I continue to hear people put the bear thesis out there, but the market is just not trading that way at present.  I believe investors see the global weakness out there and are already buying stocks in anticipation of further easing from central banks.  Traders who wait for the actual central bank announcements before buying may be making a mistake.  With Friday's weak jobs number in the U.S., an accomodative monetary policy across the globe was pretty well ensured.  Markets are forward looking.

*  Below you can see a short-term rate of change indicator (red) plotted vs. ES futures (10/2/15 to the present), where each bar represents 500 price changes in the index.  This normalizes for activity during slow periods, such as overnight.  I like the perspective as a short-term overbought/oversold measure.  In general, I like buying oversold levels when we're making higher lows and higher highs and vice versa.  I like taking profits when we get overbought/oversold and can't make new highs/lows.

Wednesday, October 7th

*  We did indeed get the consolidation noted in yesterday's post and, so far, we're seeing some holding of the consolidation and buying of the dip in overnight trading.  I'm watching to see if we can hold those overnight lows, with a leaning toward buying weakness that holds above ES 1960.  My short-term models remain modestly bearish, however, so I'm open to the possibility of further consolidation.

*  Readers will recall that I break the uptick/downtick statistics into separate measures of buying pressure and selling pressure.  The buying pressure has been very strong over the past five trading sessions.  Returns 3-5 days out have been choppy, with little edge, but 10 days out we see 15 occasions up, 2 down for an average gain of over 2%.  We'll need to see distinct selling pressure to entertain a return to a bearish regime; we'd also need to see VIX exceed 20.

*  Put/call ratios have come down quite a bit from the recent market lows.  That's another reason I wouldn't be surprised by sloppy trading near term.  I also note the upside breakouts in emerging market currencies (CEW) and commodities (DBC); both are reversals of the previous bearishness around China.

Tuesday, October 6th

Great summary of my recent podcast with Better System Trader from The Waiter's Pad; thanks, Mike!

*  We saw very good follow through to Friday's strength, as the volatility plus the buying flows (volume-weighted NYSE TICK) created significant upside momentum.  We saw 780 stocks across all exchanges make fresh one-month highs against 143 new lows.  We've come off a bit overnight and my models are moderately bearish over a 3-5 day horizon, so some consolidation is to be expected.  My sense, however, is that many traders have missed this rally and will be interested in buying dips, which could keep consolidations modest--as much in time as in price.

*  Another reason I expect some consolidation is that we're quite stretched on a short-term basis, with over  90% of SPX shares trading above their 3, 5, and 10-day moving averages.  When we've had a moderate VIX under those circumstances (between 15 and 25; N = 12 going back to 2006), the next day has been up 3 times, down 9 for an average loss of -.12%.  Indeed, 10 of the 12 occasions posted a lower close over the next two trading days.  That being said, the next 10 days have been 8 up, 4 down for an average gain of +.37%, with 10 of the 12 occasions posting a higher close within five trading days.  So not much edge in general, though my base case is to see consolidation in the next day or two that is worth buying into.

*  I mentioned yesterday that I'm keeping an eye on VIX.  We're below 20 for the first time in a while; if any consolidation does occur in a flattish fashion, reducing realized volatility, that would suggest a return to the old volatility regime and would be bullish overall for stocks.

Monday, October 5th

*  In my Forbes blog, I review one of the best market books I've read in a long time.  It's a detailed treatment of high yield markets and a great reminder of how we can learn a great deal about the markets we trade by studying and understanding related markets.

*  Friday was a day worth studying in detail.  We had a weak payrolls number and stock futures sold off hard.  We opened with selling on the day, as NYSE TICK hit several quite negative figures, but price stopped going lower and the downticks began making higher lows.  This emboldened buyers to come in, upticks swamped downticks, and we wound up with a very strong day to the upside.  That strength has continued into overnight trading, as it indeed appears that we have successfully tested the downside.  The oversold intermediate-term indicators that I referenced last week will not hit overbought levels for a while and volatility appears to be at the bull's back, so I expect an environment in which pullbacks will be bought.

*  I will be watching VIX closely here.  One idea I'm playing with is that we've entered a higher volatility regime, much as what happened in 2007 prior to the 2008 bear market.  VIX generally bottoms ahead of stock market highs and, in the current environment, that wouldn't surprise me.  That 2007 period was a rangy topping market with good swings due to the higher volatility.

Sunday, October 04, 2015

Here's A Macro Trend Not Enough Traders Are Focusing Upon

I've long thought that financial markets are master magicians.  They get you looking at the one hand that's waving around, while the real magic is being performed with the other hand.  There have been a lot of waving hands in 2015, including the U.S. dollar and rates, stocks, and assets in China and emerging markets.  All that hand waving has led some investors and traders to lament an absence of clear themes and trends in macro markets.

Meanwhile, real magic can be found in the trends depicted above.  The top chart is a weekly chart of the WIP ETF, which tracks the prices of international inflation protection bonds.  The middle chart is a weekly depiction of the JNK ETF, which tracks the prices of high-yield bonds.  The bottom chart is of the EMB ETF and takes a weekly look at the prices of emerging market bonds.

Since the middle of 2014, these have been in a steady decline.  We are seeing global deflationary forces, with higher quality debt significantly outperforming lower quality debt.  In short, there is too little growth and too much debt globally.  Per the charts above, markets continue to price in continued deflation and continued concerns with the sustainability of debt.  

Now this is the point where the blog writer is supposed to trot out the uber-bearish scenario and headline the piece with a dire warning that will attract the eyeballs in cyberspace.  I strongly suspect, however, that the perma-bear thesis is yet another hand wave of the magician.  Here's what I'm watching in the magician's other hand:

1)  Quality - There are too many baby-boomers still out there needing to protect their capital.  Many have been reaching for yield and seeking returns in stocks.  Stocks have been a mixed blessing: strong if you've been in consumer-related sectors, weak if you've been in commodity-related shares; stronger if you've been in developed market stocks, weaker if you've emphasized emerging markets.  Those of us old enough to recall the "Nifty Fifty" know what it's like when a market reaches for quality:  large, stable companies with decent dividends and growth and little debt.  If the trends depicted in the charts above continue, it's not difficult to imagine a "boring is good" mindset among investors:  own stable, quality stuff that won't interfere with your sleep.

2)  Volatility - Some debt will not be sustainable and continued deflationary forces will weigh on global growth.  That could lead us far from the low volatility markets we've enjoyed under global regimes of quantitative easing.  The smart money managers I know express concern for the liquidity of many assets.  With investment banks no longer as active as counterparties that can warehouse risk, we are increasingly vulnerable to shocks.  That's an environment in which you want to own negative tails and be long volatility.  Predicating trading and investment strategies on the kinds of markets we've had from 2012 to mid-2014 has not worked well of late.  It's not difficult to imagine that the recent discussion of Fed hiking will look quaint in 2016.

If all this is correct, a tipping point might come when central banks continue their easing but no longer can produce the low volatility shift from bonds to stocks that we saw from 2012 to recently.  In other words, deflation dynamics would outweigh QE dynamics across assets.  In such an environment, the reach for yield would be replaced by a reach for stability.  For those not prepared, that could look suspiciously like black magic.

Further Reading:  Why Traders Succeed and Fail in Financial Markets

Saturday, October 03, 2015

Taking Intelligent Risks: How To Stay In The Trading Game

You have to risk money to make money.  You have to make sure you don't risk so much money that you can lose your stake and go out of business as a trader.  Bet too little and you never make a good return on your capital.  Bet too much and you court career risks.  So much of trading success boils down to taking intelligent risks.

Here is a useful calculation tool that can tell you the probability of hitting a drawdown threshold.  

Let's say you have $1,000,000 in your trading account, you place roughly two trades per day (500 trades/year), and you're willing to lose $200,000 of your capital before you shut down.  Your win rate is 50% and the average size of your winners is 30% larger than your losers.  You're willing to lose 1% of your capital ($10,000) per trade.  The odds of your hitting your downside limit--even with that edge--is 8.6%.

Suppose you cut your trades in half and can take only the best trades, those in which winners are 50% larger than losers.  All else being the same as above, you now have only a 0.4% chance of hitting that downside barrier.

Alternatively, lets say you overtrade and place 1000 trades in a year and now your average winner is only 10% larger than your average loser.  You now have nearly a 64% chance of tapping out.

The challenge, of course, is that markets change and our hit rates and relative sizes of winning and losing trades vary over time.  To stay in business, you want to plan your risk taking around conservative estimates of performance, not the most optimistic ones.  By studying your historical performance, you can see how you trade at your worst and ensure that in any repeat scenarios you'll stay in business.  

In my own trading, I keep daily loss limits to 0.5% of capital and I'm willing to lose 10% of my total capital before tapping out.  If I were to place one trade per day and lose my edge entirely (50% hit rate; average win same as average loss), I would have a 35% chance of hitting my stop out level.  If I place one trade per week, the odds drop to 0.4% probability of tapping out.  A huge part of risk management comes from selectivity in trading:  by taking the very best setups, maximizing odds of success, and taking fewer trades, we can ensure that we stay in the game--even if our edge leaves us for a time.

This is why overtrading is so deadly.  It increases the probability that we'll have a streak of losers that knock us out of the game.  The eye-opening reality is that most traders could cut their total number of trades in half or even more, size up those best trades, retain the lion's share of their profitability, and keep their drawdowns modest.

We win the game and stay in the game not with low risk taking or with high risk taking, but with smart risk taking.

Further Reading:  Risk Intelligence