Sunday, December 08, 2019

My Only Edge in Markets

Here's a screenshot from Friday's trade in SPY (bottom panel), with the NYSE TICK (ratio of stocks upticking to downticking) in the top panel.  Overlaid on the TICK is a 10-period moving average, and the blue line represents the zero level, where upticks and downticks are equal.

I've studied the hell out of my winning and losing trades and the bottom line is that I only have one edge in trading.  When I identify spots where sellers are dominant, but can't push the market significantly lower, that works out as an area to buy.  The sellers are trapped and have to cover.  When I identify spots where buyers are dominant, but can't push prices to new relative highs, that is often worth fading.  The buyers are trapped and have to bail.

Everyone is overleveraged.  No one can take meaningful heat.  That is the source of my short-term trading edge.

I make money when I trade that edge.  I lose money when I try to be someone other than who I am in markets.

Which makes self-understanding and especially self-acceptance the only true source of trading edge.

Further Reading:


Wednesday, December 04, 2019

Not All Negative Emotions Are Problems

I recently spoke with an experienced, insightful trader who was experiencing performance anxiety.  He was so concerned with losing money that he failed to follow his own rules regarding entering positions, taking profits, etc.  As a result, he chronically felt frustrated, because his ideas were good, but his trading was mediocre.

It turns out that this trader had a pretty small account and was trying to use his trading to support himself and his family.  As a result, he was taking positions that were quite large--quite leveraged--relative to his capital base.  This ensured that, if he had a normal and expectable run of losing trades, his account would draw down meaningfully.

He knew that he could not afford to draw down significantly, so he was caught between a rock and a hard place.  He had to take risk to make the money he needed; he could not lose much of the money at all.  

In such a case, anxiety is a normal and healthy response.  It is information, not a problem.  It is telling us that the trader's goals are not realistic and are placing too much pressure on him and his performance.  He either needs to find other ways to support his family while developing his trading or find a position as a funded trader.  Most important, he needs to trade without the fear of risk of ruin.

Many times, the negative emotions of rational people are themselves rational responses to irrational situations.  If a spouse experiences emotional abuse from a partner, reactions of fear and anger are normal and natural--and they are telling us something!  Negative emotions can become prods to get us to look at our circumstances and expectations and make constructive changes in those.  Too often, we look to rid ourselves of negativity rather than looking into it and learning from it.

Further Reading:


Sunday, December 01, 2019

Training Your Mind By Training Your Body

This is a radical and powerful idea:

Figure out what you want to develop in your life and then create disciplines and workout routines that exercise those capacities.  That is training your body to cultivate your optimal psychology.

I recently reviewed research concerning the ways in which the right kinds of physical exercise can generate surprising psychological benefits.  After just a couple of days, that article has been downloaded 60,000 times, illustrating the level of interest people have in finding new ways of developing their potentials.  Counseling, coaching, and psychotherapy can be helpful in addressing performance challenges.  Through the right physical disciplines, however, we can directly experience the person we wish to become.  Are we interested in becoming more disciplined and self-controlled?  More resilient in the face of adversity?  More able to draw upon our storehouses of energy?  More grounded in a sense of self-mastery?  All of these can literally be exercised by the right disciplines.

It's a game-changer for psychology:  Don't talk with someone to reach your goals; do the things you wish to become.

Further Reading:


Friday, November 29, 2019

Tracking the Psychology of the Market

Whether one is a portfolio manager or trader, success comes from generating sound market ideas and then translating those into positions that provide positive reward relative to risk.  There are many big-picture managers who develop great ideas but fail to implement them as excellent trades.  Similarly, there are many short-term traders who treat trading patterns as ideas, only to get run over by what is happening in the larger picture.  Great trading is an integration of the strategic and the tactical.  

Many of the trading patterns that I rely upon to implement bigger-picture ideas are measures of the psychology of the marketplace itself.  The NYSE TICK measure, which I have written about for a while, looks at the moment-to-moment upticks and downticks in every single NYSE stock and combines those into a single measure.  When buyers are dominant, we see more upticks than downticks; when sellers dominate, we see more downticks.  We can create a short-term moving average of the TICK, which looks like an oscillator.  By observing if the oscillator is mostly above or below the zero line and whether it is making higher or lower peaks and valleys, we can detect overall sentiment over the course of a trading day.  A cumulative measure of the TICK, constructed like an advance-decline line, can provide us with a sense for longer-term shifts in sentiment.

Recently, I have taken a more detailed look at the upticks and downticks.  Using data from the Sierra Chart platform, I have constructed TICK measures specific to the SPX 500 stocks, NYSE stocks, NASDAQ stocks, and Russell 2000 stocks.  As illustration, we see above a 20-minute moving average of upticks vs. downticks for the SPX 500 stocks only, covering the day of November 27th.  Comparing similar moving averages for the Russell 2000 TICK and the NYSE TICK can help us identify when there is stronger and weaker sentiment among the small-cap and large cap segments of the marketplace.  When we see strength and weakness across all the TICK measures, we can be alert for the possibility of trending market behavior.

