Sunday, December 30, 2018

Navigating Turmoil and Opportunity in Markets

In life we find that periods of turmoil are often the periods of greatest growth and development.  Psychologically, turmoil shakes us up and challenges our assumptions.  That opens us to new experiences and major life changes.  My marriage (going on 35 years strong) came after a period of personal and career turmoil; those taught me what I needed in life.  Similarly, it was the sting of losses I took in markets in the early 1980s that led me to re-evaluate my trading and take a more promising and profitable quantitative direction.  From a spiritual perspective, our task is to find the opportunity in turmoil.

In financial markets, one manifestation of turmoil is volatility.  When we look historically, periods of high volatility have generally corresponded to longer-term opportunity for investors.  The hard part is weathering short-term gyrations in order to participate in that bigger picture.  Secular bear markets (and I am open to the thesis that we may have entered into one in the stock market; see this debt-cycle analysis from Ray Dalio) can last quite a while:  consider how long it took for the market to return to its 1929 and 1972 peaks, for example.  For that reason, the bulk of our family capital is tied up in safe fixed income instruments that can provide a 3+% annual yield during a period that could prove disinflationary and not too friendly to risk asset prices.

Still, it would be foolish to hide under the bed covers and ignore the possible opportunities that can arise from the recent period of volatility.  One site that does a great job of separating signal from noise is A Dash of Insight, which has an excellent post looking at the year ahead.  Jeff Miller makes the important point that today's turmoil provides an opportunity to invest in tomorrow's themes and strong companies; see his list of "timely ideas".  

Yet another valuable resource is the new book The Lifecycle Trade from Boboch; Donnelly; Krull; and Daill.  The authors study IPOs and super growth stocks to identify their common trajectories and ways in which traders and investors can participate in their growth.  The idea is that today's turmoil fertilizes the soil of growth for a new generation of market leaders and promising technologies.  Stocks and industries that maintain their upward paths even during bear market times are candidates for tomorrow's large opportunities.

So that is our challenge during periods of turmoil.  To win the game, we have to stay in the game.  That requires prudence.  But to truly win, we have to use turmoil to find opportunity.  That requires optimism, resilience, and vision.  A solid business plan addresses threats and opportunities...we may be entering a period replete with both.

Further Reading:


Friday, December 28, 2018

Investing In Your Trading

Margie and I have adopted another rescue cat, so now we're back to four after Mali passed away last year at the ripe old age of 17.  Bringing in a new one requires considerable time and patience.  We start off with the new cat in his own bedroom, with the two of us taking turns sleeping with him, playing with him, feeding him, etc.  Eventually he learns to feel safe and comfortable with us and we start the bonding process.  Gradually we introduce the new one to the other cats and monitor their interactions closely.  By playing with all of them in an open area, we create a non-threatening environment.  As the cats bond, it becomes possible to play with them together.  Just last night, the new boy, Aries, slept in the crook of my arm while Mia slept on top of me.  To put it mildly, I got little sleep!  But there was a lot of purring and it was a big step forward in the bonding of those cats.

The big takeaway is that relationships succeed when we approach them as investments, not as trades.  It is when we focus on short term returns that we fail to put in the time to cultivate depth and cement a future.  As a psychologist, I've spoken with more unhappy couples than I care to count.  The common feature is that each member of the couple is focused on what they are not getting out of the relationship.  No one is losing any sleep building long-term bonds.

So it is with trading.  If we approach our trading as a trade, then it's all about the next trade and the most recent P/L.  Yes, we might keep a perfunctory journal regarding the day's activities, but is that really investing in the future of our trading?  As I'm writing, we've been seeing VIX levels in the stock market in the 30 area, much higher than we saw months ago.  To illustrate the difference, consider that for the month of August, we saw roughly 1000 bars of price action in the ES futures, where each bar represents 500 price changes.  In December thus far, we've had almost 3000 bars.  Each bar averaged a range of .11% in August and almost twice that in December.  In short, we're seeing much more activity, much more volatility:  markets doing a lot more per unit of time.  That takes every bit as much adaptation as bringing a new animal into the home!

Some traders I know step back and make those adaptations.  They are investing in their trading future by learning how to trade different market conditions.  Other traders forge ahead, doing the same things as they've always done, gunning for short-term returns.  They may make money, they may lose money, but they surely don't grow their business.

As we come to the close of the calendar year, it's a good time to reflect on the investments you're making--and need to make--in your trading.  How is December going to make you a better trader in 2019?

Further Reading:


Wednesday, December 26, 2018

The Psychology of Trading a Crazy Market

It's been a while since we've seen a VIX greater than 30.  It's also been a while since we've seen three consecutive days where there have been fewer than 100 stocks across all exchanges registering new monthly highs and well over 2500 making fresh monthly lows.  And it's been a while since we've seen fewer than 10% of all SPX stocks trading above their 3, 5, 10, 20, 50, 100, and 200-day moving averages.  I recently wrote a Forbes article on what market history tells us about the paths of bear markets.  Over this holiday period alone it has generated well over 40,000 hits.  That tells us something about market psychology.

I recently participating in a podcast with J.C. Parets of All Star Trading.  If you haven't checked out his series, I suggest you do so.  You'll find a wealth of trading perspectives.  In my session with J.C., we discussed how the volatility of markets can induce our own emotional and behavioral volatility.  An important priority in trading crazy markets is doubling down on our own sanity.  That means mentally--and emotionally--rehearsing being wrong on trades so that we are prepared to take the right actions if the stuff hits the fan.  As a rule, the more we face the heat of battle, the more we want to keep a cool head.  When we *anticipate* the losing trade, we allow ourselves to normalize it emotionally--and that helps us keep the cool head.

Indeed, it's not at all unusual that I will structure a trade that looks like it has momentum in its favor.  I put on a price stop in case of reversal, but I also put on a time stop.  If the move cannot materialize in a relatively short period of time, momentum on that time is not what I had expected.  That itself may disconfirm my idea.  Exiting the position for a modest loss can set up a trade the other way.  In such cases the loss is a tuition we pay for valuable market education; a fee we fork over for useful information.

When we take the threat out of losing, we open the door to using losses as learning lessons that make us better.  That's a great psychology for a crazy market!


Sunday, December 23, 2018

Trading With Hypotheses, Not Conclusions

Noticing some good buying activity late Thursday and a holding above the Thursday lows in the evening session, I started Friday morning with a hypothesis.  I believed we could see meaningful short covering and buying pressure if early weakness during the morning trade could hold above those overnight lows.  That did indeed happen, and we saw solid buying come into the market a little after 10 AM EST.

Before long, however, the buying rolled over and sellers began to take control.

Two ideas crossed my mind as this occurred:

1)  This shouldn't be happening if we're putting in a bottom.  An oversold market should generate more meaningful and sustained buying, reflecting the interest of value buyers operating on a larger time frame.  The failure to sustain buying goes against my hypothesis and suggests we haven't yet made a durable bottom.

2)  The Fed indeed was a game changer.  As I had pointed out in the previous post, the participation in the market completely changed after the Fed's announcement.  The inability to sustain buying from the oversold condition supported the hypothesis that this was a new and important input into the stock market.

In both cases, I have hypotheses and update my belief in those hypotheses given market action.  If I had traded as though these were firm conclusions and not hypotheses, I would not have been sufficiently flexible to first anticipate strength and then later trade the market's short side.  Being on the lookout for information that disconfirms our views--including trades that don't work--is essential to risk management.  It's also critical to our trading psychology.  We want to embrace disconfirming evidence, not become threatened by it.

So where do we get hypotheses from?  This is where quantitative analysis intersects nicely with discretionary judgment.  The quant work tells us what has occurred in the past under conditions that we're seeing at present.  Sometimes that work suggests the presence of a significant directional edge.  One excellent source for such studies is the Quantifiable Edges letter, which reviews potential edges in the stock market each day.  The most recent letter notes the very oversold condition of the market and goes back 20 years to examine what has occurred in similar circumstances.  By viewing the market through several different lenses (including recent Fed activity), Quantifiable Edges is a fertile source of hypotheses.

Right now, the work from QE suggests a high probability of a rally.  Rob Hanna, however, notes that, in situations when we *didn't* get a bounce under these circumstances, the downside was ugly.  Plus, Rob's work suggests the Fed is not being accommodative at present.  So right away this sets up a flexible thought process for Monday:  looking for evidence of putting in a bottom and seeing buyers take control, but also being sensitive to the possibility of ugliness and a deeper capitulation.  

With proper risk management, a hypothesis disconfirmed is not a failure; it can be the source of opportunity.

Further Reading:


Friday, December 21, 2018

Asking The Right Market Questions

A while back I wrote a blog post about three questions to ask about any market.  It turned out to be the most popular TraderFeed post ever.  That says a lot.  Readers are interested in approaching markets intelligently--by asking the right questions--not just in finding out someone else's answers.  

The U.S. stock market has played out the weakness discussed in recent blog posts.  We've also seen weakness in overseas equity markets, weakness in Treasury bond yields, weakness in high yield bond prices, and weakness in many commodities tied to economic activity.  The movement across asset classes tells us that this is about something fundamental.  The increased volume tells us that this is connected to larger, institutional market participants, particularly those involved in macroeconomic investment.  

We saw this clearly in the aftermath of the Federal Reserve meeting and announcement.  Going into the announcement we were seeing some decent buying flows, as measured by the number of stocks trading on upticks versus downticks.  Upon the announcement we saw very strong selling flows on very enhanced volume.  That told us that fresh participants had come into the market (institutional flows) and that they were aggressive sellers (hitting bids in the ES futures).  Among the people I speak with, the consensus was that the decision to continue to shrink the balance sheet at the current pace was effectively a monetary tightening just as we're seeing global economic weakness.  Market participants anticipated that this would exacerbate the weakness.

As I mentioned to the traders at SMB in their morning meeting, this is the time to ask the right market question.  If the Fed decision was indeed a game changer, we should not see a meaningful retracement of the decline from the pre-announcement highs.  In other words, if the lower prices post-Fed cannot attract significant value buying from higher time frame participants, then we have to assume that the macroeconomic sellers are in control of the market.

Sure enough, we did get some early buying and sure enough it could not retrace a significant portion of the post-Fed decline.  That set us up for a further leg of weakness on Thursday.  Finally, later in the afternoon on Thursday we saw some decent buying flows come into the market, and we held the afternoon lows in late session trading.  Those pre-Fed highs remain a significant level and I will be watching buying versus selling flows this morning to see if we can get any buying more substantial than the typical short-covering.  The only way we start to put in a bottom is if prices get to the point where longer time frame participants come into the market, attracted by bargain prices.  That would give us very strong upticks among stocks, not just waning downticks.

These are the questions that I find helpful in active trading:  who is in the market (volume); what are they doing (buying versus selling flows); and where are they doing it?  An ancillary, important question is:  To what degree are buying and selling flows meaningfully moving the market?  This is the question of efficiency.  As we saw post-Fed, we can have buying flows, but if they cannot retrace a significant portion of the prior decline, we can anticipate that those buyers will be the ones trapped on the next leg down.  Can the sellers take us below yesterday's lows?  That's a good question to ask going into today's open.  Trading psychology is not just about the trader's psychology; it's also about reading the psychology of market participants.

Further Reading:


Sunday, December 16, 2018

What In The World Is Going On With The Stock Market?

Why are stocks falling like this?  That's the question I've been hearing from a number of investors and traders.  In the previous post, I posed the question of whether we might crash.  That post has received almost three times as many hits as my average post--and that is just in two days.  That tells me uncertainty is high.  The sentiment, as I noted in that post, is bearish.

But the question posed with anguish is *why* this is happening.  The U.S. economy is not in such bad shape despite political turmoil in the U.S. and concerns about tariffs and trade wars.  Nor do we have a Federal Reserve that is aggressively tightening monetary conditions.  Inflation overall is tame and there are few signs of overheating in the economy.  Indeed, with solid employment numbers, we were not so long ago hearing about being in a sweet spot of economic growth.

Alas, U.S. investors and traders can be horribly U.S.-centric.  One thing I love about working out of London is that the perspectives tend to be more global.  That is important when markets--and those managing capital--are so intertwined.  Perhaps what is going on in the U.S. stock market is not about the U.S.  Perhaps it is not about President Trump; not about the daily dose of polarized, politicized commentaries from MSNBC, FOX, CNN; and not about chart patterns and wave counts of American markets.

Consider an excellent article in the Washington Post reflecting upon the difficulties of Britain, given the problems associated with Brexit and the problems associated with remaining in the E.U.  The author poses the scenario:  Suppose Italy defaults on its debt and Britain is asked to bear some of the load.  Will its citizens really want to take on more debt?  Will the Yellow Vests of France want to step up to the plate and shoulder that debt?  What happens in the event of sovereign debt default?  Could Italy be the epicenter of a crisis that the ECB would have trouble responding to, given already low rates?  As Robert Samuelson notes, the ingredients of a crisis are present.

So now let's look at some charts of banks.  Here is Deutsche Bank:

Here is Credit Suisse:

Here is Goldman:

Here is an ETF for European stocks:

Uniformly, it's been a straight shot down from early January, unlike U.S. stocks, which peaked in September.  Now, however, U.S. stocks are moving down alongside their European counterparts, with banking shares among the downside leaders.

Here is one last chart.  This one is a cumulative running total of all NYSE stocks trading on upticks minus those trading on downticks.  The measure is updated every second of every trading day.  It's one of the most sensitive indicators of buying and selling pressure, as it reflects the aggressiveness of buyers (lifting offers) and sellers (hitting bids).

Notice how, during the decline of early 2018, the cumulative uptick/downtick line did not move significantly lower and indeed held above its February lows when we bottomed in the spring.  The cumulative TICK line was not able to make a new high going into the ultimate peak in SPY and, indeed, started trailing off before we actually peaked in the index.  That was one yellow caution light I noted in September.

From there it has been straight down in the cumulative measure, reflecting aggressive selling across the entire stock universe.  In that respect, this decline has not been like the previous one.

As I mentioned in the previous post, my job, both as a trader and as an investor of family capital, is to stay open minded and consider a range of possible scenarios.  That means looking beyond the U.S. and trying to make sense of areas of the financial world that are weakest.  It also means collecting data that others overlook and looking at time frames wider than the norm.  My goal, per Helen Keller, is to ensure that my sight enables me to also have vision.  At the moment, I can't say I am comfortable with what I see.

Further Reading:


Friday, December 14, 2018

Are We Going To Crash?

That is the question I've been hearing a lot lately.  I don't hear anyone talking about stocks running to new all-time highs.  I do hear about all the market woes, from tariffs and trade wars to discord in Europe to political turmoil in the U.S.  My job, as a trader and as an investor, is to entertain a variety of scenarios based upon the data in front of me.  As much as possible, I want to stay open minded to what others are not looking at.  Very often that is where an edge can be found.

For example, on September 24th my blog post highlighted caution signals for the overall market.  A variety of supply/demand flow measures had turned decidedly negative.  We've seen weakness in stocks overall since that time.  Reports indicate record amounts of cash being taken out of the market, with 49% of surveyed investors expecting a market decline over the next six months.  That is the highest percentage since 2013.

And, yet, with all the selling, all the negative news, and all the bearishness, we have merely roundtripped the early 2018 performance.

This chart shows the ES futures from May of 2017 to the present.  Each data point represents 50,000 contracts traded.  You can see that the entire bear period to date has, so far, been a relatively flat correction on a large time scale.  That is not so unlike the 1994 market, which dipped in the first and last quarters of the year, forming a range.  The upside break of that range lasted six years.

Thus far, the flow and breadth measures that I track are not telling me that the selling has dried up.  I need that confirmation before more seriously entertaining the upside.  The below chart from Index Indicators, depicting the daily SPX average versus the number of 52 week new highs minus new lows, is quite informative.  Notice how we hit a maximum number of new lows during the February decline, with new lows drying up over the next several months even as price moved lower for a while.  On the reverse side, note how new highs dried up as we made fresh index highs in September, per the blog post at that time.  At present, we've been seeing price weakness, but not a meaningful drying up of the number of stocks posting fresh 52-week lows.  My measure of cumulative upticks versus downticks continues to make new lows, reflecting net hitting of bids across the broad NYSE universe.

As long as I'm not seeing signs that the lower prices are bringing in fresh value buyers, my game plan remains to fade short-term overbought levels that roll over at lower price highs.  I'm open to both sides of the market, however, and am monitoring day over day strength versus weakness to handicap the odds of a big picture break from the longer-term range.  The key is stepping back and seeing 2018 as a range.  A break to new lows that still cannot find buyers will tell one story; a break that traps sellers and vigorously returns to the range could tell a very different story.  Right now I'm a bear who is uncomfortable having so much company in that view.

PS - I'm updating this at 8:35 AM EST on Saturday morning.  This was originally posted yesterday morning and already has gotten more hits than the majority of my blog posts.  That, too, nicely reflects current sentiment. 

Further Reading:


Monday, December 10, 2018

Three Keys To Trading Performance

In the latest Forbes article, I share three important trading lessons that I have learned from Victor Niederhoffer.  These are not the usual trading psychology homilies; they reflect real-world experience with making sense of market behavior.

The truth is, I could have offered a dozen more lessons I've learned from Vic--all of which are highly relevant to trading.  Here are a few keys to trading performance inspired by his example and reinforced over the years:

1)  It's all about the reps - Vic became a squash champion with fanatical practice, drilling and mastering shots.  In preparing for more active trading this coming year, I am using each trading day as a review, tracking the "trades of the day" and the ways in which they have set up, the ways of best entering them, the ways of best managing positions after entry, etc.  Every day becomes a textbook lesson in good trading.  As markets change, the trades of the day also shift--and the reps are helpful in adapting to the new market conditions.

2)  Think outside the box - I am convinced, based on years of experience working with successful traders, that there is no edge in being consensus.  If you are part of the herd looking at the same charts, regurgitating the same narratives, there is no way to achieve distinctive returns.  My own trading has undergone a renaissance as the result of making cycles the most basic unit of analysis.  Identifying dominant market cycles within stable market periods allows the trader to know when markets are likely to exhibit momentum and when they are likely to reverse.  This has freed me from bullish or bearish biases--there are always ups and downs to be exploited in markets.

3)  Collect people - Vic is a consummate collector.  He has collections of art, collections of books, collections of historical artifacts.  His house is a veritable museum.  But where Vic has been most successful is in collecting people.  He seeks out accomplished people in various fields and brings them together, whether online, in meetings, or in parties.  I don't know any successful traders who don't have well-curated professional networks.  Quite simply, people who are excellent in their domains bring out our own excellence.  We internalize what we experience; that is why we should always surround ourselves with excellence.

Life is too short to settle for mediocrity.  What are you doing in your practice, in your thought processes, and in your social life that elevates you toward excellence?  Such reflections are an excellent way to begin planning for a new trading year.

Further Reading:


Thursday, December 06, 2018

Finding A Mentor, Not A Guru

One of the best things a developing trader can do is find mentors.

One of the worst things a developing trader can do is follow gurus.

Gurus are not mentors.

Gurus offer answers; mentors teach you how to arrive at answers.

Gurus promote the right way to do things; mentors teach you to find the right ways for you.

The recent Forbes article highlights the sobering fact that 95% of people are imitators; only 5% are initiators and innovators.  Isn't it interesting that those odds are similar to the odds of independent traders becoming consistently profitable?  Imitation is not a winning strategy.  It is a sure path for being part of a herd.

When I spoke with traders at the recent meetup for My Investing Club, I emphasized the importance of learning from your own trading experience:  what works for us and makes sense to us often reveals our underlying strengths.  A mentor can help you learn from your experience; not follow their advice and experience.  

The MIC home page begins with the phrase, "Mentorship is the shortcut to success."  That calls to mind a story recalled in a Jewish book called Tanya.  A Rabbi was trying to find his way to the city and asked a child for directions.  The child explained that there was a "short and long way" and a "long and short way".  The Rabbi took the short and long way and found his path obstructed.  He then returned and asked the child why he had said the path was short.  The child said, "Didn't I also tell you it was long?"

The path of the guru is the short but long way.  It promises quick answers, but these don't work in practice, because they do not draw upon *your* strengths and *your* ability to adapt to shifting markets.  When you follow the guru, you become obstructed--and that makes it a long way.

The long but short way is mentoring.  It takes time to learn from experience and internalize those lessons, just as it takes time to become a golf champion or an Olympic winner.  Mentoring can accelerate the development process by helping you learn from both successes and mistakes--and by giving you *many* models of success that you can integrate to make your own.  That makes mentoring the long but short way--the real shortcut, as MIC notes.

The Forbes article points out how easy it is for us to become influenced by others.  I have never met a consistently profitable trader who has not demonstrated a high degree of intellectual independence.  At SMB, for example, developing traders are part of a team and receive mentoring from senior, successful traders.  They are expected, however, to develop their own "playbooks" and cultivate their own understandings of markets, stocks, and opportunities.

One of the most common errors we make in thinking about trading success is that mentoring is limited to the early years of development.  If markets always traded the same way and followed the same patterns, this would be the case.  It is the ever-changing nature of markets that ensures we not only learn, but continually relearn and update our learning.  That means it is helpful to have mentors throughout one's trading career: colleagues we can learn from.  In dynamic fields, such as medicine and technology, education is not enough.  Success requires continuing education.  And that means ongoing mentoring.  

Further Reading:


Monday, December 03, 2018

When Your Past Overwhelms The Present

Margie and I are currently fostering a lovely young cat who spent the first year of life in a relatively confined space.  He was wary upon first meeting us, but warmed up and began to play and purr.  This morning, I set up his cat bed in a larger room so that he could become accustomed to new space.  When he saw me carrying the bed, he had a complete meltdown.  He panicked, hurled himself against the window to escape, and shook and growled.  When I put the bed down and spoke to him softly, he calmed down and was eventually able to resume play--but only after returning to his safe bedroom space.

Trauma occurs when life incidents become such threats that they overwhelm our coping.  Not all trauma is full-blown PTSD.  Many events in our lives leave scars that can be reopened at various times in our lives.  A person who was mistreated as a child may function quite well as an adult, but suddenly "overreact" when treated unfairly at work or in a romantic relationship.  Not so different from the cat.

All of us bring our personal histories to trading.  When unresolved issues of self-worth, anger, or anxiety are triggered by the challenges of markets, we can be a bit like the cat.  We can "overreact".  But, of course, what looks like an overreaction in the present is really nothing by a reaction to our emotional past.

Not all of us are acting out our past in our current trading.  But if you find yourself "overreacting" to life events outside of markets--at work, in relationships--there is a high probability you'll bring those issues to your trading.  That's when a professional counseling relationship can be useful to resolve those issues.  No amount of playing with indicators or listening to trading coaches will put your past into perspective.  Investing in the right kind of help could be the best thing for your trading.

Further Reading: