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:
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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 Barchart.com) and the number of SPX stocks making fresh 5, 20, and 100-day new highs versus lows (data from Indexindicators.com). 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 Indexindicators.com); the number of stocks crossing above/below their 20-day moving averages (data from Barchart.com); and the number of stocks registering buy versus sell signals on various technical trading indicator/systems such as RSI and Bollinger Bands (data from StockCharts.com). 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:
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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:
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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 time. This 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:
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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:
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After having gone undercover lately and signed up for a number of trading services, I'm left shaking my head. The great bulk of what passes for mentoring and trader education is amazingly simplistic and non-original. To varying degrees, the services exhort would-be market wizards to follow the lead of the mentor/guru/teacher and enter into a world of ongoing profitability, with all the associated desirable benefits. The entire experience of tasting the world of the trading beginner reminds me of Andy Huang's doll, who pursues an ever-receding glamorous future, only to find the whole thing an illusion.
When I've given talks, traders have assured me that they see beyond the superficiality and recognize that the shining path to trading success is a psychological one. One common observation is that, "We all look at the same charts; it's got to be about psychology!" So, in avoiding the superficiality of grounding their futures on random chart shapes, they look to me to provide a different superficiality: one of facile self-help.
On a number of occasions in the past year, I've given talks to groups of traders and presented actual methods for working on oneself. Not just platitudes, but real techniques supported by real research. During each talk, I share my email address and encourage attendees to reach out to me with questions regarding implementing the ideas at no charge and with no possibility that I will try to ensnare them in marketing, since I offer no commercial services to individual traders.
What percentage of traders (who often pay good money to attend these conferences) subsequently get in touch with me and follow up to work on themselves?
In the past year, the answer is none.
Absolutely none.
It's too bad, because there is a way of pursuing trading as a genuine performance field and as a path to personal growth. At each firm where I work, I interact with people who have built their success the right way. What percentage of those people at professional trading firms actually use the methods touted by the services that I sampled recently?
None.
How many graduates of these educational groups and academies actually wind up at the professional trading firms where I work?
None.
But the noobs pay their fees to the services and communities and reach, reach, reach for that ever-receding illusion of a shining future.
Take a look at trading conferences that are offered and the percentage of sessions actually devoted to new and promising trading methods. If I go to a conference in psychology, I'll learn about new research and counseling/therapy applications; if I go to a medical conference, I'll hear about cutting edge outcome studies and promising new treatments for diseases. What proven, promising new methods do we see discussed at trading conferences?
None.
In coming posts, I'll highlight actual innovations in trading practice and why they are helpful. None of them is a "setup" that will make you rich--that's more of playing the wrong game. All of them, however, will be ways of better understanding what the market is doing and the implications for bullish and bearish flows going forward. In our relationship with markets, just like our other relationships, we get furthest when we know what to look for, when we actually listen and observe, and when we strive for understanding, not for quick payouts.
Further Reading:
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The above observation seemed to resonate with a number of attendees at the recent Traders4ACause conference. It's not enough to write a journal and express written goals. If you're not making daily efforts at change, change never occurs.
This is a very important principle. Ultimately, everything we do is practice. We are either practicing the right thoughts and behaviors or we are "practicing" the wrong ones. We always internalize our experience. It's when we tackle change on a daily basis that the change becomes part of us. The great enemy of change is procrastination.
So how do we overcome procrastination? As long as the prospect of change feels as though it will *consume* energy, we'll find ways to avoid it. We're wired to conserve our limited energy supplies. If something doesn't feel like a necessity, we tend to put it off.
The key to undertaking daily changes is to find a framework for pursuing your goals that *gives* you energy. That means framing goals in inspiring ways. It means finding the right social support for your goals. It means emotionally linking to the trader--and person--you ultimately want to become. This is why "discipline" alone will not bring you to your life goals. Ultimately, it is *how* we pursue our goals that determines whether they are energy-renewing or energy-draining.
Traders often wonder why they aren't improving. After all, they're putting in screen time and journaling their results! But that approach wouldn't facilitate change in any field. You could spend endless hours playing chess and keep summaries of your games, but nothing would change. The real chess masters literally replay every one of their games and review in great detail what they could have seen differently, which moves they could have made. In the process of extensively reviewing many, many games, they internalize new ideas. They get far more experience than grandmaster wannabees because they pick apart each game and figure out how an expert would have set a strategy and put it into practice. Move. By. Move.
That replaying of the game is a process of discovery. You learn to see new and different things and identify new, promising areas of opportunity. That is *exciting*; it gives energy. So often we procrastinate because we approach the change process with no sense of urgency, enthusiasm, or inspiration.
The motivation to trade is very different from the motivation to learn trading. You can learn quite a bit from money managers and traders by observing them outside of market hours. It's the productivity of the non-trading hours that determines the ultimate level of mastery achieved.
Further Reading:
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Riding on the plane on the way to Las Vegas and the Traders4ACause gathering, I had an interesting thought that I quickly tweeted: What if all our usual assumptions about coaching, counseling, therapy, and psychology miss something essential? What if the most important thing is not to use our thoughts, actions, and insights to change how we feel? Rather, what if emotion itself is our gateway to change? What if our feeling states are what we internalize over time?
A lot of things begin to make sense if this is the case. It's why psychological change has been linked to "corrective emotional experiences", for example, and why traumas can be so life changing. We internalize our experience, which explains why the quality of home life is so important in a child's development.
In the most recent Forbes article, I review fascinating new research in what is called "prospection": our ability to connect our present selves with our futures. It turns out that some of us are relatively "farsighted": we are able to live our present lives in ways that connect deeply to our future. Others are more "nearsighted", making short-term decisions that never build their desired future. As the article explains, it's our emotional connection to the future that enables us to operate in farsighted ways.