Over time, we can become quite good at detecting patterns in the uptick/downtick data to identify how sentiment is actually moving the market.  For example, note how in the first half of the chart above, we get periods of net selling that fail to move SPY meaningfully lower.  In other words, the sellers are present, but are unable to move the market.  This is valuable information.  Observe how buying could not move the market higher late in the day, which was equally valuable for the astute trader.

The big takeaway here is that higher-frequency market information (the TICK measures update multiple times per minute) can capture the trading patterns of active participants, revealing the evolving psychology of the marketplace.  Longer-term shifts in this psychology can help us generate market ideas; shorter-term shifts can help us find good risk/reward spots for implementing those ideas.  Of course, it's important to use psychology to understand and master ourselves.  What is often missed, however, is that psychology is equally important in understanding the markets that we trade.

Further Reading:


Sunday, November 24, 2019

Is Your Trading Purpose-Full?

What is the purpose of your trading?

For many market participants, this would seem to be a foolish question.  "Of course!", they might exclaim, "The purpose of my trading is to make money!!"

Is it that simple, however?

The purpose of a job is to make money.  But is that the purpose of a career?  Is it the purpose of a calling?

If someone were to suggest that the purpose of my being a psychologist is to make money, that would strike me as absurd.  Do I make a living from my profession?  Of course.  But is that the *purpose* of what I do?  Of course not.  Show me an artist whose aim is to make money and I'll show you a mediocre artist.  A priest, minister, or rabbi?  A physician?  The good ones aren't in it for the money, even though it is their primary source of income.

When a trader approaches his or her craft to make money, what they're really saying is that markets are their job, not a career, and most certainly not a calling.  We shouldn't be surprised, therefore, when they treat trading as an activity limited to market hours, and we shouldn't be surprised by the lack of true passion and effort that goes into their market preparation, review, and journals.

Purpose breeds passion.  Passion without purpose is mere emotion and drama.

The most recent Forbes article is based on eye-opening research that reveals the emotional, health, and productivity benefits of living with a sense of purpose.  Purpose gives us resilience--the ability to bounce back from setbacks.  Purpose also enables us to draw upon hidden reservoirs of energy.  All of these are key to success in markets.  

The trader who trades for money has nothing to energize them during inevitable periods of drawdown.  As the Forbes article makes clear, many of the greats of trading have been motivated by a sense of purpose beyond immediate P/L.  Teaching/training others; learning new modes of self-mastery; discovering new patterns and creative sources of edge--all of these are purposes associated with the process of trading, rather than the outcome.

If there isn't an overarching point to your trading process, trading will eventually feel pointless.  That is not a formula for success.

Further Reading:


Wednesday, November 20, 2019

The Importance of Context in Trading and Trading Psychology

Here's an interesting market display from Sierra Chart.  It is a Market Profile-style depiction of volume traded at each price in the ES futures over the past seven trading days.  The grey regions represent the value areas for each day; the magenta line represents the point of control, and the green areas represent volume traded above and below the value area.  Thus at one glance we can track the red arrow on the most recent day and see where we are currently trading relative to recent value, whether buying/selling volume can take us above/below the point of control and above/below the value area, whether volume is increasing or dying out as we move out of the value region, etc.  In short, the display places current market activity in context, helping us understand the meaning and significance of moves that are occurring.

Many trading problems occur when we lose sight of context and become so focused on short-term price action that we get run over when the larger picture predominates.  For instance, we may see the market moving lower in the short run and chase the move lower, missing the fact that the selling is on reduced volume and is unable to establish value lower.  When the market snaps back to the point of control, we get whipsawed out of that short term trade.

It's interesting that many trading psychology problems also occur when we fail to put our activities in proper context.  We can become frustrated by three losing trades in a row, failing to appreciate that, with a hit rate near 50%, this is bound to occur often to active traders.  Similarly, we can become overconfident or underconfident based upon our recent trades and thus lose sight of well-established rules for setting stop loss points.  Reminding ourselves that we are not as bad as our most recent losses might make us feel and not as good as we might feel after a win is also establishing context.

So much of trading psychology is possessing the mindfulness to process the larger context before acting on and reacting to the most recent market and trading events.

Further Reading:


Sunday, November 17, 2019

Peak Experience and Peak Performance

When I wrote the recent free blog book, Radical Renewal, I started with the insight that many of the problems we encounter in trading psychology are ones in which our egos become attached to short-term performance.  Once we make profit and loss a measure of our personal success and value, we introduce fear, greed, frustration, and overconfidence into our processing of markets.  To the degree that we become focused on outcomes, it becomes impossible to fully focus on sound trading process.  Too, when we are self-focused, we lose our focus on what is happening in markets.

One idea that emerged during the writing of the book is a bit different:  It's not simply the presence of negative emotional experience that interferes with good trading performance, but the absence of distinctively positive experience.

The psychologist Abraham Maslow wrote about "peak experiences", which are powerful experiences of positive emotion, meaning, and purpose.  In the book, I explore the idea that peak experiences are the positive equivalent of traumatic stresses.  Just as trauma is processed directly with the potential of reshaping personality, peak experiences exert a similar--but more constructive--reorganization of our experience.  Consider the "born again" experience of a religious person or the experience of falling in love.  These exercise an ongoing inspiration that gives us energy and positive emotional experience.

What supercharges our performance is a level of absorption in what we're doing that opens us to the flow state and peak experiences.  I question if we see ongoing peak performance without an engine of peak experience.  The trader's focus on negative emotion is the surest sign that flow states and peak experiencing are missing.  We achieve in any field when we discover something profound and meaningful that inspires ongoing effort.  That is the ultimate psychological edge of any entrepreneur.

Further Reading:


Tuesday, November 12, 2019

The Two Paths Toward Winning

I recently interviewed with Seth Freudberg of the SMB Options Group, and the interview was posted to YouTube.  In the interview, I summarized research I had conducted at a number of different trading firms regarding what creates success for traders and portfolio managers.  As I suggested in a recent tweet, a major finding is that distinctive performance is based upon distinctive strengths.  The idea that all profitable traders have a particular "secret sauce" ingredient that creates their success is silly.  What we find is that success--in trading as in other fields--leverages native talent and interest, builds skill upon that base, and then channels those talents, skills, and interests in ways that exploit opportunity.  

In general, there are two paths toward winning for traders:

1)  The first path is where the trader has experienced success and is engaged in markets in ways that are interesting and fulfilling to him/her.  Very often, the approach to trading makes use of one or more strengths that show up in other areas of life.  For example, someone who demonstrates unusual intellectual curiosity outside of markets will make use of that curiosity in developing new sources of edge in markets.  Of course, markets are always changing, and so the trader who has experienced early success must work to maintain that success.  Like a talented athlete, this trader is always working on his or her game, refining and expanding skills and finding new opportunities.  Working harder and better at your game:  that is the first path to success.

2)  The second path is where the trader has not experienced success and is frequently frustrated in his or her engagement of markets.  Such a trader may work harder and harder, but the path to progress is a slow one.  Over time, the trading takes energy; it does not energize.  That is one of the best signs that this trader is playing the wrong game.  All the work on refining skills won't be helpful if you're playing the wrong game.  Getting better and better at implementing a random chart pattern that lacks edge is not going to lead to distinctive profitability.  Working harder and harder at approaches to trading that don't leverage your talents, skills, and interests will similarly lead to mediocre results.

If you look at most performance fields, you'll see that each one actually incorporates specific roles that require unique skills and interests.  On a baseball team, the role of pitcher requires very different skills from the role of outfielder or catcher.  In an orchestra, the violin player is "playing a different game" from the percussionist and keyboardist.  The medical world has space for pediatricians, psychiatrists, and surgeons:  very different "games" indeed!  A huge part of success is finding the game that is right for you, given your native abilities, your interests, and your skills.  Very, very often you have to try many paths to performance before you find the one that is right for you.  Indeed, trying out all specialties is a requirement in medical training and in many formal training programs at investment banks.

The most popular TraderFeed post of the year was one that called out many providers of "trading education" for promoting strategies that have no edge whatsoever.  That's a different way in which we can find ourselves playing the wrong game.  A huge part of the learning curve for a developing trader is trying different approaches to markets--shorter term, longer term, discretionary, quantitative--and different markets to see which "specialties" truly fit with talents and passions.  Only then can we find sound mentoring to help us play the right game the right way.  There are some excellent resources in the appendix to my blog book that point the way toward such mentoring.

That is the challenge of trading:  There is no single path toward winning.  The challenge is to find our path.

Further Resource:


Sunday, November 10, 2019

How The Market Cuts You Up

Perhaps the best trading psychology advice ever:

Move the heart, switch the pace, look for what seems out of place

I find you in the morning

After dreams of distant signs
You pour yourself over me
Like the sun through the blinds
You lift me up

And get me out
Keep me walking
But never shout
Hold the secret close

I hear you say
You know the way

It throws about
It takes you in
And spits you out
It spits you out

When you desire
To conquer it
To feel you're higher
To follow it

You must be clean
With mistakes
That you do mean
Move the heart

Switch the pace
Look for what seems out of place

Friday, November 08, 2019

How FOMO Can Help Your Trading

I recently posted an article about how we can use our greatest weaknesses to become valuable strengths.  Here is a dramatic example from a money manager I've been working with.

The portfolio manager suffered from that common malady of FOMO:  the fear of missing out on potential market moves.  Although he had rules for entering positions that carefully circumscribed risk and reward, he would see the market moving away from his ideal entry point and, fearful of missing out on the opportunity, he would chase the short term movement.  All too often that led to paper cut losses and big distractions during the day.

Now, of course, the usual coaching strategy to help this person would be to mentally rehearse scenarios that trigger FOMO, along with the "best practices" for managing such market opportunities.  Those visualizations would be accompanied by stress management techniques to minimize the anxiety that is a typical part of FOMO.  Such an approach can be quite useful.

But suppose we view FOMO as a potential trading/investing strength!  Perhaps the FOMO is simply an unhelpful channeling of a positive drive for achievement and performance.  Rather than try to eradicate the FOMO, how could we channel it in more constructive directions?

The way we did that was by transforming FOMO into FOMOP.  FOMOP, we decided, was a fear of missing out on one's process.  It is a fear of losing the process orientation that has accounted for long-term success.  

To deal with FOMOP, the manager actively recounted, during preparation time, instances in which deviations from good process led to losses.  He specifically looked for scenarios in the upcoming day's market action that could lead to process breakdowns and prepared for them as potential landmines.  He actually cultivated his fear; he didn't try to overcome it.  He wanted to be *appropriately* fearful of losing discipline, just as, say, an alcoholic might be appropriately fearful of relapse.

As a way of gauging progress, he graded himself at the end of the day purely on process grounds:  how well he generated ideas; how well he structured trades based on the ideas; how well he managed those positions and their associated risk; etc.  The goal was to achieve consistently high process scores at the end of trading days, whether those days had positive P/L or not.

The interesting finding has been that FOMOP works!  Indeed, this portfolio manager has shown dramatic improvements in the rigor of his trading (he executes his own positions) and investing.  This has translated into a better mindframe and, most critically, into improved absolute and risk-adjusted returns.  Instead of fighting his fear of missing out, he has channeled it in a way that improves his trading.  That fear came out of a positive drive for performance; it wasn't something to be battled and eliminated.  

What if most of our weaknesses are simply strengths channeled the wrong way?  How might it help our trading, our mindset, and our relationships if we can find the positive drive behind the weakness and use it to fuel one of our strengths?

Further Reading:


Sunday, November 03, 2019

How to Use Our Emotions as Information

Emotion is the output of the brain's fast processing system, a rapid pattern recognition system that quickly captures whether a perceived entity or event is good or bad for us, safe or dangerous, something to embrace or something to avoid.  If we had to rely on slower, analytical thought to assess if an oncoming car was a threat, we would be in a collision by the time we reached a conclusion.  Our emotional processing enables us to act quickly, facilitating fight or flight when needed.

The price we pay for sharing emotional/fast processing with the animals is that we can act quickly and not always accurately.  The salesperson who comes across as helpful and interested may or may not have your best interest in mind; the situation that you fear may actually be the very one you need to tackle in order to grow.  Emotion is necessary for navigating the world, but not sufficient.

There are traders who act impulsively--and unprofitably--on emotion and conclude that the answer to successful trading is to curb or even eliminate emotion during trading.  From this perspective, emotion is a weakness to be overcome if one is to trade rationally.  To put the matter politely, this is a limited view.  Eliminating emotion--even if it were possible--would be to remove our capacity for fast processing.  Good luck retaining a feel for markets if you're busy denying your feelings.  Imagine a parent who lashes out at a child out of anger or frustration and then concludes that he or she will solve the situation by removing all feelings from parenting.  Would they then become a good parent?

The most recent Forbes article tackles a very important topic in trading psychology:  How we can turn our weaknesses into strengths.  Rather than try to overcome or eradicate our feelings, we can channel them in a way that assists our trading.

Here's one way of doing that that:

If I feel something strongly about the market before I have conducted my usual analyses, I immediately entertain the hypothesis that if I'm feeling that way, perhaps others are as well.  In other words, before I do my preparation, I'm processing the same charts, the same headlines, and the same social media chatter as everyone else.  If what I'm perceiving frightens me or makes me think a phenomenal opportunity is at hand, I want to consider the possibility that this is a consensus perception.  In that context, my feelings are not an automatic guide to action, but rather are important information to consider when conducting my pre-market preparation.

So let's say that there is a tremendous amount of bearish chatter among market participants and I'm becoming worried about the possibility of a bear market, triggered by trade wars, political conflict, and economic weakness.  Recognizing my fear and acknowledging it enables me to see if the market data I look at actually support such a view.  In recent weeks, for example, the data have not been supportive.  Indeed, a number of formerly weak market sectors and international indexes have been displaying relative strength.  Noting the disparity between my emotional/fast processing and my analyses allows me to consider the possibility that bears will be trapped on any move higher, sustaining the upside.  In such a case, my emotions are a source of information, not a weakness to be battled.

Many traders turn to techniques such as meditation as "enlightened" ways to rid themselves of emotion.  It's not clear to me that this is the true purpose of meditation, certainly not in the Buddhist and western religious traditions I reviewed for my recent blog book.  Rather, the idea is to gain awareness of our feelings, while simultaneously acting as their observer.  The Forbes article summarizes important research that finds that embracing our vulnerabilities actually makes us stronger, more whole.  Our emotions can derail our trading or inform it.  It all depends upon our degree of mindful self-awareness.

Further Reading:


Wednesday, October 30, 2019

How to Trade - 4: Going From Analysis to Synthesis

Before exploring the information above, it will be helpful to review the previous three posts in this series, as this post will integrate much of the information from earlier.  In the first post, we took a look at the importance of determining who is in the market, whether they are leaning toward buying or selling, and noting the prices at which they are transacting.  These variables tell us whether a market is rangebound and cycling versus trending, and they alert us to markets that are getting stronger and weaker.  The second post introduced the idea of context--how short-term moves are nested within longer time frame activity and how trade opportunities are created by the lining up of shorter and longer time frames.  We also explored how the use of event time can create more stable time series of prices, so that we can more readily perceive market cycles.  In the third post, we examined the ideas of breadth, strength, and momentum, all of which help us understand phases of market cycles, particularly at longer time frames.  

Gathering all this information and taking note of what it means is an essential part of market analysis.  We generate trading ideas, however, by putting our analyses together into a coherent picture.  It is that integration of data/analyses that I refer to as synthesis.  It is the crucial creative element in trading.  The creative, successful trader synthesizes information to generate perspectives that aren't readily visible from charts and individual pieces of data.  That ability to put the puzzle pieces together and see bigger pictures is an important element in what sets expert traders apart from the consensus herd.  

OK, with that in mind, let's engage in some synthesis.

Going into this morning's market, my breadth data have been positive as we've moved to new highs.  The number of new highs versus new lows, however, and particularly my measures of momentum such as the number of stocks generating buy versus sell signals on various technical systems have stalled.  We are not seeing a meaningful increase in the number of stocks making short-term new lows, but neither are we breaking out to new highs across the majority of market sectors.  Volume has been light in SPY and the new highs have been limited to a handful of sectors and overseas markets.  Overall, the picture has been one of a range bound market with waning upside momentum.  

If you click on the chart above (Sierra Chart platform), you'll see what I was looking at on my screen earlier this morning.  At the top left you'll see the horizontal bars at different prices, representing how much volume has transacted at each price.  The point of control--the center of where we've established value over the past several days depicted on the chart--is 3039 in the ES futures.  The prior point of control had been around 3020, so we have been accepting value higher.  That keeps me in a bullish mode.

Note that the chart is denominated in event time, with each bar representing 20,000 contracts traded.  As a result, we draw fewer bars during slower overnight trade and more bars during busier periods.  The red horizontal lines that I have drawn in depict shorter-term market cycles.  Note that, according to this view, we have recently seen a cycle bottom around 3032.50, which is above the early morning lows from yesterday.  With the bullish behavior of setting value higher over time and the potential bottoming of a cycle at a higher price low, I am leaning bullish in early morning, pre-opening trade.

(By the way, the blue arrows show how volume at the offer price tends to wane as the upward phases of cycles mature and how volume at the bid price tends to wane as market cycles bottom.  With ongoing observation, you can become quite good at tracking the strengthening and weakening within cycles.  During normal market hours, the NYSE TICK and other uptick/downtick measures also help track the maturing of market cycles.)

The middle bars and bottom oscillator track volume at offer versus volume at bid for each volume period.  Note at the right side of the chart, earlier this morning, the hitting of bids had diminished significantly, helping us identify a potential cycle low.  

Integrating this information, I was a buyer early in the morning a bit before 7 AM EST around the 3035 area.  My hypothesis is that we had seen the lows from the overnight session; my stop is below that area.  I expect that, at minimum we should retest the 3039 point of control and quite possibly the recent market highs.  We did indeed touch that 3039 level prior to the NYSE market open, leading me to take profits.  

This is a very simple trade, typical of what I do.  I look at multiple time frames and pieces of information and construct a view of the market based on trend and cycle behavior.  Having analyzed the pieces of information and then synthesized a view, I structure a coherent risk/reward structure for my trade that tells me where I'm wrong (we drop below what I assumed was a cycle low) and tells me where we should go if I'm right (first target the point of control; later target the prior day's highs.  Because today is a Fed day and flows will be unusual, I was particularly aggressive in taking profits at the first target.

Should we see a truncated up-phase for the new market cycle and a seeming top at a price level below yesterday's highs, I would be open to selling this market, given the stalling out of my momentum measures.  As I look at the market in early NYSE trade, that scenario appears to be unfolding.

The big takeaway here is that you're using market-generated information to fuel an understanding of what the market is doing, and you're creating the trade (and its management) based upon that understanding.  There is much, much more to trading than looking at price charts and looking for "setups".  My hope is that these posts inspire you to look more deeply into markets and find the opportunity that others, who are so eager to trade, miss.

Further Reading:


Sunday, October 27, 2019

How to Trade - 3: Using Breadth, Strength,and Momentum to Track Market Cycles

The first post in this series focused on market understanding, building upon the foundation of price, volume, and time.  This led us to the core idea that edges in trading come from buyers and sellers coming late to market moves and becoming trapped when demand/supply cannot move the market higher/lower.  It is their need to exit their positions combined with the new activity of value sellers/buyers (participants at higher time frames) that creates the market moves that active traders can exploit.

The second post in the series elaborated two important ideas:  context and cycles.  The rise and fall of supply and demand creates cyclical and trending movement in stocks and markets.  The complexity of market behavior is, in part, a function of longer-term trends and cycles nested within one another.  Understanding market behavior requires placing shorter-term movements into the context of larger trends and cycles.  A directional trading edge can occur when we can utilize our understanding of shorter-term cycles to find good risk/reward spots to participate in trending movement.

There are unique measures that enable us to track the waxing and waning of buying and selling pressure, such as the uptick/downtick and bid/ask volume stats described in the first post and the idea of event time as captured in the second post.  In this post, we will take a look at measures of breadth, strength, and momentum as important metrics for capturing the phases of market cycles and trends.  The next post will begin integrating all this information by applying to recent markets.

Before we get into the breadth, strength, and momentum measures, however, I'll offer a perspective grounded in trading psychology.  Any form of greatness and exemplary achievement requires the capacity for sustained, directed effort.  Whether it's starting a business, pursuing a scientific discovery, or writing a book, it's our ability to see a larger picture and sustain the pursuit of that vision that makes achievement possible.  The majority of traders do not succeed because they simply do not--and perhaps cannot--sustain the effort required to properly understand markets.  This inability to sustain effort results in the adoption of simplistic trading techniques that inevitably fail.  False trading gurus, operating under the guise of trading educators, are all too happy to exploit this need/desire for simplicity.

Markets contain many moving parts, with participants operating on different time frames and responding differently to new price and fundamental information.  Correlations among market components shift over time; the factors (momentum, value, carry, etc.) driving markets rise and fall over time; volatility shifts over time; and we move from trending/directional periods to range bound/consolidating ones across all time frames.  There is nothing simple about markets, but it is our need to (over)simplify them that creates a great deal of our losses and emotional reactions to those.  Only the capacity to sustain the effort to achieve an understanding of market behavior allows us to adapt to continual shifts in price action.

Breadth refers to the balance between rising and falling stocks within the market universe.  The classic measure of breadth is the advance/decline line, but we can think of uptick/downtick measures, such as the NYSE TICK, as indicators of instantaneous breadth.  The key idea to keep in mind is that strong trending markets reflect a broad demand or supply for stocks as an asset class.  When we see extreme breadth, we want to be thinking in trend terms.  Other times, markets may move higher or lower on modest breadth.  Often, these are markets dominated by sector rotation.  There isn't a broad increase or decrease in the demand for equities, but rather a shift from one type of stock (growth, small caps, or industrial) to another (value, large caps, or consumer discretionary).  As we will see in upcoming examples, recognition of the breadth environment can help us determine what to trade and how to trade it.  We would trade a potential trend day in the market differently from a rotational, range day, for instance.

Related to breadth is the notion of market strength, which captures the number of stocks displaying unusual upside and downside characteristics.  The classic measure is the number of stocks registering fresh 52-week new highs versus new lows.  Very often we will see skewed positive or negative new high/low balances during trending markets.  It's when markets advance or decline with fewer new highs/lows that we begin to entertain the idea of a maturing market move.  To complement the standard 52-week measure, I also track the number of NYSE stocks making fresh one- and three-month new highs and lows (data from and the number of SPX stocks making fresh 5, 20, and 100-day new highs versus lows (data from  I also follow the major market indexes and sectors in real time to see if SPX moves to new highs/lows are accompanied by similar moves in the various components of the market.  Together, breadth and strength tell us a great deal about the sustainability of market moves.

A recent addition to my arsenal of tools has been measures of market momentum.  We can think about momentum as a second derivative of price movement; it captures rate of change.  The key idea here is that momentum tends to wane before we see actual reversals of price moves.  Some of the momentum measures I follow have been doing a nice job of anticipate reversals of directional moves.  These measures include the percentage of SPX stocks trading above their short, medium, and longer-term moving averages (data from; the number of stocks crossing above/below their 20-day moving averages (data from; and the number of stocks registering buy versus sell signals on various technical trading indicator/systems such as RSI and Bollinger Bands (data from  A nice way to think about all this is that we're constantly updating our views of momentum, strength, and breadth to revise the odds of a market move continuing or reversing.

Expertise in trading requires experience and skill in integrating this information in real time.  This requires a capacity to sustain focus, the ability to process many pieces of information at one time, and the ability to detect meaningful patterns among these pieces of information.  This makes short-term trading very different from longer-term investing, which looks at different information and processes that information at less frequent intervals, but often across multiple markets/asset classes.  Success in markets requires a lining up of our cognitive strengths with the demands of the kinds of trading/investing we're performing.

Further Reading:

Friday, October 25, 2019

Learning to Trade - 2: Understanding Cycles and Context

In the first post in this series regarding learning to trade, we explored a foundation that enables us to see three things:  1)  who is in the market; 2) what they are doing; and 3) the prices at which they are doing it.  The goal is to achieve an understanding of the market's auction process, tracking the actions of buyers and sellers and their ability to move markets to new levels of value.  

Uniting these three elements are the concepts of cycle and trend.  Trend refers to the linear, directional tendency of the market over given time horizons.  Using Market Profile as a conceptual framework, a trending market is one in which we build levels of value at higher or lower price levels.  Cycles refer to patterns of rising and falling both across and within market trends.  Cycles vary in their frequency (shorter/longer term) and in their amplitude (shorter, choppier oscillations/larger ranges).  Like snowflakes, no two cycles are identical and yet each has a common structure.  The start of a cycle consists of a sharp upward momentum move, followed by lower volatility choppiness and topping, followed by a momentum move downward.  In uptrends, cycle lows will occur at successively higher price levels; in downtrends, we see lower price highs.  When longer-term trends reverse, it's not unusual to see extended periods of cycling between momentum moves.

When we place a good directional trade, we are using shorter-term cycles as information to help us find good risk/reward spots to participate in trends.  When we place a good "mean-reversion" or reversal trade, we are using shorter term cycles as information to help us find good risk/reward spots to fade extremes in longer-term cycles.  Good trading thus consists of placing market behavior in context:  using shorter-term information to help us exploit longer time frame moves.

One of the challenges of identifying cycles and context in markets is that the time series of prices is typically not stable (stationary).  During some times of day, we are busier; other times we are slower.  Some market periods show more movement; others less.  If we don't have stability in what we're trading, it is difficult to accurately generalize from the past to the future.  The analogy I often use is card-counting.  If we're drawing cards from a single deck, counting can be quite effective.  If we draw cards from multiple decks and continually shift the number of decks in the "shoe", counts will provide little information.

When traders focus on chart and technical indicator patterns, they are capturing some facets of trend and/or cycle, but these facets shift as we move forward with different volume and volatility.  Such patterns--described by traders as "setups"--often lack context, so that they do not reliably capture the cycles and trends within which shorter-term market behavior is nested.

One way I address the need for more stable price series is to capture price as a function of volume, rather than as a function of time.  A simple example of this would be to draw new bars every time we trade, say, 5000 futures contracts or 100,000 shares of stock.  During busier times, we draw more bars; slower times provide fewer bars.  Creating charts in event time helps us perceive and measure cycles more readily.  Event time also helps us capture relationships among the various phases of market cycles.

I realize this is throwing a lot of conceptual content at you.  Upcoming posts will illustrate all these concepts and eventually will lead to the new style of trading that I am teaching myself.  The main thing is to appreciate that understanding supply and demand is key to identifying trading opportunities, and placing our understanding in context is key to translating our market ideas into effective trades.

Further Reading:


Wednesday, October 23, 2019

Learning to Trade - 1: Building Understanding

This series of short posts will describe the process by which I am teaching myself a new form of trading.  The idea is to illustrate a learning process and concepts that I have found important in trading.  Eventually I'll post actual trades and how these become part of the ongoing learning process.  Given the unusual interest in the recent post on what is missing in much of the trading education world, my hope is that this blog can provide a realistic, hype-free alternative.  

OK, so step one in my learning process is building my understanding of markets.  At this point, I am not trading or even observing trading.  I want to understand what I'm dealing with before I enter the performance arena.  An example would be a mechanic studying engines before practicing on model engines and apprenticing with an experienced person.  Another example would be studying basic sciences, such as anatomy, physiology, and pathology, before shadowing a practicing physician and helping with patient care.

Understanding precedes doing.  And, typically, understanding takes a while to internalize.

The building blocks of my understanding are threefold:  price, volume, and timeThis post, the most popular in the 13 years of writing TraderFeed, describes how understanding lies at the intersection of these three variables.  We want to see who is in the market, what they are doing, and where they are doing it.  The edge that I am seeking comes from a simple reality that I observe across traders and trading firms:  In seeking meaningful gains, most participants are leveraged.  This prevents them from taking normal heat (normal adverse movement) in their trades.  If a market or stock does not go their way, they need to quickly exit.  This creates a situation in which buyers and sellers who come late to moves are potentially trapped in their positions and eventually need to bail out.  The trader who can recognize signs of exhaustion in moves and able to assess the volume that is potentially trapped can take advantage of these reversals.

This last sentence is important.

The form that these periods of market movement, exhaustion, and trapping/retracement take is one of cycles.  At the next level of abstraction, our ideas of price, volume, and time lead to ideas of trending and cyclical movements in assets.  It is the persistent need of traders to make money and not lose money that creates the mixture of trends and cycles that we see in each market.  It is the fact that different market participants operate on different time frames--some as investors, some as market makers, some as traders--that creates trends and cycles on different time frames.  Very, very often, what is a trend on a shorter time frame is a directional part of a cycle on a larger time frame.  The presence of short, medium, and longer time-frame participants ensures that trends and cycles will be nested in one another, so that understanding the context of any particular market movement is essential to trading.

OK, so far?  Note that I've said nothing about setups, chart patterns, technical indicators, etc.  It is not clear to me that those possess explanatory power.  If something is not explanatory, it cannot fuel our understanding.  We want to understand what we're trading.

Note also that I've made no reference to fundamental variables, such as earnings, economic strength/weakness, monetary policy, etc.  These are very relevant to longer-horizon investing, but only very weakly connected to the shorter time frames of the trader.  Over an average holding time of minutes to hours, the fundamentals simply don't change in a meaningful way.  They may become relevant as catalysts during Fed announcements, data releases, earnings reports, etc.  Even there, however, what is crucial is who is acting on the information, how they're acting, and the prices at which they are transacting.  We're interested in supply and demand and their shifts in real time.

Reading is essential to building your understanding.  The two frameworks that I have found most helpful are:  1) Market Profile and 2) Market Delta.  Market Profile helps us understand where price/volume relationships, so that we can see levels from which many participants are long or short.  With profile displays, we can see where markets establish value and where we depart from value.  More on that later.  My favorite source of information regarding Market Profile is Jim Dalton.  His books Markets in Profile and Mind Over Markets are essential reading for understanding market behavior as an auction process that regulates supply and demand.  Jim also has a website and offers courses and webinars related to Market Profile.  When I taught an internship program in Chicago, Market Profile was the framework we started with and the Mind Over  Markets book was the core reading.

The second framework for understanding is the distribution of volume at market bid versus offer prices.  This measure was pioneered by Market Delta.  The idea is to assess each transaction in an instrument and its location at that moment's bid price or offer price.  As a result, over time, you're seeing how much volume is going through the market and whether that volume is more aggressive on the buying side (lifting offers) or selling side (hitting bids).  The original Market Delta website and product are no longer available, but similar functionality can be found via charting platforms that divide volume at bid vs. offer.  I currently use Sierra Chart for this functionality.  Conceptually related to bid/offer volume are measures of upticks versus downticks across the entire stock market or sectors of the market.  For example, the NYSE TICK measure captures the balance of all stocks trading on upticks versus those trading on downticks at each moment of the trading day.  Both the bid/offer volume and TICK measures tell us in real time if buying or selling pressure is high/low/average and whether they are expanding or drying up.

The integration of Market Profile and the volume/TICK measures helps us track cycles and trends over their lifetimes, identifying opportunities to benefit from real-time shifts in buying and selling.  In our next post, we'll explore how to achieve this integration and internalize truly meaningful patterns in markets.

Further Reading:


Tuesday, October 22, 2019

Hey, Noobs, Here's How We *Actually* Learn Trading!

The most recent blog post on getting past trading illusions drew roughly four times the amount of traffic as my average post, and it also generated more emails than I typically receive from traders in a month.  The traders reaching out, mostly beginners wanting to learn trading, struck me as sincere, not as people simply looking to get rich quick.  They recognize that so many of the services offered by self-promoting gurus and groups are long on promise and short on substance.  They sense that there is more to understanding financial markets and instruments than looking at shapes on charts. They also recognize that psychology is part of the equation, but only a part.  We cannot master what we do not truly understand.

One of the ways I pursue personal growth is to commit myself to roles that are completely uncomfortable and challenging.  I first hit on that strategy as a shy and somewhat socially awkward sophomore in college.  I volunteered to be the social chairperson of a large dorm and then threw myself into organizing and hosting events on a *very* social campus.  Of course it was overwhelming at times, but by the end of the year I had built a comfort level in social situations that has stayed with me decades later.

Similarly, if I feel in a rut, my wife and I will travel to totally new and challenging places.  That's how we ended up on a small boat amidst the Alaskan glaciers; it's also how we explored Venezuela, Israel, the mountains in Montana, ethnic neighborhoods in NYC, and much more.  No checked bags ever; just some carry on essentials so that we can be fully mobile.  Do we get lost at times?  Do we feel overwhelmed on occasion?  Of course!  That's the idea.  No one ever grew by staying in their comfort zones.  Growing your passport is a great strategy for stretching your boundaries.

We learn trading the same way we adapt to new cultures and roles.  We start by observing and feeling our way around, gradually building an understanding of this new world.  From that understanding, we can act and, with time, build confidence.  If we travel and start acting before we understand where we're at, we just end up looking like stupid tourists and never truly experience our destination.  Similarly, in markets, if we start trading before we actually understand what makes markets move up and down, we end up making stupid mistakes.  Then we wonder why we're experiencing emotional upheaval in our risk-taking!

So here's what I'm going to do in coming weeks.  I'm going to teach myself an entirely new approach to trading using an entirely new platform and turn myself into a total noob.  I will then use this blog and tweets to document the learning process, including all the ups and downs.  The purpose most certainly is *not* to get new traders to do what I'm doing.  Rather, this is an anti-guru offering, where my value will be as a beginner.  The idea is to illustrate a promising learning process, not collect fees for stale and outdated "education".  I'll highlight winning trades and losing ones, along with lessons learned and goals going forward and modifications of process.  Most of all, I'll illustrate how we can gain an understanding of the markets we're trading.

In the interim, please note that I have written a (free) blog book on the role of spirituality and trading that describes how we can overcome ego attachments in our pursuit of profits.  The appendix to the book includes a huge number of links to resources I've found valuable and which can be useful to those attempting to get their trading off the ground the right way.  The wonderful thing about finding useful resources is that you can reach out to those organizing and subscribing to the service and learn about additional tools.  Connecting to the right groups is like taking a travel voyage, only via the intellect.

The next post will start the noob project, and the process of learning a trading strategy from scratch.

Further Reading: