What goes through your mind during trading hours? How do you talk to yourself? All of us coach ourselves via self-talk? What kind of coach are you? I recently placed a trade looking for a market bounce. The bounce was feeble and we began to sell off. I said to myself, "If the bulls are going to be in control, this shouldn't be happening." I quickly hit out of my position and reversed it. The small loss on the long position was more than exceeded by the gain on the sale. The trade was only possible because I had rehearsed an alternate scenario during my preparation of what to do if the market could not hold key upside levels. Through that alternate scenario, I was able to react to the market weakness without shock or surprise. It didn't even feel like a losing trade. It felt like, "OK, it's time for Scenario B." Notice that the self-talk was not about being wrong. It was not frustrated; it was not discouraged. A well-thought out trade that doesn't work can provide useful information. It's tuition for some useful learning. So it is throughout life. It's always important to have a Scenario B, and view setbacks as learning lessons. That means taking the ego out of the trade and viewing everything as information. It isn't about positive thinking or negative thinking. It's recognizing that it's not about you. It's amazing how we can trade with peace of mind when we are market focused and not self-focused.
The last blog post emphasized the importance of trading with a sense of inner peace. That peace comes from taking the ego out of what we are doing. But there is one other key component to inner peace: fulfillment. One of the important distinctions that we find in the research on positive psychology is the distinction between happiness and fulfillment. Happiness comes from doing things that are fun. Fulfillment comes from doing things that speak to our values. The research suggests that these are relatively independent dimensions. Sometimes doing meaningful things is not a lot of fun in the here and now. Many things that are fun may not be meaningful. Quite a few life problems occur when we pursue fun without pursuing fulfillment. Then our success ends up, in the larger picture, feeling like a failure. Trading problems occur when we pursue trading as a source of fun and stimulation rather than as a career that can provide fulfillment. The overfocus on P/L is typically a focus on seeking happiness and avoiding unhappiness. It's in developing, following, and refining good processes that we can find fulfillment. When we have plenty of sources of enjoyment in our lives outside trading, we don't need trading for entertainment and stimulation value. Many, many trading problems occur because we're trying to get personal needs met through markets. Markets can't always be fun, and they don't always generate fulfillment. Working on having a positive life--one that is happy, stimulating, and fulfilling--is a great way of taking the emotional burden off our trading and allowing us to deal with opportunity (or lack of opportunity) as objectively as possible.
I'm writing this from the Chicago Traders Expo a couple of hours before my presentation. One of the topics I'll be covering in my talk is developing ourselves spiritually as a way of furthering our life success--in relationships, in trading, and in careers. Indeed, my next book will be on the topic of renewing our lives through cultivating our spiritual development. That book is being written on a blog platform, which means it will be totally multimedia, totally accessible anywhere in the world where there is an online connection, and totally free. Best of all, the book will enable readers to make comments and share ideas and experiences, which then become part of the book--along with my responses! That way, the book becomes a dynamic entity: it will be continually revised and expanded. The book format is a nice example of what entrepreneurs have always known: opportunity comes from doing new things--and old things in new ways. In the ego mode, I want to write a best seller, make lots of royalties, and become a constant figure on the talk circuit. Good enough is not good enough: I want more. In the spiritual mode, we find what most speaks to us. Getting to that spiritual mode requires finding our peace and letting opportunity present itself to us. As I will be discussing at the Expo, so much of trading psychology boils down to getting ego out of the way, finding an inner peace and quiet, and processing markets with an open, receptive mind. I know from my own trading how easy it is to latch onto *my* view of the market and impose that view with a trade, only to have the market show me otherwise. Looking back, I can only shake my head at how the market's behavior made perfect sense--but I was blinded to that sense. It's great to have a passion for trading, to work hard at trading, and to follow markets intensively. But all too often, those activities are ego-driven. Everything becomes about P/L. Market ups and downs become our ups and downs. We'll never find our peace by succeeding at trading. Succeeding at trading requires finding our peace, because that's the only way we'll be sufficiently open-minded to truly understand what markets are doing. Finding fulfillment in our lives outside of trading is a wonderful path toward bringing peace to our trading.
I decided to take a stroll through my database and update views on where opportunity in the stock market has been residing since 2016. That provides a lookback period long enough to detect meaningful patterns and recent enough to be relevant to current market conditions. Here a few observations: * Sentiment matters: When the equity put/call ratio has been in its highest quartile, the next ten day return in SPY has been +.96%. That is almost four times the return when the ratio has been in its lowest quartile, +.25%. * Overbought/Oversold matters: Let's consider the percentage of stocks in the Standard and Poor's 500 Index that have been above their 200 day moving average. When that percentage has been in its lowest quartile, the next ten days in SPY have averaged a gain of +1.32%. When the percentage has been in its highest quartile, the next ten days in SPY have averaged a loss of -.04%. (Data from the Index Indicators site). * Volatility matters: When VIX has been in its lowest quartile, the next ten days in SPY have averaged a gain of +.69%. When VIX has been in its highest quartile, the next ten days in SPY have averaged a gain of +1.02%. When VIX has been in its middle two quartiles, the next ten days in SPY have averaged a gain of +.39%. * Context matters: When the percentage of stocks above their five-day moving averages is low and the percentage above their 100-day averages is also low, the next ten days in SPY average a gain of 1.00%. When the percentage of stocks above their five-day moving averages is low and the percentage above their 100-day averages is high, the next ten days in SPY average a gain of +.38%. Now these are observations only; they no doubt overlap to some degree and I don't pretend that, by themselves, they provide systematic trading ideas. What is needed is some framework for accounting for these observations. My straightforward framework is as follows: the market has been largely trending higher (note how rarely we see negative average returns) and, within that trend, there have been meaningful cycles of 10-20 day duration that capture extremes of volatility, sentiment, and directional movement. What this means is that traders with a habitually bearish bias have tended to underperform the opportunity set, and traders with a short-term time horizon (holding periods of intraday or swing periods) have also underperformed the opportunity set. My sense is that a great number of market participants are overleveraged: they have small account sizes relative to the returns they want/need to generate. This leads them to take good-sized positions relative to the amount they can afford to lose, which inevitably leads them to manage their positions on shorter and less optimal time frames. In actual practice, many traders simply don't have the ability to take heat on holding periods of even 10-20 days, even though they may pride themselves on trading "macro" ideas. My experience is also that traders are very keen to look for trends and trade directional momentum and lack the tools and frameworks to think about cycles and directional reversals. In short, there do seem to be edges in the marketplace, but they're not found by doing what the crowd is doing. The key is not playing the game better, but figuring out the right game to be playing.
If there is one common element I've observed among very successful traders it's that they have superior personal networks. They cultivate sources of information; they take on role models; they hang out with people they admire. In all, they spend time with people who make them better. This can become our online strategy as well. We can become caught up in noise and bickering online--or we can surround ourselves with inspiration and information. But how do we know where the great sources of online information can be found? One simple but effective strategy is to find the people who post ideas online and do so with a passion. They post regularly, and they post over periods of years. They do so because the ideas speak to them. Their passion has become a purpose--and very often it anchors their profession. Once you find a few such sites, you can then see who those people link to and whose work *they* admire. The odds are good that purposeful, passionate people hang out with--and link to--others of their kind. Before you know it, you can develop a network simply by following the links of those who post with purpose. What an amazing resource hidden amidst the noise. Here is my recent article, highlighting four of my favorite purposeful online participants. Follow their links and you'll learn a great deal. And if you have your own favorite online participants, feel free to email me with their links and I can add those links to future posts. It's a great way to build each other's networks and support people doing great work.
Imagine living your life jumping from one activity to another based upon what looked good at the time. There would be no constraints; you could pursue anything at any time. At first blush that might seem like heaven, until you realize that, cumulatively, you would accomplish nothing. You might have fun, but would your life be meaningful? After a while, all the activities begin to feel the same. Life wouldn't feel complete without some sense of purpose. In pursuing what is meaningful, we postpone things that might be fun at the moment. We invest ourselves in some greater set of goals. A full life is one in which we derive both happiness and fulfillment. We do some things for here and now fun and some longer-term things to achieve meaningful goals. We know we have hit a sweet spot in life when we find enjoyable ways of pursuing our life purposes. That means, in life, we are both shorter-term traders and longer-term investors. Activities we get into and out of day by day are trades. Goals that we seek over time are our investments. The sum is our life portfolio, and we hope that all its components produce unique, positive returns. When we find happiness in our fulfilling activities, the result is an unusually high level of well-being. So it is with our financial lives. There is trading for immediate gains, and there is investing for longer-term returns. One pursues short-term opportunities; the other seeks longer-term growth. Increasingly, I see a sweet spot of performance among those who find trades that align with a longer-term view. When a portion of a portfolio can earn investment returns over time and another portion can benefit from the price path over this period, the total, risk-adjusted return can be handsome. For that to happen, the shorter-term trading must be aligned with the bigger picture view. In life and in trading, there is much to be said for diversification across time frames--and the alignment of shorter and longer term pursuits. I recently enjoyed the commentary on the week ahead from A Dash of Insight. I won't steal Jeff's punch lines, but suffice it to say that he summarizes a wealth of economic data with conclusions that I just don't hear from the majority of traders. The big picture he perceives in multiple data sets and multiple analysts has meaningful conclusions for those trying to trade stocks, stock sectors, and the overall market. See also the recent perspectives from The Fat Pitch site, which looks at one data source after another to get a sense for the probabilities of impending recession. There are important big picture market implications from this information that can inform trading *and* investment. As a back of envelope calculation, I looked at the percentage returns from SPY each day since 2016, broken down by overnight change (yesterday's close to today's open) and day change (today's open to today's close). The returns over the two time segments were pretty equivalent. In other words, roughly half of all the recent bull market has not been available to the pure day trader. There is an important message in that.
A psychologist learns to listen to people. Sometimes what they say is straightforward. Other times, a person will jump from topic to topic in seemingly unrelated ways. The psychologist knows that, at those times, what doesn't make seeming logical sense makes a psycho-logical sense. Maybe the person first talks about an overbearing boss at work, then talks about not feeling well, then talks about a friend who has been distant lately. Underlying all of these is a feeling state, a sense of discouragement and frustration. It's that state that is the theme, not the particulars. One has to see beyond the concrete details to appreciate the underlying theme. Sometimes markets trade in uniform, coherent ways that we call trends. Other times, markets move up and down in seemingly random ways. We call those markets choppy and see them as difficult or even impossible to trade. But what if markets, like people, make their own sense during the times when they seemingly flit from up to down and back again? The "choppy", range-bound market may be one that is trading with a dominant cycle. It may be trading non-directionally, but continuing relative strength versus overseas shares. It may be in a range itself, hiding relative movements of individual market sectors. Perhaps growth stocks are strong and value shares are weak. Natural resource stocks are strong, rate-sensitive issues are weak. Large caps are weak, small caps are strong. Very often, beneath the "choppy" chart are real themes that can be traded. But we have to listen and look beneath the surface. Like the psychologist, we have to be sensitive to themes behind what seemingly doesn't make sense. Many, many times we develop a narrative--a view--and then become frustrated when the markets don't follow our story. Can you imagine a psychologist operating that way? If we can take our egos out of the picture--our desires to make the big market calls--we can open ourselves to what markets are really doing and trade accordingly. It all begins with a simple question, "What is the theme here?"
I'll be speaking on Tuesday, July 24th at the Traders Expo event in Chicago, and one of the things I'll be covering is how we really know we have an edge in markets. I'll also share with the group some of the edges I am currently pursuing in my own trading. In a broad sense, there are two forms of knowing: * Predicting - Being able to anticipate future events; * Understanding - Being able to explain events. We can predict without understanding. We know to anticipate changes in weather without being able to explain the chain of events by which these occur. We can understand without being able to make specific predictions. We might understand reasons for a market's behavior without being able to predict when and how the market will move. This is a bit of a simplification, but a good deal of what we call technical analysis seeks prediction. A good amount of fundamental analysis seeks understanding. The vulnerability of much technical analysis is that it finds patterns that appear to be correlated with price changes, but cannot explain the nature of that relationship. As the video explains, if we look at enough patterns, we can find something that appears to be predictive. Indeed, with a large enough search space (thanks to powerful computing), we can find things that work in sample and out of sample that still are random! The principle that makes sense here is that we don't *truly* have an edge unless we can clearly explain why this edge is present. Prediction without understanding is a frail basis for risking our hard-earned money. If we can explain the basis for a predictive relationship, we possess true understanding. Real conviction and confidence in trading comes from understanding the basis for what you're doing. A person with a purpose in life has a "why"--a considered set of reasons for doing what they're doing. That person is most likely to travel in a coherent direction. Without a "why", we wander through life. That's the difference between having a year of experience versus one day of experience repeated 365 times. So, too, with trading. Trading psychology is much easier when we have a genuine "why" underlying our actions. Too many people are pursuing trading because they can't figure out another way to work independently and make enough money to support themselves. This is understandable, but invariably ends badly. People setting themselves up as gurus are all too willing to exploit the desire to make a living from trading. A great question to ask about any idea advanced by a guru is, "Why?" If you--and they--can't truly explain why an idea works, how do you know you actually have an edge and not just another pattern fit to market data?
I recently received an email from someone interested in trading for a living. The person knew little about markets other than reading a few books and following some traders online. He only had a small amount of money to open an account, but indicated a passionate desire to turn this into a living. Seriously, WTF? Why is this going on? Why do so many pursue a living from markets when there is clear evidence that the great majority never succeed? Consider these results from Gallup organization polls: * Polling finds that in the UK, 14% of people indicate that they strongly agree with the statement that they have enough growth opportunities in their work. That number is 21% in France; 19% in Spain; 33% in Germany. * Another poll finds that GDP has been rising in India, but only 3% of the population describe themselves as "thriving". * A poll of healthcare workers finds that 6% report themselves as "thriving" in measures of well-being. * Surveys consistently find that 30-35% of American workers feel "engaged" in their work. Most people don't have the capital, connections, or experience to start their own businesses. They look at the jobs out there and talk with people working and don't exactly feel inspired by what they see and hear. Perhaps, just perhaps, people seek trading--against all odds, against all common sense--because the pursuit of a remotely possible winning life feels preferable to assured misery. It's the same reason refugees defy all odds on the high seas in hopes of a better home, a better life. What many aspiring traders need is not false hopes, but genuine, viable alternatives to the traditional "opportunities" out there.
Shoutout to vlogger Meir Kay, who produced an outstanding video that captures the relationship between anger and empathy. There's an important psychological lesson here. Frustration is a form of anger. It occurs when we have a goal and something prevents us from reaching that goal. We develop an idea, place a trade based on that idea, and then a burst of volume comes into the market and moves our position against us. Our hopes for profit are dashed with the reality of a loss. We can voice frustration at the market or at the traders who are "obviously manipulating" the market. We can become frustrated with ourselves and beat ourselves up over how stupid we were to place the trade. Regardless of the object of our frustration, once we become angry, we enter fight/flight mode and stop processing the world objectively. The good trader will catch themselves at that moment and take a step back, slow down, calm themselves, and return to their trading. The great trader, however, will do something quite different. Remember that markets are always speaking to us. They tell us where participants are finding value, where participation is waxing and waning, and when participation is dominated by buyers or sellers. The great trader is like a great listener in a conversation. That requires empathy: the ability to not just see, but feel what other market participants are doing. Suppose you bring up a topic in a conversation with someone you care about and they quickly change the subject and start talking about something else. You can become frustrated, filled with a sense of injustice over being "cut off", or you can step back and say to yourself, "That's interesting...my friend doesn't normally change topics like that. This must be very important." That empathy makes you a better listener. Going with the conversational flow will bring you closer to your friend. If you have formulated a great idea for a trade and the market changes the topic on you, perhaps there is an important message there. Doubling down on your listening skills and drawing upon your empathy opens the possibility of profiting from this new information. It's yet another way that developing ourselves as traders is not so different from developing ourselves as human beings. When we replace anger with empathy, frustration with listening, we make new connections and profit from those--in markets and in life.
In pursuing your life goals, imagine that you are the leader of your own team. In other words, consider that what you achieve in life will be a function of teamwork, not just your individual talent and effort. That perspective raises interesting questions. Who is currently on your team? How well are you working with them to achieve your goals and theirs? What is missing from your team? How would you add to your team to enrich everyone? My latest article introduces the notion of life as a team sport and identifies three specific factors that make teams work. This is true for sports teams and teams in workplaces. It also applies, however, to our personal lives and, yes, our efforts as traders. Who is on a team, what they bring to each other, and how they interact with one another very much determines the odds of success. I've thought long and hard about the very successful traders I've known. To a person, they go out of their way to maintain contact with insightful and talented market participants--and very often they build formal teams to assist with the tasks of generating ideas, managing positions and risk, and staying on top of developments that impact markets. Whether through informal networks or formal teams, successful traders get that way by expanding their bandwidth. To paraphrase the Michael Jordan quote above, talent wins trades, but teamwork and intelligence make for winning trading careers. As the previously mentioned article emphasizes, there is much, much more to effective teamwork than simply touching base with people who you think can help you. I would go so far to say that people often fail at their work for the same reasons they often fail at their marriages: they select the wrong teammates; they don't fully embrace the give and take of being part of a team; and they don't sustain a vision of how everyone can make each other better. Your life is an enterprise, and you are its leader. The lives of those who matter to you also represent enterprises and you are part of their teams. You're not just an individual; you're also part of an interconnected network. When you improve the network, everyone improves.
Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), Trading Psychology 2.0 (Wiley, 2015), The Art and Science of Brief Psychotherapies (APPI, 2018) and Radical Renewal (2019) with an interest in using historical patterns in markets to find a trading edge. Currently writing a book on performance psychology and spirituality. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014.
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