Friday, August 26, 2016

How Ordinary Traders Become Extraordinary

What makes trading challenging is that being average is not good enough.  You can be an average teacher, store manager, or contractor and you'll be able to make a living.  In trading, however, what is average is losing.  If you stay consistently average, you'll consistently go broke.  In performance activities, ordinary is not good enough.  The ones who make a living from their performances are extraordinary.   

Two factors define the ordinary trader:

1)  Lack of innovation - The average trader looks at the same headlines, the same charts, and the same information as other traders.  Years ago, a vendor of trading software shared with me that, when they helped customers via their support service, they found out that the vast majority of traders never moved the indicators off their default values.  Even fewer utilized customized features of the software.

2)  Lack of distinctive effort - Only in trading would keeping a journal be considered diligent effort.  If an owner of a startup restaurant went from day to day and simply kept a journal to make improvements, the restaurant would be poorly equipped to exploit trends among the dining public.  Many traders focus on central bank announcements and GDP reports.  Of those traders, how many actually read the statements of Fed governors, study the papers from Fed symposia, or follow the inputs to the final GDP numbers?  

When a lack of innovation is combined with a lack of distinctive effort, the result is a passivity of perception.  The ordinary trader is not in an active mode of processing information, and that ensures that new and deep learning will not occur.  When traders look at new information and put information together in new ways and actively investigate the utility of the novel data, they exercise their creativity and their capacity for effort.  Over time, deep learning--an internalization of meaningful patterns--occurs.

Every day, your preparation for trading, your actual trading, and your review of your trading are trips to a gym.  What makes you more than average is that each of those trips is an actual workout of your talents and skills.  Innovation and effort are what turn routine activities into workouts that make you stronger.

The chart above is what I call the Power Measure, which is a running correlation of price movement and volatility.  The above version is constructed with event data; the bars are not time-based.  The power measure is a way of visualizing whether buyers or sellers are having an easier time moving the market.  Calculating the power measure with event bars takes volume out of the equation.  It tells you more purely whether a given unit of volume is more likely to move markets higher or lower.  

There's a lot you can do with this information.  A simple first derivative of the readings tells you if markets are getting easier or more difficult to the upside or downside.  A moving average of the readings (depicted above) acts as a kind of overbought/oversold measure.  A cumulative total of readings acts as a measure of whether demand or supply is dominating over time.  

You may or may not employ a power measure in your trading.  The point is that creating measures that make sense to you, tracking them every day and within the day, and observing their patterns creates a depth of learning that is impossible for someone looking at the usual charts and canned indicators.  Innovative trading begins with innovation in perception and effortful information processing.  All of us take trips to life's gym; the question is whether those trips provide us with the workouts that make us stronger.

Further Reading:  Calculating the Power Measure