Wednesday, January 11, 2017

Trading Market Cycles

In the previous post, I proposed a scheme for reading market cycles, by breaking those cycles into phases based upon market activity.  Trading market cycles requires a kind of creative opportunism described by Gehry.  The materials on the table are characteristics of market behavior.  When trading well, we are arranging those in a fashion that enables us to capture solid reward-to-risk relationships.

A cycle-based site for stock and ETF trading that quantifies market cycles and makes buy and sell recommendations is StockSpotter.  The site makes many recommendations--more than the average trader would take in a day.  So they simulate performance by taking very many random groups of four recommendations (Monte Carlo simulation) to show the range of likely trading outcomes from following those picks.  It's one of the more elegant demonstrations of edge that I've seen from a market service.  The opportunism comes when we take other criteria for buying or selling, such as our fundamental analysis of a company or our view of the entire market, and marry those to the site's recommendations.  What we're trying to do with this kind of opportunism is join two or more independent sources of edge, so as to maximize the probability of success.

A different kind of opportunism might look at separate overbought/oversold measures on two or more different time frames.  For example, I'll look at the upticks/downticks in the market as a very short-term measure of overbought/oversold and an oscillator of price change to capture a medium time frame.  When we are topping and dropping, we'll see the measures peak at equal or successively lower price levels: the buyers still move the market, but cannot move it higher over time.  When we are bottoming and rising, we'll see the measures trough at equal or successively higher price levels.  In opportunistically aligning the time frames and market behavior, we can find solid risk/reward ways to exploit market cycles.

Still another form of opportunism for daytraders involves tracking order flow--seeing when bids or offers are holding particular levels--and joining that information to a broader view on trend/direction.  For instance, if we see recurring bids being hit at a given price level where that level holds, we might join the offer if we see that the bigger picture for the stock is higher.  

It is this lining up of market behavior that creates some of the best trades.  Waiting for the lining up requires patience and perspective.  A great deal of productive trading time is spent not trading, but actively watching for those occasions when one source of edge falls into place with another--and then pouncing on those opportunities with meaningful risk-taking.

Further Reading:  Some Great Rules for Life and Trading