Trading Notes: Week of December 28th

Thursday, December 31st

*  I'm always amazed how poorly traders perform in job interview situations. Here is what years of experience, both as an interviewee and an interviewer, have taught me about winning at the job interview.

*  The weakness yesterday has continued into early trading today, raising the odds that we've seen a price peak for the current cycle.  If that is the case, we could see a meaningful correction back toward prior cycle lows.  As has been the case for a while, weakness in the oil market has accompanied stock weakness.

*  Here's where we stand with my favorite intermediate-term overbought/oversold measure.  It appears to be cresting, as do my cycle measures.

My best wishes to readers for a happy, healthy, and profitable 2016!!


Wednesday, December 30th

*  I was looking for signs of weakening breadth in Tuesday's session and what we got was the reverse:  consistent buying through the session, accompanied by strength in commodities.  New highs among SPX stocks, as well as across all exchanges, hit their highest level since early December.  The chart of breadth among SPX stocks only shows that we continue strong, with over 80% of stocks above their 3, 5, and 10-day moving averages.  While profit taking from such levels is not at all unusual, that breadth strength is not typical of a market about to morph into a bear.

*  My intermediate cycle measure is maturing as shown below:

*  My five-day measure of selling pressure is at unusually low levels, meaning that it's been as much the absence of selling as the presence of huge buying that has lifted the market recently.  Past occasions when we've seen similar low selling pressure levels have been late December, 2014; late February, 2015; the third week in March, 2015; and the third week in May, 2015.  All led to short-term moves lower within a matter of days.


Tuesday, December 29th

*  Continued profit taking early in the day on Monday led to an afternoon bounce and further strength overnight, as we engage in what looks like topping behavior.  I will be watching breadth measures closely: if this, indeed, is topping, we should see reduced breadth.  Yesterday we had 311 stocks across all exchanges make fresh monthly highs versus 239 new lows.  Two days earlier, the new highs were 514 and 168.  Below is a chart that tracks fresh three-month new highs minus lows (red line) versus SPY (blue line):

*  The relative weakness in commodity related sectors (XLB, XLE, XME) continues, as does relative weakness among high yield bond funds (JNK, HYG) and emerging market stocks (EEM) and China (FXI).  These continue to be on my radar, as they are significant drags on stocks overall.


Monday, December 28th

*  Friday's partial session finished with a late decline, which has continued into the overnight session, as stocks seem to be following oil prices.  I continue to look to commodity and credit markets, as well as the relative performance of emerging markets to developed markets, to update views on deflationary impacts upon the global economy.  It is difficult to envision a bull market environment if we're seeing falling commodities, yield curve flattening, weak emerging markets, and distressed credit markets.

*  A few of my overbought/oversold measures are not at levels normally seen at market tops, so I'm open to the possibility of some back-and-forth movement this week.  Should we work off the prior oversold level in time more than in price and put in a lower high, that could set the stage for a stronger downward move.  

*  It would not surprise me to see light trading this week, given many traders' desire to take time off before the new year.  Low volume generally accompanies narrow ranges.  So far, however, the day's downward move in oil is not a small move.  This is worth watching.

Trading With Creativity: Finding Chocolate Markets

In the Trading Psychology 2.0 book, four themes capture what I see successful traders doing:

*  Adapting quickly to changing markets;

*  Building on their strengths as traders;

*  Cultivating creativity and becoming better at generating trading ideas;

*  Developing best practices into robust, best processes.

These ABCD themes are not so different from the factors that describe entrepreneurial success.  Indeed, I would argue that trading is less like an application of a fixed set of skills and more like running a startup business.  In fast-changing environments, the entrepreneurial firm constantly remakes itself.  Think of how Apple has changed from the company that made the original Mac personal computers--and how it continues to evolve with the Watch products and even ideas for cars.

One trader thinks about the stock market for 2015, pulls up a chart of the ES futures or SPY ETF, and declares the environment as hopelessly "choppy", with no good trends to trade.  Another trader breaks the market into sectors per the FinViz graphic below and sees a rotational environment during 2015, with plenty of trends when one sector is traded against another.  

"Choppy" is a word we use to describe a market without opportunity for sustained directional movement.  "Rotational environment" is a term we use when we break the market down into a collection of relationships, some of which can be very promising to trade.  We build creativity by looking at old things in new ways and by looking at new things.  That "choppy" market that looks impossible to trade might just make sense if we view it through the lenses of market cycles or if we view it through the lens of its relationship to other assets.

We need the wild mind to look at the world through fresh eyes and see what others don't see.  When daughter Devon was very young, we took her to a suburban playground and she saw a black child for the first time.  She became excited and exclaimed, "Look at that chocolate girl!"  She made a special effort to play with the chocolate girl and enjoyed herself.  Her world looked different through the lens of candy, and that opened the door to new actions.

There are no untradeable markets; only traders with limited lenses and tunnel vision.  There was no one for Devon to play with at the playground if she only looked for people like herself.  There are chocolate markets out there if we're willing to take a taste.

Further Reading:  Finding Your Mirrors: The Devon Principle
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The Root Cause Of Traders' Emotional Problems

So now I'll explain why traders often deal with emotional disruptions of performance and why psychological techniques to deal with those disruptions often do not address the true causes of the problems.

It's really quite simple.

Returns in financial markets ultimately derive from several overarching factors, such as momentum (persistence of directional movement); value (tendency of price to oscillate above and below one or more value criteria); volatility (absolute price movement); and carry (returns derived from holding the asset, as in the case of dividends or roll-down).  

What makes asset managers different from traders is that asset managers are attempting to garner returns from all factors.  They are not necessarily attempting to predict which factor will provide the best returns over the next time period.  Rather, they will construct a portfolio that will achieve favorable returns across a variety of possible factor-based scenarios. Central to asset management is the idea of portfolio rebalancing.  If you don't rebalance a portfolio, you will be top heavy with respect to whatever factor has most recently performed well and underweight factors that have not recently performed.  This leaves a manager vulnerable when patterns of dominance among factors shift.

The trader tends to focus on one factor and one factor only.  Perhaps the trader is a trend/momentum trader; perhaps the trader relies on patterns of mean reversion; or builds a dividend portfolio.  Invariably--and this is especially true of short-term traders--the trader attempts to reduce returns to a preferred factor.  In that sense, the trader is a bit like the blind men trying to describe an elephant.  One focuses on the tail, another on the leg, yet another on the trunk. No one truly captures the look of the elephant.

When a trader declares that he or she is, say, a momentum (momo) trader, the odds are good they'll make money when momentum is a dominant factor and lose money when value and other factors dominate.  It will have nothing to do with psychology, though the losses may bring all sorts of psychological consequences as well as monetary ones.  The trader will lose for the same reason that the blind man will get the elephant wrong:  simplicity has veered into oversimplication.

Once a trader declares that he or she is an X trader, where X is a stand-in for a factor exposure, the die is cast.  There will be winning and losing and uneven performance.  Just as the trading is going well and risk-taking increases, factor dominance will shift and losses will mount.  When trading is going poorly and the trader finally takes a new approach, the old style will return to favor.  All of these generate frustrations and losses.  The core problem, however, is the need to fit markets into a style of trading rather than finding ways to trade that fit with market behavior.

No amount of discipline, mindfulness, positive self-talk, emotional control methods, or goal-setting will make a bit of difference if you're taking one feel of an elephant and trying to figure out the whole.

During 2015, the greatest change in my own trading has been the adoption of a cycle-based framework for thinking about markets.  In some phases of market cycles, momentum/trend dominate.  In some phases, we see mean-reversion/value.  Some phases of cycles display higher volatility and correlation; other phases exhibit lower volatility and correlation.  Knowing where we're at in a cycle determines whether the trading will trade price movement or fade it; whether regimes are continuing or shifting.

Cycles don't give us an infallible picture, but they do allow us to move around and feel around before we guess what the elephant looks like.  We experience emotional disruption when we try to force markets into a rigid framework.  A flexible framework allows us to not get bent out of shape, as we adapt to market cycles rather than expect markets to conform to our trading preferences.

Further Reading:  Living Your Calling


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Facing The New Year With Eyes On The Stars, Feet On The Ground

To a surprising degree, we think in narratives.  We have stories we tell ourselves about our relationships, our trading, our careers, our future.  Those narratives provide continuity to life.  They also can become ways in which we lie to ourselves and fall victim to self-delusion.

This post explains how easy it is to fool ourselves.  It is not comfortable reading, but it is important reading.

We cannot move forward unless we're honest with ourselves about where we stand now.

We cannot improve unless we connect emotionally with the ways in which we fall short.

We cannot manage risk effectively unless we accept loss.

The greatest way traders lie to themselves is by telling themselves that they have a durable edge in financial markets.  How do you know that you have an edge?  How do you know that your edge will persist?  How will you know if you're cultivating a new edge?  If your existing edge is eroding?

We need dreams and positive visions.  Those move us forward in life.  We also need the ability to wake up, question those dreams and visions, and face hard realities.

What are your dreams for 2016?  What are the hard realities you need to face for the new year?  

Eye on the stars, feet on the ground:  a great formula for life success.

Further Reading:  The Greatest Con Job Of All
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Trading Notes: Week of December 21st

Wednesday, December 23rd

*  After seeing breadth weakness dry up per the last post, we finally saw buying come into the market yesterday afternoon, with some relief in oil and credit markets.  While this is not looking like a vigorous rally thus far, it has continued into overnight trade and is not yet running into significant intermediate-term overbought conditions.  

*  I have an experimental measure that takes a look at the relationship between expected VIX and actual VIX, based upon factors such as realized volatility and volume.  I'll be writing more about that measure in an upcoming post.  It has entered a range that has seen negative average returns over a two-week horizon.

*  Here's another unique measure that I've found helpful.  It takes a moving average of buy signals vs. sell signals for several technical trading systems across all listed NYSE stocks.  It's been a good overbought/oversold measure.  Interestingly, essentially all forward returns in stocks over a two-week horizon have either come from momentum (when this measure is quite strong) or from mean reversion (when the measure is quite weak).  In other words, when we get very strong readings, it's not unusual to have short-term follow through to the upside.  When we get very weak readings, it's not unusual to get a bounce over the next two weeks.  We are coming off a very weak reading.

Tuesday, December 22nd

*  Here's what I found when I studied the most successful traders I've worked with--and here's what it could mean for your trading performance in the coming year.

*  We've had a few recent bouts of selloff in the stock indexes.  Interestingly, new monthly lows across all stocks peaked on December 14th at 2025.  On Friday we closed lower in SPY but there were only 1131 new lows.  Yesterday, new lows peaked at 867.  My intermediate term indicators continue in oversold territory.  With continuing weakness in oil and high yield markets, rallies have been fleeting.  Breadth measures, however, are not weakening.  With a late rally yesterday, it's the bulls' turn to show what they can muster.  It is difficult for me to envision a solid rally without strength in oil, weakness in the dollar, and firmness in those high yield bond markets.  I continue to watch those markets closely.

*  Here's a chart you won't see elsewhere:  It's a cumulative running total of buy signals minus sell signals for the Commodity Channel Index (CCI) across all NYSE stocks.  Note the steady deterioration in net strength for most of 2015, which has accelerated recently.  A similar picture can be found when tracking cumulative buy vs. sell signals for other technical systems.  Quite simply, more stocks are demonstrating significant weakness than significant strength.

End of Year Drama in Financial Markets: The Global Macro Picture in a Few Charts

In the face of global economic weakness, the central banks of Europe and Japan have engaged in vigorous programs of monetary easing, while the U.S. central bank has cut back its program of quantitative easing.  That has been bullish for the U.S. dollar, as the chart of UUP depicts:

A number of emerging economies have currencies tied to the U.S. dollar, so that the dollar rise has created tighter financial conditions for them, even as those global economic conditions have weakened.  That has not been bullish for the relative performance of emerging market stocks, as the chart of EEM vs. SPY depicts:

With that global economic weakness and the tightening of economic conditions, commodity demand from China and related emerging economies has declined precipitously, as the chart of DBC depicts:

With the decline most notably in oil prices, fears of default among energy companies issuing high yield bonds have led to a sharp decline in the prices of high yield bond funds, as the chart of HYG depicts:

This past week, the Federal Reserve announced an interest rate hike and a path of future rate hikes.

Since that time, the U.S. dollar has risen; commodity prices have fallen; stocks have fallen; and high yield bond prices have fallen.  In short, the dynamics driving global macro markets have intensified and that is creating year-end drama in financial markets.  It also carries important implications for 2016, as emerging markets are going to need a large depreciation in their currencies to kickstart financial conditions.
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Be Your Best Self

Think about the five best decisions you've made in your life outside of markets:  the ones that make you most proud; the ones that have been most successful.  How did you make those decisions?  What information did you consider?  How did you process the information:  by thinking and analyzing, by discussing with others, by writing things down?  How long did it take you to make the decisions?  How much and what type of preparation went into the decisions?  

Draw a diagram that describes the process for your best decision making.  

That diagram captures your cognitive strengths.

How much of that cognitive process are you utilizing in your trading?

Can you expect to be successful in your trading if you're not drawing upon your greatest information processing strengths?

Now think about the five happiest, most fulfilling experiences in your life outside of markets:  the ones that have been most deeply meaningful and positive.  What were you doing in those experiences?  What made them so impactful?  How did you generate those experiences?  What actions went into those positive experiences?  Were these solo experiences, or were others part of them?  If others were involved, how did they contribute to the meaningful experiences?  

Draw a diagram that describes the process for your happiest and most fulfilling life experiences.

That diagram captures your emotional strengths.

How much of that emotional process are you utilizing in your trading?

Can you expect to be successful in your trading if you're not drawing upon your greatest emotional strengths?

So often, traders are not reaching their potential because they are not drawing upon the best of who they are: cognitively and emotionally.

It's not about talking yourself into discipline and emotional control.

It's about being the trader that is you at your best, cognitively and emotionally.

Further Reading:  Signature Strengths and Trading
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Trading Notes: Week of December 14th

Friday, December 18th

*  Thursday's action during New York hours completely reversed recent strength, with price weakness evident essentially from the opening bell.  When we did get some decent buying flows in the second half hour of trade, those were unable to push the market to new highs.  Meanwhile, we saw a resumption of weakness in oil and high yield markets and strength in the U.S. dollar.  From that point forward we traced out a trend day to the downside, as selling flows took over.  When you get meaningful buying that cannot push prices to fresh highs (or vice versa), that is often a great tell for intraday trading.  Those buyers are trapped on subsequent weakness and contribute to the continued decline.

*  Per my plan, I bought the early weakness, went green on the trade with the morning buying, and then proceeded to lose that gain and go into the red.  "That shouldn't be happening," was my response to the price action and I stopped out with a modest loss on the position.  When good trades (trades based on historical tendencies) go bad, there is information there.  Quite simply, the idiosyncratic influences of  the oil and credit weakness, dollar strength, and market maker selling to hedge put option losses in the face of quadruple witching overwhelmed any historical tendency for an oversold market to continue higher.  This is why flexibility in following the tape is paramount; getting locked into a market view blinds one to those unique influences that can turn markets.

*  That being said, I'm not convinced that yesterday's weakness (and some weakness so far in pre-opening trade) is a one-off that we can simply attribute to options expiry.  The weakness in emerging market stocks is real; the weakness in commodities is real; the weakness in high yield bond markets is real; and the number of stocks making annual lows vs. highs has been expanding.  All of this leaves me open to the possibility that we work off the recent oversold condition in a low Sharpe manner, ultimately making lower highs in the major indexes, and setting the stage for a meaningful decline.  The weaker and choppier any bounce from this latest weakness, the more open I become to that hypothesis.

*  I find the weakness in AAPL to be noteworthy.  It's one of those bellwether issues that bears watching.  Notice also how small and midcap stocks (IWM) are further from their 2015 price highs than large caps.  Microcaps (IWC) are similarly relatively weak.  On the other hand, the more defensive consumer staples shares (XLP) touched a new high recently.  Not exactly a pattern of relative strength that speaks to broad and strong economic growth expectations.

Thursday, December 17th

*  Once again we saw strength in stocks coming out of recent oversold conditions, with the strategy of buying weakness that stays above overnight and prior day's lows working well.  We've continued strong in overnight trading, which keeps the basic strategy alive.  Early in an upward phase of a market cycle we tend to see momentum, which means that strength builds on recent strength.  That's what we've been seeing recently.

*  Per the chart below, my basic overbought/oversold measures place us nowhere near overbought yet.  We have over 80% of SPX stocks trading above their three- and five-day moving averages, but that number can stay elevated for a while in early phases of market rallies.  I'm especially interested to observe the correlation between stocks and the oil market, which had been quite high and now seems to be breaking down.   

Wednesday, December 16th

*  Many traders try to predict what will happen next when they don't understand what is happening now.  Here's an article that addresses that situation.

*  Yesterday's post noted the oversold situation in the market and cited bullish expectations.  Those played out well in yesterday's trade and now in the overnight session.  Today's trading will be dominated by the Fed meeting announcement in the afternoon.  With traders focused on recent turmoil in high yield markets and the drop in oil, some are anticipating dovish messaging from the Fed.  It is not clear to me that this will be the Fed's primary focus, which could leave room for a "hawkish"/bearish surprise.  That being said, given the queries cited yesterday, buying weakness that holds above overnight and prior day's lows continues to make sense.

*  Note that we've bounced nicely in short-term breadth, given yesterday's rally.  If this is the start of a bull move higher, we should see the "overbought" condition stay overbought for multiple days, as the early phase of an upward cycle typically features momentum.  Where we're at in cycles helps determine whether we can expect short-term momentum versus mean reversion.

Tuesday, December 15th

*  I found yesterday afternoon's trading in ES to be very constructive.  We had significant bouts of selling pressure (high negative TICK readings) but price held above its morning lows.  Since that time, we've seen a nice rally in stocks in European hours.  The inability of selling to push prices lower and the inability of buying to push prices to new highs is often a good tell for price reversals.  (Interestingly, the NYSE TICK readings for much of the day were much more negative than the TICK readings I look at that cover all stocks, including small caps and transactions on regional and electronic exchanges.  That all-stock TICK is tracked via e-Signal.  I will be monitoring divergences between these measures closely to see if there's consistent information there.  As one savvy trader pointed out, the NYSE TICK is probably more dominated by bonds and bond-related shares trading on the exchange).

*  Meanwhile, we're in pretty oversold territory as the chart below indicates.  This tracks the number of SPX stocks making fresh highs vs. lows over a 5, 20, and 100 day time frame.  (Data from Index Indicators).  In the past couple of years, returns have been favorable when we've reached such oversold levels.  Since 2010, when this measure has been in its most oversold quartile, the next five days in SPX have averaged a gain of +.63%.  When the measure has been in the other three quartiles, the next five days have averaged a gain of only +.04%.

*  In a future post, I'll be talking more about my research into market cycles.  For now, here's a look at one of my cycle measures.  It, too, shows us at quite oversold levels.  Since 2012, when cycles have been in their most oversold quartile of values, the next ten days in SPY have averaged a gain of +1.05%.  The remainder of occasions have averaged a ten-day gain of only +.33%. 

 
Monday, December 14th

*  When markets knock you down, do you:  a) stay down and back away; b) grit your teeth and stick with what you're doing; or c) figure out what went wrong and try to adapt?  How we respond to adversity makes all the difference in our long-term success.

*  A truly weak market is one in which oversold conditions give way to even more oversold conditions, and that is what we saw on Friday.  The number of stocks making fresh new lows, which had moderated in recent sessions, exploded on Friday, following the weakness in oil and high yield bonds.  Across all exchanges, we had 60 new three-month highs against 694 new lows.  That's the highest level of new lows since late September.  With oil prices weak overseas, we're having difficulty sustaining an overnight rally.  Failure to bounce meaningfully from oversold conditions is a warning sign; I'd rather let the bulls prove themselves and buy the first pullback than try to catch knives.    

*  Note how small (IJR) and mid-cap (MDY) stocks have broken below their November levels; also note that emerging market stocks are closing in on their September lows.  Wide swaths of the equity markets are weak; this is not how bull markets behave.

*  VIX closed above 24 on Friday.  Volatility has picked up and that can lead to painful short covering rallies as well as violent downside moves.  It's important to take volatility into account when sizing positions and deciding upon holding periods for positions.

The Secret to Making Our Own Luck

This is an important post about luck and also an update of Flower's story.  If you recall from the previous post, Flower was a young Maine Coon cat abandoned by her family and living on the streets of a neighborhood for 2-1/2 months.  We went all out to find Flower a home.  I posted to this blog; we put a listing on Craigslist; I networked with friends and colleagues; I asked them to network with their contacts.

Nothing.

No one wanted this amazing cat, the most resilient animal I had ever encountered.  After considerable neglect and never really having a home, she retained a wonderfully trusting, loving personality.  How could no one want her??

With reluctance, Margie and I obtained some gates for doorways and decided to try, somehow, to integrate Flower with our very frightened cat who had freaked out on first seeing Flower.  We figured putting the cats on the opposite side of gates could allow them to see each other and interact with one another safely.

The gates never went up, however.  That day, a call came from a military family that had just been stationed at Fort Dix.  They were *very* excited about the listing for Flower.  They had had a Maine Coon cat for years who had bonded nicely with their youngest son.  The cat died and the boy missed her.  What better Christmas present than a new friend for the family?

The picture above is of Flower in her new home.  She has many people loving her and doting on her.  She has her forever home.  She even has a new name:  Princess Jersey Fluffbottom!

An observer might conclude that Flower is a lucky cat.  What are the odds that she could find a family specifically wanting a long-haired cat who is no longer a kitten?  As the recent article observes, however, luck is no accident.  There are specific things we can do to make ourselves more lucky.  If we place ourselves in front of opportunity in smart ways and do it over and over again, we become more likely to get that phone call and make that one special connection.  

The very important takeaway from the article is that luck occurs when we respond to adversity with creative effort.  That's how we get past drawdowns; that's how we stumble upon market observations that others fail to see; and that's how we find our forever future.  Having been turned down so often, the lucky one is the one who knocks on one more door.

Of course our Fort Dix family is lucky as well.  They had looked for a new cat for a while before finding their perfect match.  Happy endings are possible when we refuse to accept life's inevitable unhappy times.

Further Reading:  Making Our Own Luck
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Building Success By Breaking Things

There's an interesting fallacy in trading psychology:  Because many trading errors are made when people are in states of high physiological/emotional arousal, the conclusion is that a state of Zen-like calm and emotional restraint is necessary for trading success.  That would be a great theory, except in over a decade of working with professional traders, I can't find any successful ones who are particularly close to enlightenment.  It takes a degree of achievement orientation and drive for success to perform well in any field.  Those qualities ensure that failure will not be an easy experience.

Of course, there are ways you can become less emotionally aroused.  You can turn everything you do into a routine and then tell yourself that you'll make money because you're disciplined and follow a process.  You can trade with such small risk that no loss can ever throw you.  When markets change, your discipline will become your noose, ensuring that you continue to do the wrong things.  And when you trade well, small risk taking will ensure that you make small amounts of money.

But you'll have emotional control and a smug sense of superiority relative to all those traders who lose money and pound their desks.

Whatever.

The best traders I know are like the best entrepreneurs I know:  they hate failure and they court failure.  They hate failing, learn from mistakes, try new things, get knocked down, and refine the things they've tried.  They build things and push them until they break.  The breaking is no fun; it is frustrating; it is anything but an emotionally neutral experience.  But it's what feeds eventual success.  

If you try 10 new things in a year and two of them are successful, five of them are so-so, and three of them are dismal disappointments, you'll collect quite a repertoire by improving the so-so ideas, maximizing the successful ones, and turning the failures into funny stories when you go out.  How different from that is the person who becomes depressed because they're succeeding in only 20% of their ideas!

You can't learn the limits of your ideas unless you stress them.  That means that sh*t will break, you'll "fail", you'll be disappointed--and you'll channel all that into figuring out how to make your ideas stronger.  

If you're not developing things, breaking things, and using your frustration to make things better, you're moving too slow.  Real failure occurs when markets change faster than we do.

Further Reading:

Adapting to the Market's True Clock

The Greatest Challenge in Trading
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Trading Notes: Week of December 7th

Friday, December 11th

*  We got a bounce in yesterday's trade, only to fall back late in the day and move back to recent lows in overnight activity.  I will be watching downside follow through closely in early trade today, especially with respect to breadth, which--while negative--has improved over the past two trading sessions.  Yesterday we saw 93 stocks make fresh three-month new highs and 342 new lows across all exchanges.  My cycle measures are quite close to levels that have been typical of intermediate-term market lows.  That has me careful about pounding the downside here.

*  While trader attention has been quite focused on central banks in Europe and the U.S., we continue to see unusual weakness in emerging markets and oil.  It's a disconcertingly disinflationary trade and I find it difficult to envision a longer-term picture of higher U.S. rates, higher U.S. dollar, and higher U.S. stocks if that dynamic continues.  Note the toll taken on the high-yield bond market.  At least so far, the China weakness dynamic seems to be trumping the central bank stimulus dynamic.

*  Note that the VIX closed near 20 yesterday for the second consecutive day.  The median VIX from January through July was about 14.  The median VIX since the start of August has been 17.  I am open to the idea that 2016 could be a higher volatility year than 2015 given the above disinflationary dynamic and its potential impact on global markets. 

Thursday, December 10th

*  We saw weakness overnight, then morning strength in stocks, followed by significant selling pressure and new price lows for the latest move lower.  Interestingly, however, we saw fewer stocks register new lows on the day.  For example, across all exchanges we had 385 new three-month lows compared with 601 the day previous.  Meanwhile, we're short-term oversold per the breadth chart below, with fewer than 20% of SPX stocks trading above their three- and five-day moving averages.  We've bounced overnight from the afternoon lows yesterday and I'll be watching breadth closely on any further weakness.  Should we get to intermediate-term oversold levels and hold above the price lows from mid-November, I would start looking for an end of year rally in stocks.

*  We once again saw very different price action yesterday during hours in Asia, Europe, and the U.S.  Assuming that price moves in one time zone will necessarily continue into next ones has not been a great bet for short-term traders.  I find the current environment to be much better to trade within each time zone, buying oversold levels and selling overbought levels.  The chart below tracks short-term rate-of-change where each period represents 500 price changes in the ES futures.  This normalizes for overnight trading, but still takes into account movement overnight.

Wednesday, December 9th

*  We continue to work off the overbought condition per yesterday's post, but my intermediate-term cycle measures are not yet in oversold territory that has corresponded with recent market lows.  Meanwhile, breadth continues to deteriorate.  Across all exchanges yesterday, we had 21 stocks make fresh annual highs and 252 register 52-week lows.  This is more new lows than we saw at the mid-November market bottom.  In all, this looks like a weakening market, not a strengthening one.

*  No doubt contributing to the weakness is the unusual weakness in the high-yield bond market.  See the weekly chart of JNK below.  With energy prices continuing to fall, there are increased risks of bond defaults among oil producers.  It is difficult to square that dynamic with a bull market thesis.

*  Given the commodity weakness and heightened prospects for bond defaults, it's not surprising that much of the weakness among stocks this past month has come from raw materials shares per the graphic below from FinViz.  Even with central bank ease around the world, deflationary pressures globally have not abated.

Tuesday, December 8th

*  I'm watching volume carefully as the year winds down.  It would not surprise me to see traders pack it in early this year, given low liquidity and the challenges of P/L.  Tracking volume intraday has been very helpful in gauging how far market moves can extend.

*  We continue to work off an overbought condition (see below), with only modest losses in large caps but greater weakness among smaller caps.  That weakness has contributed to overall weak readings with respect to the number of stocks making new highs vs. lows.  For example, we had 194 stocks across all exchanges make fresh 3-month highs yesterday against 546 new lows.  That number of new lows was the weakest reading since early October.

*  If I had to choose a surprise for stocks in 2016, it would be that interest rate sensitive issues catch a bid, shrugging off any hike from the Fed and focusing instead on the (modest) path of rate increases going forward.  It is increasingly clear that this will be an abnormal hiking cycle.

Monday, December 7th

*  Here's what I see among talented traders who can't seem to make their trading their career.

*  We've moved quickly from oversold to overbought on my short-term measure, which is a 50-period rate of change measure, where each period is defined as 50,000 ES contracts traded.  (See below).  It's not unusual to see some upside follow through after such a thrust, so I'm flexible in trading today's session. 

*  One way I like to stay flexible is by going with statistics that I've gathered that find that the majority of trading days either put in their highs or lows for the day during the first hour of trade.  By watching early flows, including uptick/downtick values, I can get a sense for whether we've made a likely high or low for the day and trade the remainder of the session accordingly.  

*  The weakness in oil prices in the wake of the OPEC meeting has implications for energy shares, commodity currencies, and economic strength/weakness of various countries.  Ultimately it is difficult to reconcile commodity weakness with growth perspectives leading the Fed to likely hike this month.  Some interesting views have popped up lately regarding the possibilities of 2016 recession.  If that scenario is to hold, we should see little follow through to Friday's rally in stocks.

Better Doing Through Better Viewing: Three Observations From Friday's Trade

Here are two charts of Friday's trade in SPY (blue lines).  The top chart tracks relative volume.  That is the volume traded at each minute of the trading day as a function of the average volume typically traded during that minute.  The proportion is expressed in standard deviation units, so that a zero reading means that average volume was traded; a 1.0 reading is one standard deviation above average; etc.

The second chart tracks the number of stocks trading on upticks versus downticks for every minute of the trading day.  That also is expressed as a function of the average upticking/downticking typical for that minute, with the result in standard deviation units.  Thus, a reading of 2.0 means that upticks dominated downticks by two full standard deviations.

The charts together tell us:  a) whether significant volume is entering the market and b) whether the volume in the market is significantly skewed to the buy side or the sell side.

Friday's trade illustrates three important ideas:

1)  Trends are more likely to persist when backed by significant volume and significant buying or selling skew to that volume;

2)  Fresh flows can enter markets at any time and change the odds of trend persistence.  Note the unusually strong buying flows during the noon (EST) hour on Friday.  That is atypical.

3)  Viewing volume and buying/selling pressure in standard deviation units provides a nice check on our cognitive biases, where we might be likely to overinterpret small, insignificant market movements.  What was important on Friday was that any selling that occurred was, for the most part, not statistically significant and not accompanied by significant outflows.

I generally find that better viewing makes for better doing.  These kinds of charts make a lot more sense to me than traditional price and volume barcharts because they directly express how I think about markets.  By creating better displays--ones more adapted to how we view markets--we can improve our information processing and our decisions.

Further Reading:  Freeing Our Charts From Time
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Best Practices, Best Processes, and Why Traders Don't Reach Their Potential

One of the key ideas from the Trading Psychology 2.0 book is turning what you do best in markets (your best practices) into robust habit patterns (best processes).

What that means is that it is vital for traders to understand their strengths and how those strengths manifest themselves as successes.  When I ask traders to identify their strengths, they inevitably give generalized responses that don't map onto best processes.  For instance, a trader may say that they're good at risk management or good at reading chart patterns.  How do they specifically draw upon those strengths in day to day trading?  That is not elaborated.  

To truly understand yourself in a best practices framework, ask yourself:

1)  What do I do best in terms of researching ideas for trading?

2)  What do I do best in terms of translating my ideas into specific trades?

3)  What do I do best in terms of executing and sizing my trades?

4)  What do I do best in terms of managing the risk of my trades?

5)  What do I do best in terms of managing myself as a performance professional?

Now ask yourself:  How do I keep track of today's performance in light of the five best practices categories above?  How, specifically, do I ensure that today's trading is aligned with what I do best?

The greatest mistake traders make is spending much more time following and studying markets than following and studying their own trading performance.

Better understanding of markets does not necessarily translate into better trading of markets.

If you don't understand and act upon what drives your success, something else will inevitably drive your performance.  Every bad trade fills a vacuum.

Further Reading:  Why Disciplined Traders Make Bad Decisions
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Trading Notes: Week of November 30th

Friday, December 4th

*  Well, ECB did end up giving us a surprise and it was as much in the tone of the press conference as the content of the decision.  My take is that the central bank sent a message that they will not be bullied by markets and all the commentary on how the bank "needs to deliver."  The message from the press conference was that they are delivering the promised monetary stimulus, that this is enough, and that we should be patient and let it work.  Markets were positioned for more aggressive action and we had quite the selloff in the euro and in stocks and bonds.  We have the payrolls report this AM and then the Fed enters a quiet period ahead of its meeting.  All in all, with a moderate ECB and a Fed poised to hike, there isn't a big central bank tailwind for stocks.

*  Yesterday I noted the deterioration in breadth and that clearly extended yesterday.  We had 350 stocks across all exchanges register fresh monthly highs against 699 lows.  That was the highest number of stocks making monthly lows since November 16th.  We're extended to the downside on a short-term basis with fewer than 20% of stocks trading above their 3, 5, and 10-day moving averages (raw data from Index Indicators), so a short-term bounce is quite possible.  As the chart of overbought/oversold SPX stocks indicates below, however, we are not yet at an intermediate-term oversold point.  That has me in the mode of selling market bounces.

Thursday, December 3rd

*  So far, no great surprises from ECB; press conference coming up.  I'm not sure there's anything to change the broader dynamic of low rates and weak currency in Europe.  If we see a dovish rate hike from Fed, 2016 could bring more QE-style trade to stocks and shares with yield could find some support.  It's a theme I'm mulling over for the new year.

*  That being said, yesterday traded quite weak.  Note on the relative volume chart of yesterday's trade below how the attempted bounce from the early selling found little interest.  We bounced overnight, but we're overbought on an intermediate-term basis.  That has me selling bounces that cannot take out overnight and prior day's highs.

*  I was struck yesterday by the fact that we had 54 stocks make 52-week highs and 78 register annual lows.  Not impressive breadth.
Wednesday, December 2nd

*  From the start of Tuesday's session we could see fresh buying flows enter the market, with elevated NYSE TICK readings.  This was a clear break from recent action and ultimately led the market to new price highs for this move.  The number of stocks closing above their upper Bollinger Bands hit their highest level since November 2nd and breadth was solid (see chart below).  If this is the start of a genuine leg up, we should stay above the recent trading range and add to yesterday's gains.  The response to tomorrow's ECB action may play a role in that.  Given generally overbought levels in my cycle measures, I'm not wedded to the upside breakout idea, but will be watching breadth closely.

*  I continue to implement the change in my trading in which I view the hours in Asia, Europe, and U.S. as distinct trading "days".  All positions are opened and closed within their "days", so that there is no assumption of continuity across time zones.  I find the flows and price patterns to be quite different from one time period to the next, but do find consistency within each zone.  This has helped risk management and has also helped me become more flexible in trading ranges.  The emergence of the buying flows early in yesterday's U.S. session was a good case in point.

Tuesday, December 1st

*  We saw weakness in stocks yesterday, followed by late day strength, only to fall back into the range in overnight trade.  During this extended range, we're seeing overbought levels in my cycle measures and breadth has been waning (see chart below; raw data from the excellent Index Indicators site).  Trading the range (fading short-term overbought/oversold readings) has been what's been making money so far and it's been a make it/take it market.  With all eyes on ECB on Thursday and payrolls on Friday, I suspect we'll have plenty of volatility to break the range.  As we get to the upper end of the recent range, I'm not enamored with the risk/reward.  I'm also not inclined to take big bets ahead of events later this week, which might be the sentiment of other market participants...and that could keep us in the range near term.

*  Here's a study that I've undertaken that I believe will be of value in 2016 performance.  I'm looking at the trajectory of my winning and losing trades.  How quickly do the winners turn into winners?  How quickly do losers become losers?  If a trade is not profitable after X minutes, what is the likelihood it will be profitable at all?  If a trade is under water after X minutes, what is the likelihood it will come back?  What is the trajectory of the market after my exits?  Is my entry and exit execution providing value?  My initial findings are that losing trades pretty much start out as losing trades.  If I don't get stopped out after a period of time, the best course of action is to add to the trade.  Winning trades don't always start as winning trades, but often start as not-losing trades.  In other words, a market may bounce around in a range before going my way.  That does give opportunities for adding to positions.  Tracking the added value of those added positions is yet another study I will be undertaking.  More on this soon to come--


Monday, November 30th

*  How far can we take performance if we work with very tuned minds and bodies?  Most of us assume that we have to work hard and work long hours and this means work must take a toll on mind and body.  But if we prioritize mind and body, might we work much better and smarter?  Might we live happier and more fulfilled lives?  Perhaps we're going about development and performance in entirely the wrong way...

*  Stocks bounced off early lows in Friday's partial session, but remained below recent highs.  I continue to be underwhelmed by market breadth thus far.  The maximum number of new monthly highs registered last week was 589 on Wednesday, well below the 953 achieved in the first week of the month.  We have ECB on Thursday and the last jobs numbers on Friday before the Fed meeting this month.  I will be watching closely for evidence of the recent market strength broadening vs. rolling over.  My measure of intermediate-term market strength has not yet crested for the current cycle, per the chart below.

 *  High yield bonds continue to struggle per the chart of JNK below.  At some point, I suspect this will take front and center stage.  It's not a bull market dynamic.