So let's put these two ideas together: 1) we become our experience; and 2) our connection to the future enables us to achieve it. I suspect it's a bit of what Ayn Rand had in mind when she noted that anyone who fights for the future lives in it today. To achieve a positive, successful, fulfilling future, we must experience those things today--and each day. The future is like a beautiful building: once it is visioned, it is assembled stone by stone, wall by wall. Too often, we fail to build our future because we're not spending our days laying bricks.
If this is correct, much of traditional trading psychology is wrongfooted. It's not simply the negative emotions we tend to emphasize--fear, greed, and frustration--that undermine performance. Rather, it's psychological nearsightedness. In focusing on processes, discipline, and short-term performance, we fail to emotionally connect to our futures. Take a look at your trading journals; take a look at your conversations about your trading and about markets: How much fulfillment is expressed? How much accomplishment? How much excitement and enthusiasm over learning and discovery?
Identify all your communications about your trading: from your self-talk to your journals to your conversations with others. The emotional tone of those communications is what you are in the process of becoming. Each piece of self-talk, each journal entry, each conversation is a brick you're laying in the structure that is tomorrow. Can we truly expect to internalize success and satisfaction if those aren't daily parts of our experience? How ironic it is that we spend our time worrying about "missing out" on trades when that is precisely the kind of preoccupation that misses out on our future.
Further Reading:
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It's been a somewhat frustrating recent market for traders holding positions. We've had good volatility, but not great directional trending. That can create choppy conditions, where the chop is occasionally violent. What I've found is that markets that traders call "choppy" (and thus imply that they're not tradeable) are often ones that display cycling behavior. Another way of saying that is that markets that don't exhibit good momentum can display good mean reversion (value) behavior. It's all about identifying the market environment and adapting the trading to the behavior of market participants.
Above we can see recent action in the ES futures, with volume traded at the offer price minus volume traded at the bid price captured in the middle panel of bars. At the bottom is an exponential moving average of the volume distribution, capturing when bulls have been more aggressive (lifting offers) and when bears have taken control (hitting bids). Note the cyclicality of that behavior; note also the volume traded at each price point (left bars) and how we could not sustain a break below the value area during overnight trade.
All relevant to the psychology of the market.
I'll say something that is a gross generalization, but fits my experience. Beginning traders struggle with their own psychology; experienced traders struggle with the psychology of the markets. There are many tools out there that can help us read other players in the market better. Right now I'm playing with uptick/downtick measures (like NYSE TICK) that are specific to the Dow stocks; the NASDAQ stocks; the S&P 500 stocks; the NYSE shares; and the Russell 2000 stocks.
When we see significant upticking or downticking in one universe of stocks but not others, that says something about rotation and the perceptions of market players. When we see all elements of the universe upticking or downticking at the same time, that says something quite different. The pattern of upticking and downticking across various segments of the market reflects important distinctions between momentum/trending markets and mean-reverting/value ones.
Meanwhile, beginners look at price charts and fret about their own psychology. Perhaps they're experiencing turmoil because what they're looking at does not adequately capture the psychology of the marketplace. It's not that they're playing the game poorly; it's that they're playing the wrong game.
Further Reading:
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A common mistake I see traders making is looking at many screens, with little deep thinking with respect to any of them. Very often, what they're doing is scanning for "setups", not achieving an understanding of what is happening in the market. In other words, they're frantically looking for trades rather than truly developing ideas.
If you click the above, you'll see a real-time screenshot of what I was following in the ES futures just an hour or so ago via Sierra Chart. Each bar represents 5000 contracts traded. The middle study captures the balance of volume that occurs at the offer price vs. at the bid. The bottom study is simply a moving average of that bid/offer volume information. At the left, we can see horizontal bars that display the volume traded at each market price, in a Market Profile-like fashion. Note how, in the overnight session, we've attempted to establish support around the 2937 point of control level (the price at which most volume has transacted) and are now probing the upside. Seeing selling pressure drying up at that point of control suggested that we were not establishing a new value area and could probe the upside, creating a nice risk/reward trade.
But you had to have that information to frame the idea; you had to understand the relationships between volume and price in Market Delta and Market Profile frameworks; and you had to be awake and alert around the London open to actually see what was going on. Our trading perception shapes what we will process, and our processing shapes our understanding. High confidence trading comes from deep understanding.
Further Reading:
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I'm looking forward to the upcoming Traders4ACause conference, where I'll be doing something new. Instead of talking to the group as traders, I will speak with them exactly the same way I talk to the psychology and psychiatry trainees I work with at Upstate Medical University. In other words, I will teach the group literally how to act as their own therapists, using research-based techniques for dealing with problem emotions and behaviors.
A key idea is that before we can change any pattern of thought, feeling, or behavior, three things have to happen:
1) We have to become better at recognizing the pattern occurring in real time;
2) We have to switch our mindset so that we can approach the situation in a different way;
3) We have to make a conscious effort to not follow our old pattern and try something new.
A vital element in this change process is that switch of mindset in the second step. The various approaches to change involve different techniques for making that switch and seeing the problem in a whole new light. For example, if you get worked up about missing a trade and then step back and rehearse a different internal dialogue, telling yourself that getting worked up--not the missed trade--is the *real* problem, that helps you distance from bad habits and exercise more control over your next actions and decisions.
The general rule is that we cannot change our problem patterns unless we become aware of them as they are happening and then emotionally connect with the costs of those patterns. We don't change by writing in a journal. We change by turning our problem patterns into enemies and finding the motivation to smack them down.
All change begins as an internal battle.
I look forward to pursuing this area at the T4AC event and in future blog posts.
Further Reading:
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