Sunday, January 31, 2016

Mental and Emotional Preparation for Trading

An important implication of the recent post on how to avoid bad trading decisions is that it is not enough to plan trades, write in a journal, or review performance.  If we make decisions in cognitive, emotional, and physical states that are different from the ones we occupied during our preparation, we're likely to find that the decisions we plan won't always be the ones we act upon.

Experienced traders don't just create a plan for a trade; they often plan a variety of possible scenarios for their positions based upon how markets behave, news that comes out, central bank decisions, etc. By anticipating a variety of events, these traders enable themselves to respond quickly in the face of surprise.

This mental preparation is most effective if it is also emotional preparation.  In other words, we want to not only anticipate a scenario, but also the thoughts, feelings, and physical states likely to accompany that scenario.  If a market is topping, for instance, and my short position starts to go my way, I know that I may feel uncomfortable on a bounce, and I know I'll have thoughts about stopping out of the trade.  I also know, however, that if it's a weaker bounce consistent with the broader topping action, it could be an attractive level for adding to my position.  If I plan the trade mentally but not emotionally, I increase the likelihood that I could act on the feelings and impulses of the moment and scratch out of a trade just when I really should be adding to my risk.

When we anticipate the thoughts and feelings that can nudge us from our best intentions, we make ourselves more resilient.  We're more likely to respond to stress with "been there, done that."  The idea is to make our planning as broad as possible so that we're anticipating a wide range of scenarios--and responses to those scenarios.  If there's one thing we want to minimize in trading, it's surprise.  Surprise--whether positive or negative--will shift our states and nudge us from trading plans.  When we prepare for a wide range of scenarios in which positions go our way or against us, we take the surprise out of market events and keep our responses more stable.

We cannot--and should not--eliminate emotion from trading, but that is also not necessary.  Preparation puts emotion into perspective; we gain control, not by staying Zen, but by anticipating situations that are likely to take us out of calm focus and preparing our responses to those.

Further Reading:  How to Trade Your Plans Once You've Planned Your Trades

Saturday, January 30, 2016

The State of Our States: Trading With Self-Awareness

The recent post on burnout emphasized an important--but often unrecognized--point: We derive energy not just from the state we're in, but from shifts in our physical, emotional, and cognitive states.  Too much exercise; too much concentration; too much rest and we become fatigued: we lose energy.  Variety in our states enables us to be serious and to have fun, to be active and to have moments of quiescence.  When life becomes too routine, we paint ourselves into a psychological corner in which we occupy only a fraction of the healthy, vital states available to us.

Why is this important to trading?  

What we know--and therefore what we can act upon--is in part a function of our state of mind.  We recall something important in one mindstate; we become distracted and forget it in another mode.  We study diligently for a test--and then can forget it all if we become test-anxious.  We know our trading rules and are committed to them when we're focused--and then we abandon all discipline when frustration strikes.

So much of trading boils down to pattern recognition.  We recognize how short-term price behavior fits into a longer-term picture; we see how fundamentals line up with price action; we observe how volume behaves around certain price levels.  If what we know is in part a function of the state we're in, an essential challenge of trading psychology is to sustain the states that are optimal for pattern recognition.  Are those energized states, or are they quiet and focused ones?  Are they happy, positive states, or are they ones in which we dampen emotion?  Are they states in which we're actively engaged with people, or are they ones in which we sustain an inward focus?

The fact of the matter is that each of us processes information differently and so best apprehends patterns in different ways.  The introverted and analytical person likely requires different states for information processing than the extroverted and intuitive person.  Only our successful life experience--and especially our successful trading--can tell us how we best perceive and act upon patterns.

We can practice race car driving for years, but we'll lose on the race track if our car is badly out of tune.  The problem with many traders is that they are out of tune: they fail to sustain the cognitive, emotional, and physical states associated with their unique success.  There is more to market knowledge than self knowledge, but without self knowledge we cannot make use of even the best market insights.  Self-awareness facilitates market awareness.

Further Reading:  Burnout as the Absence of Emotional Variability

Monday, January 25, 2016

Trading Notes; Week of January 25, 2016

Friday, January 29th

Easy to get burned out sitting in front of screens all day and trying to stay disciplined.  Here is an important antidote to burnout.

*  I've been offline for a couple of days, swamped with coaching work with traders.  Whenever that happens, it's a sure sign that markets are tricky and people are having trouble making money.  We had a real risk off start to the year, with oil, stocks, and emerging markets lower and firmness in the U.S. dollar.  Late last week we saw a sharp rebound and these posts talked about having put in a momentum low for this market cycle.  Evidence was also suggesting that this cycle was not like ones we had seen in 2014 and 2015, with far more persistence of weakness in stocks.  This week we have generally continued the bounce, but in a highly choppy fashion, making it difficult to make money from either the bull or bear side.  Hence the recent frustration of traders.

*  A momentum low implies the possibility that further price lows could remain ahead, albeit with breadth divergences.  That is what we saw in the trade following May, 2010; August, 2011; and certainly January, 2008.  Thus far, this has been a low Sharpe ratio bounce; not the kind of resumption of uptrend that we saw following, say, the October, 2014 low.  That uneven bounce increases the likelihood in my estimation of those retests of lows.

*  Which brings us to today's trade.  With the move to negative rates in Japan, we saw a sharp rally in stocks, followed by a sharp dip, followed by more rangy behavior in the ES futures.  Oil has rallied significantly from its lows; VIX has remained above 20.  I'm concerned that we're having trouble making fresh highs in ES in pre-market trade even with the Japan easing and oil strength.  That has me looking to sell strength as long as we can remain below the post BOJ highs.

*  Note that there is a difference between a retest of lows and the start of a fresh bear market leg.  When we had extended bottoming processes in May, 2010; August, 2011; and even that January, 2008 period, there was a two-way trade and rallies interspersing the declines.  My leaning will be to take profits opportunistically on short trades and not necessarily assume a resumption of a high Sharpe downtrend.

Tuesday, January 26th

*  After failing several times to stay above the 1900 level, we saw a selloff in the ES contract that featured numerous very negative NYSE TICK readings.  The inability of buyers to get the upticks much above +500 for any sustained period was a clear indication that we had put in a top and that sellers were in control.  Prices continued to weaken during Asian hours and now have rebounded in premarket, with a bounce in oil.  All of this is consistent with a market that has made a momentum low and is early in a bottoming process.  Note that such a process took months in early 2008, mid-year 2010, and fall 2011, with multiple rallies and pullbacks.  This two-way action can be frustrating for bulls and bears alike and highlights the importance of not assuming that moves will extend.

*  Note the significant weakness in KRE, the ETF for regional banks.  Some of those banks have exposure to energy-related loans, which could be in jeopardy if oil prices continue weak.  That's a dynamic I am watching closely.  I'm also watching the big banks (XLF) to see how global economic weakness, particularly among emerging market countries, might affect loans and market exposures.

*  Note that we continue to be significantly oversold on most breadth measures.  I expect further working off of this oversold level in the next couple of weeks.  My cycle measure has turned up, but is not at levels that have corresponded to intermediate-term highs.  As noted before, we've made a lower low in that cycle measure, which opens my thinking that what we're seeing is more than the kinds of corrections that we experienced in 2014 and 2015.

Monday, January 25th

*  Friday saw a continuation of the rebound from momentum lows, with breadth finally touching short-term overbought levels.  Over 80% of SPX shares closed above their 3 and 5-day moving averages; that's the first time we've seen that since December 24th.  (Data from Index Indicators).  The rally took the great majority of stocks off their lows.  Across all exchanges, we had 139 monthly highs against 208 lows.  Compare that with 44 monthly highs and 3250 lows just two days previous.  (Data from Barchart).

*  One sign of continued strength on Friday was that significant negative readings in the uptick/downtick measure (NYSE TICK) could not stop us from making higher price lows and higher price highs.  I will be watching for that dynamic in early trading today.  A drop below the Friday afternoon and overnight lows would likely break that pattern and signal fresh selling interest.

*  I will also be watching this week to see if the bearish market themes (weak oil; weak emerging market shares; strong dollar versus EM and commodity currencies) reassert themselves.  I'm also watching to see if we can print fresh price highs for this rebound with continued strong breadth.

*  A nice view of the market's cyclical behavior is provided by the number of NYSE shares giving buy vs. sell signals for the Parabolic-SAR measure.  That cumulative total has tracked market cycles well over the past two years.  (Data from Stock Charts).  As you can see from the chart below, we've bounced, but are not yet near levels that have corresponded to intermediate-term cycle tops.

Sunday, January 24, 2016

The Key To Overcoming Frustration In Trading

Dale Carnegie was right; many times it's not our work that runs us down, but our emotional responses to the work.  Fear and greed often get first billing in discussions of traders' emotions, but it's frustration that I encounter most commonly.  Traders become frustrated when they feel they miss moves; they become frustrated with losses; they become frustrated if they make money and feel they should have made more.  This is why changing the dynamics behind frustration is the single greatest psychological improvement traders can make.  

To be sure, frustration can serve as a motivator.  After all, we become frustrated when our desires and goals are thwarted.  Learning from what is holding us back can give us the motivation to overcome those obstacles and ultimately succeed.

We can't channel frustration constructively, however, unless we're first aware of the frustration.  It is the mindful awareness of frustration than enables us to pull back, assess the situation, and move forward in a positive way.  If we're not aware of the frustration, we can't pull back, and we're most likely to act impulsively out of that frustration.  Those decisions are rarely good ones.

"I'm really frustrated right now; this is not when I should be trading," is something I've told myself more times than I can count.  I'll take a short time out; I'll take the rest of the day off--I'll do what it takes to address the frustration and re-enter markets with a fresh mindset.  I can only guess how much money those decisions have saved me.  When I act out of frustration, I'm placing the trade because of me--not because of genuine opportunity offered by markets.  When we plan trades and rely upon best practices, we trade mindfully and proactively.  When we act on frustration, we trade reactively--and often violate those best practices.

To stay proactive, we need to use frustration as a cue to stop and reflect, not as a spur to act.  Frustration can become our friend if it becomes our prod to improve who we are and what we do.

Further Reading:  Turning Around Your Trading

Saturday, January 23, 2016

Going Back To School For Your Trading

Well, it's a snowy Saturday in the next station to heaven, so Mia and I are listening to love songs and going back to school.  There's no better formula for a full life than to live meaningfully and learn constantly.  That way, you're always growing: in your heart and in your head.

Going back to school is an exercise I return to periodically that keeps me fresh as a trader.  It's really a return to the process by which I learned trading.  For well over a year, at the end of the day I printed out charts of the market (price/volume) and charts of every indicator that I believed could have value in anticipating market moves.  I knew that, for any limited period of time, indicators could randomly appear to have value.  Over the course of weeks and months, however, patterns recurred that helped me focus on the measures that added true value.  It was through those initial explorations that I discovered trading patterns in NYSE TICK (upticks/downticks among all NYSE stocks) and breadth divergences.  Those remain staples of how I look at markets to this day.

When I returned to trading after a five year hiatus during which I worked full time at a hedge fund and was not allowed to trade for compliance reasons, one of my first steps was to get back to school.  I observed new patterns, including the relationships among macro markets and how movements in currencies, rates, and commodities were related to moves in stocks.  Carefully reviewing market behavior minute by minute, day by day, gave me a fresh appreciation of volume and volatility and the ways in which large institutional participants help to move the market.  This led to new ways of viewing the uptick/downtick and breadth data, as well as new ways to measure buying and selling pressure to be on the right side of the market movers.

Still later, I felt my trading results were not what they should be.  Specifically, I became disenchanted with my quantitative models and looked at why they occasionally broke down.  I began focusing on the question of whether cycles exist in the market and whether those could aid the identification of relative highs and lows.  Once again, I made a day to day study, minute by minute, and returned to school.  What I found was that measuring cycles in chronological time was not particularly effective.  More properly, I found that cycles are better identified in event time than chronological time.  That led to new ways of measuring overbought and oversold markets, as well as new ways of assessing volatility.    

So now it's back to school.  I'm reviewing recent markets and the most meaningful recurring patterns among  the measures I track.  What I'm finding is that I follow a lot of things that ultimately are not crucial to decision-making.  I could be much more efficient by tracking a more limited set of unique data.  I'm also finding real value in looking at how shorter-term cycles are nested within longer-term ones; i.e., viewing cycles in context.  This was particularly helpful in identifying the market turn this week.

There are three important lessons in all this:

1)  In getting back to school and looking at markets through fresh eyes, we can adapt to changing markets and we can continuously grow as traders. If you merely have a passion for trading, you'll overtrade.  It's a passion to understand and master markets that can keep you going through the ups and downs of your equity curve.

2)  None of the most important information that shows up in my reviews is a traditional technical market measure, such as a chart pattern or canned oscillator.  None.  The value is in new data and new ways of organizing the data.  If you're tracking the information other people are tracking and if you're assembling the information the way others are, you're just not going to achieve distinctive returns;

3)  The best way to improve your trading psychology is to improve your trading.  People hope they'll trade better if they improve their mindset, control their emotions, etc.  All that can be useful, but cannot substitute for genuine insight and information.  When you go back to school, you cement your own learning.  That is what gives us the confidence to take risk and stay with trades when the odds are with us.  

OK, Mia and I are finishing the last song and heading to the basement.  That's where the exercise room is located and where we work on body after working on mind.  That's a different school, but one that is equally important. 

Keep growing.

In all respects.

Further Reading:  Learning From Our Trading

Tuesday, January 19, 2016

Trading Notes, Week of January 18, 2016

Friday, January 22nd

*  Yesterday's post noted the possibility that we had put in a momentum low for the recent market cycle.  Price action on Thursday was supportive of that hypothesis, as we saw very significant selling pressure in the afternoon, with multiple NYSE TICK readings below -1000.  That was similar in selling intensity to the puking we saw at the price lows, but now we were holding higher in price.  The market's ability to make higher price lows and higher highs is what we look for if we've indeed put in a momentum low.  Meanwhile, we've moved higher overnight, again consistent with the momentum low notion.  (Note the recent significant strength in oil prices, as well).  Bottom line is that, short-term, we appear to be transitioning from a "sell the bounce" to a "buy the weakness" mode. 

*  Here's a nice view of breadth among SPX stocks, which tracks the number of stocks making 5, 20, and 100-day new highs vs. lows.  Note how we've stayed oversold far longer than during recent declines; also note how we're still in oversold territory despite the recent bounce.  I expect stronger breadth numbers before we see a test of recent market lows.

*  Yesterday was the first day in 11 sessions in which we registered fewer than 1000 stocks across all exchanges registering fresh monthly price lows.  Still, only 46% of SPX shares are trading above their 3-day moving averages and only 31% above their 5-day averages as of yesterday's close (data from Index Indicators).  Those short term breadth measures should continue to strengthen if we've indeed seen that momentum low.

Thursday, January 21st

*  We saw concentrated selling early in the day followed by a vigorous rally with significant buying strength that erased much of the day's losses.  The breadth numbers were particularly extreme with 44 stocks registering fresh monthly highs against 3250 new lows.  The depth of the oversold condition, combined with the vigor of the buying, opens to the door to the hypothesis that we've put in a momentum low for this downward cycle.  With the reaction to the ECB meeting most recently, we've moved higher in trading.  We should see further upside follow through and divergences in the breadth data on further weakness if, indeed, we've put in a momentum low.

*  That being said, to reiterate a point made for a while now, this cycle has been deeper on the downside than cycles over the past two years and is more consistent with downward moves in 2010 and 2011 than 2014 and 2015.  These deeply oversold declines in 2008, 2010, and 2011 eventually went on to make further price lows well after the momentum point at which we'd maxed out the number of shares making new lows.

*  Here is an overbought/oversold measure that I track based on event bars rather than time-based bars.  What I look for in a bear market is overbought levels at lower price highs; those are often good regions for shorting.  In a bull market, you look for oversold levels at higher price lows.  Those are often good areas for buying.  In a range market, you'll see successive overbought and oversold levels at similar price extremes.

Wednesday, January 20th

*  Stocks came well off their highs during trade Tuesday with accompanying oil weakness and that weakness has continued in overnight trading.  That has taken us to new price lows and pretty well negated whatever divergences we were seeing in the data, as noted yesterday.  The important tell in Tuesday's trading was the inability of rallies to sustain either in time or price, as we made successive lower highs.  If we were coming off a momentum low, we'd expect to see value buyers sustain buying.  When buying is not sustained, there's a good likelihood that it's more short-covering than initiative interest.

*  Meanwhile, whether you look at VIX, volume, or the pure volatility measure that I follow (volatility per unit of trading volume), all are elevated, but none of seen the kinds of capitulation spikes that have characterized past sharp declines.  A break of the 2014 and 2015 lows may help yield such spikes; it's something I'm watching for.

*  Once again, to emphasize the themes from last week's notes, there is every evidence that this decline is different in character from the corrections we've seen during the past two years.  Oversold levels that had led to sustained rallies--characteristic of a range trade--are no longer finding buying interest.  It is difficult to imagine sustaining a move higher until we can find a bottom in oil and related commodities.  

*  It is also difficult to imagine the Fed sustaining a program of rate hikes in the face of deteriorating financial conditions.  The market decline is getting to the point where it will dent consumer confidence.  Note the superior relative performance of utility shares.  Yield becomes attractive as a flight to safety, but yield is also more attractive if rates are likely to stay lower for longer.

Tuesday, January 19th

*  Everyone wants to trade with confidence and conviction, but that means that we have to keep mind and body in peak conditioning, especially during busy markets.

*  We traded to new lows for this move on Friday, but interestingly we saw the first evidence of divergences in the new lows data for SPX stocks.  For example, we had 129 more new 100-day lows than new highs on Friday, surprisingly short of the 167 differential on Wednesday.  Only 8.96% of SPX stocks traded above their 10-day moving averages on Friday, but that was still higher than Wednesday's level of 4.98%.  (Data from Index Indicators).  Among SPX sectors failing to make new lows on Friday were XLU, XLE, and XLV.  The relative strength of the XLE shares is notable, given the recent weakness in oil.  We've bounced well off Friday's lows in holiday and pre-market trade. 

*  Last week's trading notes observed evidence that the current market downturn has been more persistent than recent corrections.  When we've had significant declines in August, 2011 and May, 2010, we saw follow-through weakness even after a momentum low was reached.  I am open to that possibility in the present market.  If, however, we have indeed put in a momentum low, we should see more of a two-way trade going forward than what we've seen thus far in 2016.

*  My intermediate term strength measure, which takes into account 5, 20, and 100-day new highs vs. lows among SPX shares, opens the week in unusually oversold territory.  With VIX closing above 25 on Friday, we should continue to see meaningful volatility.

Monday, January 18, 2016

How To Be Your Own Trading Coach

Here is a coaching exercise that can make a meaningful difference in your trading:

At the end of the day or week (depending on your frequency of trading), identify your best trade and your worst trade.  Then dissect each one:

*  How did you prepare personally during the time leading up to your best trade?  Your worst trade?  What was your state of mind?  Your physical state?  

*  How did you research the idea that went into your best trade?  Your worst trade?  What information did you rely upon?  What information did you disregard?  What was your edge going into the trade?

*  How did you enter and size your best trade?  Your worst trade?  How did you manage the position while it was on?  What information did you process and rely upon during the trade to add to the position, scale out, or stay in the position?

*  What was your state of mind while the trade was on?  What were you doing during the life of the trade?

*  How did you exit your best trade?  Your worst trade?  What information did you process to aid the exit?

Your best trades are your role models.  By reviewing your best trades, you ground yourself in your best practices.  If you are mindful of your best practices--if you know how you make money--you're more likely to be consistent in drawing upon those best practices.

Your worst trades are role models also, but in a reverse way.  By reviewing your worst trades, you become mindful of the mistakes you make and the patterns of your poor trading.  It is much easier to interrupt our negative patterns if we're aware of them in the first place.

How would your profitability look if you could just eliminate one bad, losing trade and replace it with one good losing trade each week?  I suspect it would be a meaningful difference.

The successful role models you need to study are not gurus.  You at your best are the best role model you can have.  You can be your best trading coach.

Further Reading:  Best Practices of Best Traders

Sunday, January 17, 2016

Money Management in Trading: Gaining the Upper Hand by Playing Your Hand Correctly

Yesterday's post on how to renew yourself after a challenging market week is an important one.  It's easy to become so caught up in short-term market action that we fail to pace ourselves through the market year.  Many times we make poor decisions, not because we lack effort or discipline, but simply because we've depleted our resources and no longer have the concentration and energy level to properly identify and pursue opportunity.

A measure of a trader's wisdom and experience is the amount of thought they put into money management.  I've emphasized in the past that you should never lose so much in one trade that you cannot be profitable on the day.  Similarly, you should not lose so much in a day or week that you can't be profitable on the week or month.  You will always lose money, you will always have losing trades, you will always have drawdowns, and you will always have periods in which you're out of sync with markets.  Good money management allows you to stay in the game--emotionally and financially--during those periods of downturn.

There's another facet of good money management, however, and that's maximizing opportunity when it is present.  My general experience is that losing trades usually become losers early in their life.  If I'm not stopped out within minutes of my entry, the odds are good that I have a winning trade.  At some point, buyers can't push the market higher or sellers cannot push us to fresh lows and I recognize that my trade is working out.  That recognition is important--and I rarely see it discussed as a topic in trading psychology.  It's not the issue of being right or wrong, and it's not the issue of being confident or fearful.  Rather, it's the insight that comes from a kind of Bayesian reasoning in which we continuously update the odds of our trade working out.  At some point, we're not just right in the trade, but we recognize that the odds have tilted greatly in favor of this being a profitable trade.

That experience of not just being right but recognizing that we're most likely right can be a powerful cue to add to the trade.  If our Bayesian updating is accurate, that added piece should have a high hit rate, which more than makes up for the fact that the add is closer to the target than the initial entry.  Adding to the trade when the odds of success have risen is a way of ensuring that you'll be smallest when you're wrong and largest when you're right.  A good add is as good as a good fresh trade.

Sound money management places us in control of our finances.  We cannot control markets, but we can control the size of our betting and we can control our bet sizing as we draw cards and our hand unfolds.  A good trader trades with the odds.  The great trader recognizes how the odds shift during the life of the trade and bets accordingly.

Further Reading:  The Importance of Playing the Right Game

Saturday, January 16, 2016

The Cure for Market Fatigue and Frustration

To say it's been an eventful start to the new year is quite the understatement.  As I've chronicled in the market updates, there is every indication that 2016 is a different from recent years.  There is greater volatility, and oversold levels that had led to bounces in the recent past have not been able to find buyers.  With the increased directional movement and potential opportunity set, you would think this would be a wonderful psychological environment for traders.  Oddly, however, I've been hearing more about fatigue and frustration than fortune and fulfillment.

Two factors seem to be responsible for the negative emotionality:

1)  Slowness to Adapt - I heard it at $50 and I heard it at $40 and I'm hearing it with the break of $30:  oil prices are going to rebound.  I've also heard quite a bit of "We're overdue for a bounce."  Just recently, the Fed deemed the economy to be sufficiently robust to raise interest rates.  How could we now be crashing?  Staying grounded in old perceptions and not updating with fresh observations of what is actually happening has kept many traders from profiting from the risk-off of early 2016.  Traders have also been slow to adapt to the increased volatility, placing stops too close and taking profits too early.  This creates a psychological environment ripe for frustration and negative self-talk.

2)  Fatigue - There is meaningful--and different--market movement in Asian, European, and U.S. time zones.  Many traders have attempted to track and trade markets through the 24-hour day and that has been both stressful and tiring.  I've noticed much more checking of prices via phone during non-trading hours, as traders holding positions feel a need to be switched on to developments overseas and overnight.  With the fatigue comes diminished concentration and the potential for impulsive decision-making.  With fatigue, as well, it becomes more difficult to hold frustration at bay when losing money or missing a trade.

The bottom line is that when markets are moving more than usual and moving in all time zones, you are going to leave a boatload of money on the table.  You're not going to catch every move, and it's going to hurt when you get a trade wrong.  If you treat all movement as opportunity, you're going to chronically feel frustrated, as there will always be profits you failed to earn.  So much of our fatigue is not simply a function of lack of sleep, but the result of negative self-talk that comes from frustration.

I spent a very enjoyable day on the trading floor at SMB this past week, talking with the traders and doing my own trading.  I placed two trades all day:  made money on an early selloff in the morning and made money on a rise in the afternoon.  Did I make money in the overnight trade?  Nope; didn't trade it.  Did I make money on the initial sharp move higher from the midday lows?  Nope; didn't trade it.  Did I trade in size?  Nope; I target a set level of daily P&L volatility so that I trade smaller when markets become more volatile.

So how should I feel at the end of the day?  From one perspective, I left a ton of money on the table.  From another perspective, I traded the patterns that I research, I made money, and I had a great day talking with traders who have grown tremendously and who are doing interesting and profitable things in the market.

At the end of the day, it's important to know the game that you're playing; accept the games that you're not playing; and find peace with who you are, what you can do, and what you can't do.  Only some market movement is opportunity: that sphere of movement that overlaps where we truly possess an edge.  BMW doesn't fret over buyers who choose to drive a Chevy; that's not the game they're playing.  The people who run Silversea cruises don't bang their heads against walls because they "left money on the table" when people chose Disney cruises.  You judge yourself against your own yardstick, against the metrics that capture who you are and what you're trying to accomplish.

Trading can be fun and we can be passionate about markets, but nothing is so important that it should dictate and control our physical and emotional well-being.  Trading has to fit into our lives and skill sets; otherwise, our relationship with markets becomes an unhappy and even abusive one.

Further Reading:  The Real Reason We Trade Emotionally

Monday, January 11, 2016

Trading Notes, Week of January 11, 2016

Friday, January 15th

*  Thursday's rally was short-lived, and that has been the outstanding feature of the recent downturn in the stock market.  As noted in the prior posting (below), we have stayed oversold for far longer than has been typical of corrections in 2014 and 2015.  The weakness in oil continued overnight and we've broken to new lows for the move following the data release this morning.  Selling bounces that roll over at lower price highs continues to be the winning strategy.

*  The chart below of one of my primary cycle measures is worth a thousand words.  Quite simply, this is a different cycle from those of the past two years and suggests to me that we've entered a different regime.  Using patterns from the recent past to extrapolate into the near-term future is hazardous to our wealth.

Wednesday, January 13th

*  Tuesday was the first day in which we saw the number of stocks making fresh new lows decline day over day.  To this point, it has been quite a broad decline, with fewer than 10% of SPX stocks trading above their 50-day moving averages and only about a quarter of the stocks trading above their 200-day moving averages.  Indeed, yesterday was the first day in nearly two weeks in which we've seen more than half of stocks closing above their 3-day moving averages.  That is unusually consistent weakness and is but one of the things leading me to believe that this is more than a mere correction in a bull market.

*  Below is a breadth measure I keep for SPX stocks, capturing the percentages closing above short-term moving averages (data from Index Indicators).  We can see that we have stayed oversold far longer than is usual in a normal correction.

*  Yet another look at market weakness is a running total of buy vs. sell signals for all NYSE stocks across various technical measures, such as Bollinger Bands (data from Stock Charts).  The quality of the bounce we can muster from these oversold levels will tell us a lot about whether this is part of a multi-year range or a first leg in a larger bear market move.  My cycle measures are at lower levels than we have seen during recent corrective moves, which once again opens my thinking to the possibility that we are in a different regime, not the rangy corrective mode of much of 2014 and 2015.  

Monday, January 11th

*  What is the secret behind the energy level of extraordinary performers?  This article tackles this most important topic.  Success is not about controlling your emotions, but rather channeling them toward ever-greater achievement.

*  Late weakness in U.S. stock index futures on Friday spilled over to early overnight trading before a reversal in European hours.  We are now quite oversold, with fewer than 10% of SPX shares trading above their 3, 5, 10, 20, and 50-day moving averages.  (Data from Index Indicators). Interestingly, where this broad weakness has occurred for the first time in a month (7 occasions since 2006), the market posted a lower daily close in all seven occasions within a five-day period.  Five of the occasions, however, posted a higher daily close within two trading sessions, with four of the five exceeding 1.5%.  Bottom line is that I'm prepared for two-way action and for volatility, with VIX closing Friday above 27.

*  One of my favorite overbought/oversold measures is in oversold territory, but note that the lows at October, 2014 and August, 2015 occurred at even more oversold levels.  Just because we're oversold doesn't necessarily mean we're at a bottom.  I prefer to stay open-minded.

*  Back to those seven occasions in which we saw fewer than 10% of SPX stocks trading above their 3, 5, 10, 20, and 50-day moving averages.  The dates in which those occurred included September and November, 2008; May and June, 2010; and August, 2011.  In all those occasions, we saw bounces but further price lows over coming months.  A major call traders need to make here is whether we're currently seeing a correction in a bull market or the unfolding of a bear.  I'm open to the latter and will be watching closely for the quality of bounces from here.

Sunday, January 10, 2016

Fears, Excuses, and the Path to Our Ideals

Consider the following traders:

*  Trader A experiences a fear of missing market moves and takes too many trades in too many stocks.  He has winning trades on great ideas, but his returns are so-so, because they're watered down by overtrading;

*  Trader B chronically undersizes her trades, rationalizing the low risk-taking as good risk management.  In fearing to lose money, she doesn't make meaningful money on her good ideas and feels a lack of fulfillment as a result;

*  Trader C has lost money recently and is afraid of going further into the hole and possibly losing his job at a hedge fund.  As a result, he waits for the perfect setup, missing significant opportunity along the way.

In each case, the trader's actions are dictated by fear.  In each case, yielding to that fear reinforces the very threat that prevents good trading.

When people suffer from a phobia, such as a fear of being in crowded places, how do they overcome the problem?  Certainly not by staying away from people!  Isolating oneself would only reinforce the phobia, as it's acting on the premise that the threat is too threatening.  It's by gradually facing the fear--first in imagery, then very incrementally in actual experience--that confidence is built and threat is taken down.  We build confidence--and a sense of competence--by moving out of our comfort zones and tackling the discomfort of the unfamiliar.

Here's a valuable exercise:  Imagine your ideal self.  Imagine what you're doing in your trading, in your personal life, in your relationships.  Really create images of that ideal self; create a movie in your head.  See yourself acting and interacting.  See yourself physically, spiritually, socially.  What does that ideal self look like?  Who are you at your ideal?

Now think of all the fears that stand between you and that ideal, recognizing that every excuse for not being at our best represents a fear that we're not facing directly and consciouslyExcuses are the buffers that keep us from our fears.  We'll make changes tomorrow; we'll make changes when we're less busy; we'll make changes once we become profitable.  We don't have to face the edges of our comfort zones when we bask in the comfort of excuses.

Once you have identified the fears keeping you from your ideal, then you approach those fears the way a phobia patient approaches his or her fears.  You very gradually and steadily face your fears.  You consciously refuse to take marginal trades and face the possibility of "missing a move".  You consciously size a position larger and face the possibility of a larger loss.  You consciously pull the trigger on a good risk and face the possibility of a further setback.  In each case, you act on the premise that you are stronger than the fear.  

In the end, we will either realize our ideals or we will betray them.  Every ideal worth achieving lies on the other side of discomfort, the other side of fear.  If you're living life fearlessly, you're living life in your comfort zone.  We grow, not by banishing fear, but by making it our friend--and catalyst.

Further Reading:  Fear and Trading Returns

Saturday, January 09, 2016

Achieving Distinctive Trading Returns by Trading Distinctively

So let's say you wanted to start a grocery store in your community.

How are you going to succeed?

After all, the WalMarts of the world can buy in greater bulk and negotiate better prices with food companies than you could.  You're not going to beat them on price.

The Wegmans of the world can build supermarkets that are super markets, complete with food courts, coffee bars, and more.  You're not sufficiently capitalized to beat them on variety.

The 7-Elevens of the world can locate in multiple locations throughout communities and carry the products people most want to buy immediately.  You don't have the resources to beat them on convenience.

So what are you going to do?  If you open a small, generic grocery store, you will get a certain part of your anatomy handed to you.

I would argue that starting up as a trader is no different from starting up a grocery store in terms of the competitive dynamics.  

You can't compete against the large institutions that have huge asset bases and can make money by investing across multiple assets with a variety of uncorrelated strategies.

You can't compete with organizations that spend millions of dollars annually on research, developing fast market-making algorithms.

If you want to make money in financial markets, you'd have to make money the same way you'd make money in the grocery business:  by carving out a niche and being better in that niche than anyone else.  You'd have to be unique--and you'd have to be superlatively good at what makes you special.

DeCicco's is a regional grocery chain in suburban New York.  What makes its stores unique is a focus on craft beer.  They have a large, well-curated selection of craft beers and several of their locations have craft beer bars within the stores.  DeCicco's also places great emphasis on fresh foods, cheeses, and prepared foods.  It's easy to go there, have a fresh pizza or prepared entree, sit down in the craft beer area, and enjoy a meal after doing your shopping.  That experience cannot be readily duplicated by a competitor.

An independent trader similarly needs to find strategies that are unique, that exploit opportunities in the marketplace, and that cannot be readily duplicated.  Taking a generic trading approach to a crowded, competitive marketplace is a sure way to not achieve distinguished results.  

Not all unique strategies win, but all generic ones, over time, fail.  Markets are simply too efficient to give awards to me-too's.

What is your unique edge as a trader?  It's not enough to say you have great motivation, great intuition, great chart reading skills, great fundamental knowledge, etc.  If you can't explain your specific trading edge clearly--if someone learning what you do doesn't have the reaction a first time visitor to DeCicco's has--you are almost certainly too generic.

In trading, as in life, do something distinctive or do something else.  Life is too short and too precious for me-too.

Further Reading:  Finding and Focusing on Your Edge

Monday, January 04, 2016

Trading Notes, Week of January 4th, 2016

Friday, January 8th

*  We finished Thursday with very weak breadth, as over 2000 stocks across all exchanges registered fresh monthly lows.  Moreover, fewer than 10% of SPX shares closed below their 3, 5, and 10-day moving averages.  In a correction, such oversold levels generally lead to relatively quick bounces.  During bear moves, weakness can beget further weakness before any bounce materializes.  Early August, 2011 was a notable case in point.  We saw buying enter the market with the China fix overnight and then again with the strong payrolls number.  Still, we're registering lower price highs and so I can't conclude we're out of the woods simply because we're oversold.

*  My primary cycle measure is in oversold territory, but not yet at levels that have recently corresponded to intermediate-term market lows.

*  Note the rise in VIX; my pure volatility measure is also elevated, which means that we are not only likely to see heavy volume, but also more movement per unit of volume.  That has important implications for sizing of positions, stop placement, etc.

Thursday, January 7th

*  Yesterday's post noted the macro headwinds from China/EM/commodities and pointed out that intermediate cycles had not yet bottomed for stocks.  Overnight we're seeing more of the headwind dynamics, with another day of weak trade in China and oil trading sharply lower.  That has dragged stocks down significantly.  Selling bounces remains the operative strategy; my cycle measures are in oversold territory, but not yet at levels associated with recent market bottoms.

*  Because of the China dynamic, important market moves are occurring outside of U.S. trading hours.  That has important implications for both day-traders and for those holding positions overnight.  Day-traders operating during U.S. hours are finding markets already extended by the time trading starts.  Traders holding individual stocks overnight are subject to gap risk.  It's a classic example of a change in markets that requires traders to adapt.

*  In yesterday's trade, new three-month lows expanded, ending divergences that appeared to be showing up among breadth figures.  With today's weakness, I expect further negativity of breadth.  While my intermediate cycle measures are not in bottom territory quite yet, short-term we're quite oversold (see chart below) and my measure of pure volatility (volatility per unit of volume) has once again spiked.  That combination raises the odds for short-term, sharp short-covering rallies.

*  The collapse of oil hurts commodity producing countries, hurts major growth areas of the U.S. economy, and reflects a situation in which demand from weak economies overseas cannot overcome increased supply.  Below is a chart of the past year in WTI crude.  The bear in oil has become the bear in stocks.

Wednesday, January 6th

*  After an indecisive session yesterday in which bulls could not mount much follow through to the strong bounce late Monday, we've continued the downtrend in overnight trade, with oil notably trading weaker.  I continue to see China/EM/commodity weakness as major headwinds for stocks.  My intermediate cycle measure is not yet in bottom territory, per the chart below:

*  Interestingly, thus far we're not seeing as many stocks making new lows as we did at similar levels in December following declines.  I'm particularly impressed with how utilities stocks and energy stocks have held up reasonably well despite the Fed rate hike concerns and falling oil prices, respectively.  My base case expectation is for a break of the December lows and an expansion of breadth weakness, but I am very aware of the alternate scenario in which weakness cannot expand new lows.  That would be more consistent with a trade in which we're closer to the bottom of a range than poised for a true bear correction.

Tuesday, January 5th

Great post from Bella on the kind of self-observation and diligence it takes to be a consistently successful trader.

*  We continued the sharp decline in early trade Monday, but per yesterday's observation re: volatility, we saw a ferocious late-day rally that wiped out the day's declines.  The intraday advance-decline line had been showing strength into the afternoon, leading to that late day rally.  When we're oversold and selling can't push the market to new highs, that's when we're most vulnerable to the sharp short squeezes.

*  The weakness has continued in overnight trade and, per the intermediate overbought/oversold measure below, we're not yet at oversold levels that have historically led to sustained bounces.  This measure is based on 5, 20, and 100-day new highs versus lows among SPX stocks only (data from Index Indicators):

*  That being said, we're quite short-term oversold per the measure of the percentages of SPX stocks trading above their short-term moving averages, per the chart below.  When we're oversold like this on a short time frame, my leaning is to play make-it, take-it with short positions and not necessarily count on moves to extend over longer time horizons.

*  Right now, it's just a one-day observation, but I do notice that despite yesterday's broad weakness, fewer stocks across all exchanges made fresh new lows than at the December low points.  It would be very significant if those downside divergences were to hold up on further weakness in stocks.

Monday, January 4th

*  With the sharp decline in China to start the new year, stocks have sold off sharply overnight.  The decline on the heels of an already short-term oversold market confirms yet further that the intermediate-term cycle has turned downward, per the chart below:

*  My measure of "pure volatility"--the volatility that we see per unit of market volume traded--has exploded higher with the overnight move.  Spikes in pure volatility commonly occur near market bottoms, but the cycle measure above is nowhere near a bottom level.  My concern here is that we're starting 2016 at a higher volatility regime, where we'll not only see high volume and volatility, but higher volatility for each unit of volume traded.  That means we could see large moves even on relatively short time horizons.  Short-covering rallies can be painful when volatility regimes explode.

*  China and emerging markets broadly have underperformed U.S. stocks for a while now.  This trend may be accelerating, as concerns about global weakness in the face of a strong U.S. dollar take hold.  Such a global trend would make it difficult for the Fed to engage in further tightening and could weigh on the U.S. economy.  These are themes I'll be tracking early in 2016.

Sunday, January 03, 2016

Doing More By Doing Less

Jeff Davis has recently posted on goals for 2016 and the importance of focus.  The idea is that we can often achieve more by eliminating the clutter from our lives and from our trading routines.

When we process data too broadly, we process nothing deeply.

When we process too much data, we actually lose information.

If you follow one course until you're successful, you cultivate expertise.  If you pursue many strategies simultaneously, it's difficult to master any.

My favorite approach to trading is to trade a known edge with consistency and to always be engaged in research to cultivate new sources of edge.  Development is a stair-step process of discovering the new, cementing it as expertise, and then engaging in further discovery.  We grow by learning new things and more things, and we grow by deepening the application of what we know already.

Too much trading is winging it, with no real plan to implement the old or develop the new.  As a result, a new year's experience becomes the old year repeated--not a fresh year of growth.  Go with the flow?  That only works for dead fish.  Better to focus and achieve targeted aims than to approach a year in scatter-shot fashion and accumulate little.

Further Reading:  Proven Strategies for Building Happiness

Saturday, January 02, 2016

Teamwork in Trading: Processing More Information, Better

There are two great mistakes traders make in processing information.

The first is to process market-related information in isolation.  If we surround ourselves with smart people, we reap the benefits of parallel processing.  Inevitably some colleagues will see things that we miss or see things that we see, but in unique ways.  Opening ourselves to the ideas of others can help us think more critically about ideas we take for granted.  At times we will lack confidence; at times we will suffer from overconfidence.  In both situations, processing information in parallel with insightful peers can help us find the happy medium.

The second mistake we can make is to substitute the thinking of others for our own.  Instead of first developing our hypotheses and then testing them against the ideas of others, we short-circuit idea generation and jump onboard ideas we hear from others without fully vetting those ideas.  Little wonder that we then lack the true conviction to stick with those ideas when they move against us.  When we substitute the judgement of others for our own, we reinforce a lack of confidence in our own abilities.

Steve Burns recently posted top tweets of the week--itself an interesting social approach to trading--and featured an interesting observation from Assad Tannous.  Assad pointed out that if a trade isn't worth tweeting, it's not worth taking.  In other words, if you care about the people you're addressing, you're not going to spew garbage.  You're going to share ideas you think are genuinely worth sharing.  What Assad is saying is that if an idea is good enough to give to someone you care about, it's good enough to have as a position.

The right teamwork can amplify our individual work.  Several perceptive, creative people operating in parallel can see more of the world--and see the world in more ways--than any of the individuals in isolation.  The right teams, whether in trading or in romantic relationships, make us better.

Further Reading:  Building Your Success Pyramid