The latest Forbes article makes the case that self-talk is destiny. How we process the world--and how we talk to ourselves about ourselves and world--shapes our reality. That, in turn, defines what we experience as possible and impossible and shapes our actions. Nowhere is this more true than in trading, where we are constantly dealing with issues of being right and wrong, uncertainty, and making/losing money. If you click on the above graphic, you'll see a matrix that describes four styles of self-talk. These styles can be positive or negative in their emotional tone and they can either increase or reduce the energy available to us. Let's take a look at the four styles and what they might mean for you: Challenging - This is self-talk that pushes us to do better, do more, and tackle new and larger goals. Worrying - This is self-talk that anticipates negative outcomes in the future, triggering fight or flight responses. Calming - This is self-talk that reassures and puts things into perspective, dampening negative feelings and keeping us focused. Self-Blaming - This is negative self-talk directed against oneself, dampening initiative and generating depressed feelings. Clearly, at different times we may engage in different self-talk. Much of trading psychology talks about dealing with negative emotions (worry, frustration, self-blame) and ways of sticking to trading plans (calming, focusing). That is an important shift. The Forbes article adopts a different perspective, however. Just as we are in danger of living lives that are too sedentary (creating health risks), we can adopt mindsets that are too sedentary. Many of us can deal with adversity by calming ourselves and avoiding undue worry and self-blame, but not many of us consistently talk to ourselves in challenging and energizing ways. Take a look at the work of Emilia Lahti and David Goggins cited in the Forbes article. These are peak performing professionals who have used unusual physical challenges to push their mindsets to redefine what is possible. A useful exercise is to listen to a David Goggins video clip and think of his talk as your self-talk. This kind of challenging talk is often found in athletic settings and in the military, but rarely do we see it in office settings--and rarely do I find it on trading floors. It's great to reassure ourselves, accept losses, and find learning lessons in our setbacks. That is necessary for a solid trading psychology, but is it sufficient? If our self-talk is not intensely challenging, how will we intensively tackle new challenges? A calm mindset is helpful at times, but sedentary calm will never rouse us to do better, do more, and throw ourselves into challenges that expand who we are and what we can do. How inspiring and challenging is your self-talk?
We all have heard the statistics: the very low percentage of market participants who ultimately make their livings from their trading. Here, from a trading psychology perspective, are three reasons why sustained success is so elusive: 1) Markets are ever-changing - It is common for a trader to find success with a particular strategy (such as trend/momentum trading), only to lose money consistently when market conditions change. The successful traders I've known find multiple ways to win, which provides them with diversification and ways of succeeding across market environments. But that requires research and the ability to continually acquire new sources of edge. Many people are interested in trading; not so many in continually learning and adapting. The challenge is not just succeeding in trading, but sustaining success. 2) Trading requires the ability to navigate a contradiction - Trading is all about making money, and yet it is the focus on money that leads to many of the behavioral mistakes of money management. The more we focus on making more and trading larger, the more we can overtrade and trade reactively. The best traders I've known are idea focused, not primarily focused on profits and losses. What attracts many people to trading is precisely what needs to be put aside in order to succeed. 3) Markets are more efficient than ever - Strategies described by great traders of the past simply do not work any more. With so much computing power devoted to markets at every time frame, it's unlikely that one will find success by looking at the same charts, indicators, and data series as everyone else. I'm seeing many traders succeeding by focusing on less efficient markets and more specialized trading strategies. At some point in time, making a living from gold mining in California became very difficult. The easily accessed ore was already mined. That required going to new areas and utilizing new mining techniques. Many traders seek success by doing what others are doing. That's like digging for gold where everyone else has been digging. There are many would-be pundits and gurus talking about sure-fire ways of making money in markets. Very, very few provide verified track records of their success. The reality is that it is quite difficult to succeed at trading, just as it's difficult to make a living from playing a sport or from singing and dancing. It's fine for the developing trader to have eyes on the stars as long as they also have feet squarely on the ground.
Note the blue and red lines in the chart above. If you were to just look at those, you would conclude that they are totally separate instruments. Trend is different. The volatilities of the time series are different. And yet, they represent a single market: the SPY ETF of U.S. stocks. The blue line represents cumulative price changes during the overnight (from each day's close to the next day's open) and the red line represents cumulative price changes during the day session (each day's open to the same day's close). What can we infer from these time series? * Much of the overall upward trend in stocks has been expressed during overnight and pre-market hours in response to overseas buying and buying in response to pre-opening data releases. Day traders have not participated in the general upward drift of stocks over the past 15 months. * Flows from overseas impacted by the returns from international markets are markedly different from flows dominated by U.S. participation. The series is dominated by the trade during the last quarter of 2018, when U.S. participants bailed out of stocks relative to non-U.S. participants. Much of the rebound so far in 2019 has been those U.S. participants jumping back into stocks. * Swing trading has been difficult because these time series are independent. We cannot assume continuity from day periods to overnight periods. The correlation between price behavior during the day and during the overnight has been -.03. For this same reason, investors managing risk very tightly can easily get stopped out when trading in one period fails to follow through with the action of the previous period. I will hazard yet another perspective: Recent trading in U.S. stocks has been dominated by the herd behavior of equity and macro funds. Those funds, spooked by seeming Fed tightening, began selling in 2018 and then accelerated their selling to retain profits for the fiscal year. When the Fed emphasized "patience" in its rate and balance sheet policies, those funds were underinvested and needed to gross up their exposures to generate performance for the new year. Interestingly, we're starting to see divergences in behavior among sectors, with banks, industrials, and small caps underperforming. That may be an initial indication that the herd might be behaving in less herd-like ways going forward. At some point, the fundamentals of individual companies and industries will begin to matter once again.
I've been hearing from many confused traders who have underperformed the overall market during this run from the December lows. The common refrain is that they are waiting for a pullback to enter the trend--or they are looking for the start of a larger move to the downside. I heard this late in January, then in February, and now in March. Aren't we due for a substantial correction? Let's get a little perspective. Above I've charted one of my favorite indicators, the cumulative NYSE TICK (red line), versus SPY (blue line). The cumulative TICK takes the average five minute reading of upticks versus downticks for all NYSE stocks and adds the value for the current five-minute period to the running total. It thus works similar to an advance-decline line, but is much more sensitive to short-term strength and weakness. Note how the cumulative TICK line topped out well before the overall market peak last year. This led me to question the viability of the rising market. Indeed, the market--and the cumulative measure--fell precipitously during the fourth quarter of 2018. Then, however, with the dramatic turnaround in Fed policy, we saw a dramatic move higher in stocks--and in the cumulative TICK measure. As I pointed out earlier this month, this kind of strength is typical of bull market momentum, not a market getting ready to roll over. Very recently, we've seen some breadth divergences with fewer stocks making fresh one- and three-month highs, but until we see a meaningful expansion of short-term new lows and a sustained turn in the TICK measure, it's difficult to make a case for more than normal pullbacks. One of the problems that I'm seeing is that traders committed themselves to a bear view late in 2018 and have been fighting the recent rising tide ever since. That getting locked into a view is a classic case of ego-based trading, where being "right" becomes more important than following the market. In the recent Forbes article, I summarize fascinating research dealing with dark and light sides of our personalities and their impact on our trading performance. (Check out the links at the end of the article, which lead you to a free online test that allows you to get feedback on your own light and dark traits!) An important implication of this perspective is that we need to channel our ego needs in constructive ways so that they don't color our trading. We don't trade well by making market calls. We trade well by sensitively following what markets are actually doing.
In his book 59 Lessons: Working With the World's Elite Coaches, Athletes, and Special Forces, Fergus Connolly makes a very interesting distinction between discipline and self-discipline. He points to elite special forces troops. When they begin their training as soldiers, they are expected to do what they are told. When their commanding officers give an order, they follow that order. That is discipline. When that soldier gets to the point of special forces training, however, the situation is different. The challenges faced by special forces operators are complex and ever-changing. They can't possibly rely upon commands from a superior. They have to think for themselves. As Connolly observes, "...especially as conflict has become much more unconventional, a need has arisen to develop independent operators who can think and act with ingenuity in highly unpredictable situations...there is no such thing as external discipline with elite performers, only self-discipline...Discipline is what you do at the behest of someone else, while self-discipline is when you do it on your own initiative." (p. 184). So how does this relate to trading? Many traders look for recurring patterns in markets ("setups") to guide their entries. Examples would include breakouts from ranges, gaps on news or earnings reports, moving average crossovers, etc. Acting on those setups with fidelity is discipline. Traders are doing what they've been taught. What happens, however, once the trade has been placed? Very quickly the flows of buyers and sellers create a fluid, complex situation not unlike that faced by the special forces operator. Now there are no mechanical setups to act upon. The trader has to think independently about whether to add to positions, scale out, hold for targets, stop out, etc. Responding to those fluctuating conditions requires self-discipline. I have been impressed in recent years at how many traders generate good ideas and enter positions at good levels. They simply cannot weather the price path once the positions are on. Very often, when we review where they stopped out of positions, we find that the trades ultimately worked out and hit planned targets. The problem was not discipline in finding and entering trades. The problem was the self-discipline required to navigate the trade. Not every good, disciplined soldier can function as an elite special forces operator. The ability to follow instructions is not the same thing as developing principles and guidelines for navigating fluid, complex, uncertain situations. Discipline is all about "if A, then B". Self-discipline is more about envisioning multiple what-if scenarios and knowing how to respond to each. The disciplined trader takes the break out trade. The elite trader tracks order flow and the flow of buying and selling from the point of breakout and flips the position if those breakout flows are not sustained. A great deal of trader education emphasizes discipline. Success in financial markets, however, requires self-discipline. The training of traders should look more like the training of elite performers who operate in fluid situations and less like the training of grunts in basic training.
In the most recent post, I outlined some of the risks of becoming wedded to trading plans and thus trading with a bias that prevents us from adapting to how the market is actually trading. By coincidence, Steve Spencer of SMB posted this excellent video that provides a practical example of how he traded his plan in the stock $NIO. He entered the trading day with a view/bias, was stopped out of most of his position, but quickly identified criteria that would get him back in the trade. Sure enough, after spiking higher and taking him out, $NIO went back into its range and gave Steve a profitable opportunity to act upon that original plan. By being very aware of key price levels, Steve was able to determine whether the stock was ready to make the move he anticipated. When $NIO moved to morning highs, Steve lost the trade, but not the idea behind the trade. This allowed him to trade flexibly within his bias or plan. The discipline was not stubborn adherence to the original idea, but knowing the price levels for acting upon the idea. I notice many successful short-term traders making use of the idea of key price levels. What they are doing is identifying prices at which other traders act in concert, highlighting levels from which we can potentially expect supply/demand imbalance. There are many tools available for identifying such price levels, including: * Market Profile - Effective in identifying impulsive moves out of value areas, starting potential trends; * Market Delta - Effective in visualizing volume coming into a market, hitting bids or lifting offers, starting potential impulsive moves; * Bookmap - This is an order flow tool that I'm starting to explore. It creates a chart of historical order flow, highlighting price levels where large traders lurk. I also recommend following Steve Spencer. Over the years, I've come to appreciate his effective trade planning. As the quote from Eisenhower suggests, the important thing is not the plan, but the planning process. None of us can predict price paths perfectly. At any time we can get stopped out of a trade. The skilled trader has criteria set out for determining when the idea is wrong--and for determining when the idea is still valid to re-enter the trade. Great trading is trading with flexible plans.
We commonly hear the advice that traders should "stick to their plans" and that planning and remaining true to plans is the epitome of discipline and the key to success. It ain't necessarily so. Let's take an analogy: If I meet with a person for the first time in a counseling session, I don't go into the session with a treatment plan. That would be crazy. Rather, I listen to what the person says, look for patterns in the issues they present, and then come up with an idea of what might be going on. I'll run that by the individual and, together, we'll develop a plan for addressing those problems. Very often the plan will be grounded in the kind of helping that research has found to be useful for the issues presented. If I were to start the session with a plan for intervention, the therapy would be doomed from the outset. I would be imposing my views and understandings on this other person without listening to what is actually going on. Surprisingly, many traders go into a day or week with their plans firmly cemented. They don't wait to listen to the market and detect themes. They decide that the next move will be up or down and they place trades accordingly. Folks, that is not trading a plan. It is trading a bias. If you don't listen to the market and instead impose your own view of what *should* happen in price action, you are not sticking to a plan. You're sticking to your bias. A true plan, whether for medical patients, counseling clients, or markets, outlines different possibilities for different presenting challenges. It's really a decision tree, which you navigate by collecting information. A treatment plan comes from a thorough history taking and diagnosis. A trading plan similarly comes from an examination of history and a "diagnosis" of how buyers and sellers are behaving in the here and now. The key skill is listening with an open mind. When we focus on formulating our plan, we're consulting ourselves, not the market. There's a lot to be said for coming into the trading day or week with hypotheses, not conclusions.
Yeah, that first ring must have really confused Alexander...! Meanwhile, we keep ringing up higher highs on rallies and higher price lows on corrections. We also continue to see the number of stocks registering short-term new highs expand. This past week, for example, well over 1000 issues made fresh one- and three-month new highs, the strongest figures in quite a while. New three-month lows have been consistently below 100. Even so, wannabe bears continue to talk about how we're overdue for a correction, how global economies are stalling, how trade wars will derail us, etc. etc., all the while missing what has been happening the last two months. Who dis? OK, so that's water under the bridge. What can we typically expect in a year in which January and February start strong? It turns out that Ryan Worch of Worch Capital has addressed this very issue in a post that pulls together a good amount of analysis. He finds that early momentum during a year tends to continue over the following ten months. There are corrections to be sure, but the vast majority of occasions have been higher by year end. One possible reason that might be relevant to the current market is that the bull move of 2019 has been global. Worch cites the work of Charlie Bilello, who finds that, out of 48 country-based ETFs, only two are showing negative returns thus far during 2019. With central banks seemingly on hold globally, investors have been emboldened to own yield, own stocks, etc. Bearing this out, my cumulative measure of NYSE stocks trading on upticks versus downticks has been relentless in making new highs. As Bilello points out, however, every time is different. None of us have seen this movie before, and that calls for a degree of humility. Could war erupt or vicious trade wars? Could we see major disruptions in a messy Brexit? Of course. Just as the Fed's turnaround at the end of the year turned equity markets around, surprise events could put us in reverse. All that being said, momentum markets tend to correct more in time than price, as bulls late to the party look to add on any dips. So far that's been the case. Too, when we have pulled back, there have been enough bears that we see evidence of hedging in the put-call data and in the elevation of implied volatilities relative to realized vol. At the moment, VIX has come down and we're not seeing the same level of hedging as earlier in the rally, so it may take more corrective action to shake out those late bulls and suck in the hopeful bears. I have to say, however, that the number of traders I speak to who hold the view that we're moving to all-time new highs in a fresh bull market is close to zero. Who dis?
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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