Friday, July 12, 2019

Looking at the Market Through Different Lenses - 4: Momentum

A great way to lose money in financial markets is to play the same game as everyone else.  Yes, copying the masters is an essential phase of the learning process, as for artists.  At some point, however, you copy Master #1, Master #2, etc. and out of that learning find your own style, your own voice.  For the greats, the synthesis is something wholly new.  They don't just play the game better; they play a different game.  Impressionist painting is not a better form of realism; trading risk parity is not a better way of trading market direction.  Innovation is essential to elite success in markets, as in business and the arts.

Very often, the right question is not, "Why am I not making money in trading?" but rather, "Why *should* I make money with the kind of trading I'm doing?"  If you're looking at the same charts, the same stocks/instruments, the same data as others, why *should* your results be distinctive?

Lack of innovation is a hallmark of mediocrity.  It doesn't matter how much "passion" you profess for trading.  High levels of success never came from being a "me too" performer.

Above is a chart of the recent market, where each data point represents a large number of price changes in the ES futures.  That is, we draw a fresh bar every time ES makes X number of price changes.  As I've indicated in the past, this normalizes market behavior over the course of slower and busier market periods, making it easier to identify market cycles.  The red line is what I call the "Power Measure", calculated over a moving 40-bar window.  It is a rolling correlation of absolute price movement (price range) and net directional price movement (price change).  A simple way to think of the Power Measure is to consider whether the green (up) bars on a chart are larger or smaller than the red (down) bars over a given lookback period.  That is, are we seeing more upside or downside momentum?

Interestingly, the Power of a market is relatively uncorrelated with its rate of change.  Some deep thinking about high and low momentum up and down markets bears fruit.

Note how negative Power readings (downside momentum) occurring at higher price lows offer good buying opportunities; positive Power readings (upside momentum) at lower price highs become candidates for selling.  If upside and downside momentum cannot generate fresh price highs and lows, we have a situation in which buyers and sellers become trapped in their positions.

The goal of this post and the three others in this series (see links below) is not to get you to think about markets the way I do.  Rather, it's to illustrate the importance and value of viewing markets through fresh lenses.  It doesn't matter how much emotional control you exercise in your trading if you're part of the herd in your idea generation.

Previous Posts in This Series: