Monday, February 24, 2020

How Can We Determine When The Market Is Topping Out?

Recently we took a look at framing hypotheses for trading that suggested we could be seeing a correction following a solid run-up in prices for the major stock indexes.  This morning, as I write, we certainly seem to be correcting.  Above, I drew a chart of the ES futures, covering roughly the past month and a half, with each bar representing 350,000 contracts traded.  (Data from Sierra Chart).  As in the earlier post, the middle graphic shows the net amount of volume transacted at the market's offer price (green) minus the amount transacted at the market bid price (red).  This is a great way of tracking the psychology of the marketplace itself, a sorely neglected topic in trading psychology.    

The previous post examined this market from a cycle perspective.  Here we're asking a different question:  How can we identify when a market might be topping out?

To answer this question, we need to look at, not only the amount of volume at bid and offer, but also two other things:

  • How much is volume moving price?
  • How much breadth strength are we seeing with the volume?
Note where I drew the pink arrows that we have a good amount of volume lifting offers, suggesting that buyers are aggressive.  Despite that, price has stopped moving meaningfully higher.  Moreover, when we look at the breadth statistics for that period, we see something interesting.  The number of stocks across all indexes making fresh one month new highs and fresh one month new lows were as follows:

Feb. 12th:  634 highs; 313 lows
Feb. 13th:  562 highs; 389 lows
Feb. 14th:  595 highs; 408 lows
Feb. 18th:  602 highs; 580 lows
Feb. 19th:  682 highs; 402 lows
Feb. 20th:  646 highs; 476 lows

We can see that, as buyers were lifting offers, the number of stocks making new highs could not meaningfully improve.  Moreover, even though we were hovering at all time highs, the number of stocks making fresh lows was not all that different from the number registering new highs.

This pattern occurs at the tops of many market cycles.  Buyers are aggressive, sentiment is bullish, but the buying cannot move price or breadth significantly higher.  This occurs because there are many resting sell orders above the market absorbing the buying.  Large market players no longer perceive value at the elevated prices (or might be perceiving risk associated with the virus outbreak, political events, etc.) and are using the market strength to exit their positions at good prices.  This leaves a lot of bulls trapped and needing to puke positions on a market decline.

Many short-term market edges can be attributed to bulls and bears getting trapped in their positions once their activity can no longer move the market higher or lower.  This is why the psychology of the marketplace is just as important as the psychology of the trader.

Further Reading:


Friday, February 21, 2020

The Hidden Cause of Trading Psychology Problems

There are two groups of traders that I see struggling:

1)  Newbies

2)  Experienced traders trying to regain a lost edge

Both experience considerable frustration and discouragement, and both often turn to trading psychology for help.

The hidden cause of their trading psychology problems, however, is what I discuss in the most recent Forbes article:  they short-circuit the learning process and never truly internalize a new edge in the markets they're trading.

The odds of trading success go way up if you do the learning process right.

This is true for all performance domains, and it's why we see coaches and mentors in fields as diverse as athletics and performing arts.  

The central skill of trading is pattern recognition.  The central element of success is drawing upon pre-existing talents and interests.  Simply trying to copy someone else's "setups" is not going to create genuine learning or performance.

Many, many of the problems that trading psychologists talk about are due to failures of learning and development processes, not failures of the psyche.  As Nate Michaud of Investors Underground recently pointed out, these problems follow from an overfocus on profitability at the expense of cultivating sound trading processes.

Further Reading:


Monday, February 17, 2020

Changing From the Ground Up: The Power of Microhabits

What if you created just one microhabit? 

A microhabit is a very specific pattern of thought, feeling, and behavior that you enact at a particular time.  The key to success behind a microhabit is to make it highly circumscribed and perform it faithfully and regularly.  For example, one of the microhabits that I've developed is writing for a few minutes in a personal journal each morning.  I write whatever comes to mind and let it flow, stream of consciousness.

That's it.  Each journal entry is short and unplanned.  So it's easy to do no matter where I am or what I have scheduled later that day. 

What happens with the microhabit is that it leads to unexpected consequences.  For instance, writing the short blurb in the journal gets me in the mood to do more writing and stimulates me to work on related projects.  Ideas that crop up in the journal writing inspire me to tackle a problem in a new way.  Challenges that I've placed on the back burner come up in the journal writing and provide a fresh motivation to get them done.

In short, instead of changing from the top down by setting big goals, we can change from the ground up with small habits that reverberate across our lives.

What is a positive microhabit you might incorporate into your trading?  How might that impact other aspects of what you do in markets?  One trader I worked with made a slight change to how he enters positions, giving him slightly better reward relative to risk.  That led to spontaneous changes in other aspects of his position management that contributed further to his profitability.

Perhaps, by achieving very small changes, we internalize the sense of being able to change, inspiring us to make other changes. 

Maybe we internalize our self concepts one action, one thought pattern at a time.

Maybe who we are--and who we become--is constructed from the ground up.

This is a promising area of trading psychology that I'll be developing in coming posts.

Further Reading:


Saturday, February 15, 2020

Trading Hypotheses and Trading Ideas

As I'm writing this, it's 6:39 AM on a Sunday morning.  I've just finished an hour of market analysis and prep for the week.  Just a little example of the difference between dreaming about success versus waking up and prepping for success.  Recently I asked a trader to send me a review of his trading.  He explained that he was busy with personal things and would get that to me in a few days.  Right.  I'm still waiting for the review.  If you were to talk with this trader, he would sound convincing about his "passion" for trading.  Too bad he doesn't have a passion for working on his trading.

OK, off the soap box.  Above is an interesting chart of the ES futures, covering roughly the past month of trading.  One unique aspect of the chart is that each bar represents 300,000 contracts traded.  Below the chart, the green and red bars show whether buyers or sellers were dominant during that 300,000 contract period; e.g., whether more transactions were occurring at the current market offer vs. bid price.  The bottom oscillator captures a moving average of the volume at offer/bid data.

Ask any market participant about the stock index futures and they'll tell you that we're in a bull market of historic proportions.  And they wouldn't be wrong.  We've seen quite an upward trend recently.  Still, market cycles can occur within the context of market trends; few trends move higher with no corrections whatsoever.

A worthwhile heuristic I use in framing trading hypotheses is that the number of volume bars representing selling is roughly proportional to the number of bars of subsequent buying.  Another way of saying this is that the volume "trapped" by fading a trend is proportional to the amount of volume that ultimately has to cover their positions.  What is important in this is that we're framing a hypothesis, not jumping to a conclusion.  Before we can have a trading idea--and any "conviction" in that idea--we have to entertain a worthwhile hypothesis.  Worthwhile hypotheses come from looking at fresh market data or the usual data in fresh ways.  Creative perception precedes creative ideas: if we see the same things as other people, we'll likely trade how they trade and what they trade.  In other words, stale perception makes us part of the consensus, the herd.  It's seeing what others don't even look at that gives us hypotheses that can become promising ideas if subsequent order flow supports those hypotheses.

The chart shows the current proportionality between volume pushing the market lower and volume recently pushing us higher.  The question is whether the shorts have all been trapped and buyers exhausted, leading to a potential cyclical move to the downside.  Toward that end, I note that at the market peak this week we saw 496 stocks across the major exchanges register fresh 3-month new highs.  That compares with 751 at the January peak.  Similarly, we registered 182 new 52-week highs among NYSE stocks on Friday, with 60 stocks making new 52-week lows.  That compares with 226 new highs and 7 new lows at the January peak.  At the January peak, we saw the percentage of SPX stocks trading above their 50, 100, and 200-day moving averages at 79%, 84%, and 80%, respectively.  Most recently, those numbers are 65%, 72%, and 76%.  Small cap stocks are trading below their January peak, as are stocks outside the U.S.  In sum, as we've moved to new highs in February, the market has been losing strength relative to January, which is what we'd expect in a cyclical scenario.

To re-emphasize:  all this frames a hypothesis and the kind of unique information I look at in framing hypotheses.  If we get a fresh thrust to the upside this coming week with enhanced breadth and volume, that would clearly violate the hypothesis of a coming cyclical top.  If we see sellers dominating with weak breadth, that would support the hypothesis and could lead to an actual trade idea that I'd need to frame with sound risk/reward.  

This is a nice little example of what I do in my market preparation daily.  You may very well look at different markets in different ways.  That's great.  The idea is to have a framework for thinking about buying and selling and ways of measuring buying and selling to generate hypotheses and ideas that are more than mere subjective perceptions of chart patterns and indicator readings.  In generating ideas, I'm much more interested in understanding what markets *are* doing than in predicting what they will do.  

Oh, by the way, on the chart above, note that the point of control (the price with the greatest volume traded over the month) is 3325.  If we do see a failed upside break vis a vis the February rise, I'd expect that level to be tested, as buyers would become the ones trapped.  That's a different hypothesis...

Further Reading:


Friday, February 14, 2020

Knowing Your Limits as a Trader

Here's a big shout out to Tom Canfield for his recent tweet on finding his limits in trading the volatile TSLA stock.  We get so many boastful tweets and self-promotions, it's refreshing to hear from a real trader who is going through a real growth process.

We talk about many trading strengths, but rarely discuss acceptance.  A top athlete in track and field may not be a top basketball player or a top weight lifter.  A great portfolio manager might make a wildly unsuccessful day trader and vice versa.  So much of success is finding what we're good at and making the most of those strengths.  But that presupposes that we can accept who we are and what we're good at--and what we're not.  

Often, we only know what we're good at by pushing our limits and finding out what works and what doesn't.  I know traders who are freakishly good at trading one kind of market and not others.  They only learn that by pushing, failing, and then coming to a reckoning--and an acceptance of the limits of their strengths.

We cannot make the most of who we are if we are always trying to be someone else.  It's great to push our boundaries, but even greater to fail fast and use the experience to double down on what makes us successful.

Further Reading:

Tuesday, February 11, 2020

*This* is What Winners Do

I'll keep this relatively short and to the point.

In the previous post, I mentioned the SMB traders who reviewed every day's trades in elaborate detail, not just looking at charts but actually replaying the day.  They truly re-view their trading.  Like professional athletes, they're spending as much time in practice and workouts as in actual performance.  That gives them so many more reps than other traders, so much more material for pattern recognition, that their odds of trading success skyrocket relative to their peers.  They are doing what winners do.

This morning, I reviewed market information for the day and came across an analysis forwarded by SentimenTrader.  What they did is go back in history and create a daily ratio of the performance of growth stocks to value stocks, noting the recent distinct outperformance of growth shares.  They then looked at what that ratio had to say about, not only the direction of stocks overall, but for that ratio of growth to value.  I won't give away their intellectual property, but suffice it to say that they find something very, very few traders I know are even looking at.  That is what winners do.

If you want a good read, check out the practice habits of Michael Jordan during his NBA days.  Jordan was always a good and promising player since his days at UNC, but it was his mode of working that turned him into a superstar.  It was his practice ethic and competitive drive that made him great.  That is what makes winners.

This should be your goal in life:  To find the activities that so capture your interest, your talents, and your passions that you pursue them with more breadth, depth, and effort than the average person.  I look at many traders and they are totally "me too".  They trade the same names and ideas as others; they put in the same effort as others.  Nothing.  Stands.  Out.

C'mon!  Life is too short to be "me too"!  Is that what you want on your gravestone as an epitaph:  "Me too"???  Our challenge is to figure out that intersection of our strengths (what we're good at) and our passions (what is meaningful to us) and leverage those into something that makes us unique, more than mere "me too".  That is what winners do.

Further Reading:


Sunday, February 09, 2020

Counterfeit and Genuine Confidence in Trading

Here's an observation I've made regarding developing traders I work with on a regular basis at SMB.  Because I've worked with them from the very start of their trading in most cases, I can clearly see what has led to their success and what hasn't.

The less successful ones start with stated confidence and want to bring what they know to trading.  

The more successful ones start with an awareness of what they don't know and bring an open mind to trading.

The less successful ones are undercapitalized and feel a need to become profitable quickly.

The more successful ones try different markets, time frames, and trading styles, make lots of mistakes, and gradually figure out what they understand and do well.

The less successful ones engage in minimal reviews of their trading and set very broad goals.  They do not keep statistics on their trading to monitor whether their goals are being met.

The more successful ones review their trades daily in great detail, actually re-viewing the trades made and how those could have been done better.  They use statistics on their trading to hold themselves accountable for their goals.

The less successful ones look to psychology to help their trading, as they get frustrated when they don't make money.

The more successful ones use their best trading to help their psychology.

The less successful ones talk about confidence in terms of the "setups" they are trading.

The more successful ones ground their confidence in their learning and trading processes.

The less successful ones develop a counterfeit sense of confidence based on how they have performed recently.

The more successful ones develop genuine confidence based upon the time and effort placed in the learning process.

Perhaps I can provide an example.  One trader sent me his monthly review of his trading.  It was two pages, had no specific reviews of trades, had no detailed statistics on his trading, and finished with a general goal to be more selective in the taking of trades.  Another trader sent a review for the same month.  It ran over 200 pages.  It detailed every trade made, what was done well, and what could have been done better.  The first trader meets with me occasionally.  The second one has been meeting with me every week, focusing on the most recent lessons learned and improvements made.  The first trader is looking to make money.  The second trader is like the flower:  just blooming.

My son Macrae and I have been taking lessons in archery.  It's an interesting sport; one I've never given much thought to.  A big part of success is learning the correct form for each phase of the shooting process and then replicating that form with precision.  There are adjustments to be made when changing distance, changing targets, etc., but the key to success lies in unusual self-control.  Psychology is important to archery performance, particularly in stilling the mind and staying focused on the target.  But psychology cannot substitute for good form and continuous learning and  practice.

So it is in the trading world.

Further Reading:


Friday, February 07, 2020

Performance Anxiety: The Most Common Psychological Problem Traders Face

Performance anxiety is common in all fields where performers care about the outcomes of their performance.  Before a big game, baseball, football, and basketball players may experience performance anxiety.  The actor or actress before the play starts; the trader facing a volatile market--all can find that their stress levels get in the way of their performance.  Performance anxiety occurs when we become so focused on the outcomes of our performance that we no longer stay in the natural flow of performing.  It happens to golfers, it happens in the bedroom, and it happens to many traders.

When we learn trading the right way, we minimize performance pressures.  By starting with trading in simulation mode, then building consistency, then trading small, and only taking meaningful risk when we have a track record of consistent success, we give ourselves time to build the confidence that keeps performance anxiety at bay.  When I first began doing talks for groups, I became quite nervous, and that interfered with the effectiveness of my communication.  With gradual and repeated experience and learning what works and doesn't work in my public speaking, I've gotten to the point where talking with people is fun.  Some talks go better than other ones, but I know nothing catastrophic is going to occur.  

This is why losing the right way in trading is so important and why risk management is so important.  Once you trade and trade and see what works and doesn't work and see in your own experience that some trades will work better than others, the process becomes more familiar and less threatening.  If we're experiencing undue performance anxiety, we want to take risk off the table entirely, go back to simulated trading, and just focus on the process of trading well.  Traders I work with often maintain a checklist of their best practices that grounds them in what they do well in generating ideas, managing positions, managing risk, etc.  When we take risk off the table, we can get back to keeping score based on *process* and eventually letting wins and losses take care of themselves.  Gaining confidence in a learned trading process that draws upon our distinctive strengths is a major antidote to performance anxiety.

One of the most effective techniques for reducing performance anxiety is mentally rehearsing scenarios of positions going against us, staying calm and focused with deep breathing, and then imagining how we would handle those situations.  If we engage in that exercise routinely, the scenarios of loss become familiar, and we've trained ourselves to stay centered when they occur.  It's very difficult for something very familiar to be very threatening.

Below are posts and resources that discuss performance anxiety and ways of overcoming it.  Very often, the best approach is to take risk way down, refocus on consistency of process, and then only gradually put risk back on.  Once we can embrace normal, expectable losses as potential learning experiences, they become less threatening.  That allows us to simply enjoy the process of understanding markets and grounding our trading in that understanding.

Further Readings:


Monday, February 03, 2020

The Toughest Questions Traders Can Ask Themselves

The most recent post on trading trauma and trading addiction received the most hits from readers in quite a while.  Perhaps it's because these topics are relevant to many traders and yet so infrequently discussed.

The toughest questions we can ask ourselves are ones that challenge our most basic assumptions.  Here are questions every trader should be asking periodically to ensure that they are not only doing things right, but doing the right things:

Is trading genuinely adding to the well-being of my life?  Is trading providing you with true happiness, fulfillment, energy, and self-esteem?  If trading was your romantic relationship, would you want to stay in that relationship?

*  What am I giving up in life because of the time and energy I commit to trading?  Does trading truly encapsulate your greatest strengths, or is there something else you're meant to be doing with your life:  something that could better leverage who you are and what you're capable of doing?    

*  If I knew that I only had five years to live, would I be spending my time trading?  What *would* be your priorities?  If trading wouldn't be a priority, why?  If you wouldn't spend your time trading if you only had a very limited time on this earth, what does that tell you about how you're living your life today?

As noted in the earlier post, the people who make their living selling education, products, and services to traders and who make their living from the commissions and assets of traders --those people have no vested interest in your asking those questions.  If someone wants you to pay for their services as a guru, or as a trading coach, or as a mentor, or as a customer of trading products, they don't have a lot of upside asking customers, "Are you sure trading is the right thing for you?"

And let's face it.  When we've invested time and effort into trading and not received commensurate personal and financial reward, it's not so easy to contemplate those questions ourselves.

So the questions go unasked.

Here's a different perspective you may not get elsewhere:

You are important.  

The time in your life is important.  

You can do amazing things in your life.  

The goal is not to trade, and the goal is not to make money.  The goal is to have the happiest, most productive, and most purposeful life possible.

There are lots of bright, shiny objects out there that distract us from the meaning and purpose we're meant to fulfill in life.  When we ask the right questions, we ensure that we don't stay so preoccupied with feeding our egos that we ultimately lose our souls.

Further Reading:


Saturday, February 01, 2020

Trading Addiction and Trading Trauma: Two Trading Problems Rarely Discussed

One takeaway from the recent Forbes article is that we become better as performers (and as people) as we become free.  That means freedom from destructive habit patterns, and it means freedom from the internal chatter that can control us and divert our will.  What does it mean to plan our trade and then not follow that plan?  What does it mean to engage in the very patterns--chasing prices out of FOMO, failing to take good trades--that we know harm our results?  We do the wrong things because we are not truly free.  We are imprisoned by thoughts, feelings, and action patterns that hijack the will and harm our trading, our relationships, and ultimately our fulfillment.  Psychology and spirituality, at their best, are ways of breaking out of our prisons.

If the usual trading problems place us in prison, there are two overarching problems that can place us in solitary confinement:  trading addiction and traumatic stress.  Trading addiction occurs when we become hooked by the ups and downs of profits and losses, much as a casino player can become hooked on gambling.  Much of what we politely call overtrading is actually addictive trading.  The need for the thrill leads us to place trades when our wise minds know that there is no objective edge present.  I have seen traders so addicted to active trading that they have lost life (and family) savings.

Traumatic stress is familiar to us from accounts of people who come back from war or who undergo brutal attacks or physical/emotional abuse.  Traumatic stress is different from normal anxiety that can show up in performance situations.  The hallmark of traumatic stress is the loss of stability and security and the presence of highly stormy emotions, ranging from frustration and self-blame to fear and panic.  It is not well recognized that failure to manage risk well can create massive losses--and painful trauma.  Once traumatic stress occurs, subsequent trading ends up re-traumatizing the trader, leading to further losses and emotional damage.

If you read accounts of "trading psychology", you'll rarely encounter discussions of trading addiction or traumatic stress.  There is a reason for this.  The answer to both problems is to stop trading.  Before there can be any possible constructive return to financial markets, the addicted or traumatized trader needs to cease trading and work on their addiction and trauma.  If they ever can return to markets, it will be as very different people with very different strategies that provide them with control and consistency.    

Who in the trading world finds a vested interest in telling traders to stop trading and take care of themselves?  Not the vendors of "trading education" and trading seminars.  Not the vendors of trading software and services.  Not the proprietors of trading communities and trading firms.  Not even trading coaches.  Certainly not brokerage firms and publishers of trading materials.  Everyone who sells to the trading public (and professional traders) needs those market participants to keep trading.  There is no upside for them in telling people to back away from markets and heal their wounds, regain control of their lives, and escape the prisons created by their market involvement.

A while back I wrote an article on trading coaches as whores.  Who in the coaching world will give a trader honest feedback that they lack the skills and talents to become a successful trader?  We know from research that the vast, vast majority of people who pursue active trading will not be able to sustain an ongoing living from their efforts.  But who is willing to acknowledge that?  Who is willing to tell traders that active trading can ruin their lives, traumatize them, and leave them (and their families) scarred by addiction?  

The trading coaches, trading educators, online gurus, trading communities, trading software vendors, brokerage houses, publishers, and so many more are actually selling the same product.  They are in the business of selling hope.  There is nothing wrong with hoping, but it's important to acknowledge the damage that can be done by pursuing false hopes.  Successful trading can be a ticket to financial freedom, but many more traders may find in trading their own prisons.

Further Reading:


Thursday, January 30, 2020

What Motivates a Successful Trader

The quest for self-esteem is the surest sign of its absence, as Ayn Rand once observed.  The motivation of unsuccessful traders is to become a success.  As the recent Forbes article points out, that ego-based motivation makes us vulnerable when we face inevitable losses.  This is the problem with what Maslow called deficit motivation.  When we seek something to fill a perceived void within us, any disruption thrusts us back into that void.  For example, if I feel unlovable and unworthy, I may desperately seek companionship in relationships, but how much will I have to give to those relationships?  How well will I be able to navigate challenges in those relationships?  If what two people bring to relationships are gifts, they naturally support each other and benefit from their interactions.  If two people merely bring needs to relationships, they are always taking from one another and cannot tolerate situations where the other cannot give.

All traders have relationships with the markets they trade.

How well would *your* romantic relationships and friendships go if you interacted with your partner and friends the way you interact with markets?  Great relationships bring strengths to interactions.  Barren relationships bring needs.  When we bring our needs to our trading, those color our decisions, and our relationships with markets become barren.

A great way to identify beginning traders with promise is to focus on the promise they have fulfilled in other areas of their lives.  Such traders bring developed strengths to their learning curves.  Less promising traders are looking to become successful.  They are not looking for self-esteem; they're not seeking to leverage existing successes and strengths.  When I hear a trader talk about their "passion" for trading, I ask about the other passions they are currently fulfilling in their lives.  If I can't get a concrete answer, I know that passion comes from a void desperately needing to be filled.

Trading cannot repair our damaged, bruised, or underdeveloped egos.  Just as relationships cannot provide us with the love and esteem we are unable to provide to ourselves, market cannot make us successful.  Rather, we leverage the strengths and successes that we already possess to find ways of maximizing opportunities we perceive in markets.  Many of those strengths, the recent article notes, are spiritual ones:  they come from the soul, not the ego.  What that concretely means is that there are certain ways of viewing the world, certain abilities we possess, and certain ways of acting that make us who we are and define us at our best.  The developing trader should not be trying to get rich; the developing trader should figure out ways in which he or she is already wealthy in terms of what they do well and who they are and then figure out how to express that in an approach to markets.

What motivates a successful trader is what motivates success throughout life.  Success follows from consistently being the person we already are when we're at our best.

Further Reading:


Tuesday, January 28, 2020

A Different Look at the Hindenburg Omen

I notice that the excellent SentimenTrader site observes that the Hindenburg Omen market pattern was triggered yesterday in the U.S. stock market.  Basically, that pattern occurs when we've had a strong market, but register a high number of stocks making fresh 52-week lows.

As a rule, I'm more than skeptical about technical analysis patterns and especially ones with dramatic titles.  The logic behind the Hindenburg notion, however, makes sense to me.  If we have many stocks making new lows when the overall index is high, that suggests weakness beneath the surface.  A trending market, like a rising tide, should lift all boats.  In the Hindenburg situation, many boats are not lifting and indeed are sinking.

I decided to test out a different version of this pattern.  I collect data on all listed stocks making fresh 3-month new highs and lows on a daily basis.  (Data from  Going back to the start of my database, late 2010, I examined all occasions in which the SPX was up more than 5% over a prior 3-month basis, but we register more than 500 stocks making fresh 3-month lows.  

Out of over 2200 days in the database, only 46 displayed this pattern.  Interestingly, over the next three trading sessions, we had 18 occasions up, 28 down for an average loss of -.49%.  That compares to an average three-day gain of +.15% for the remainder of the sample.  Even 20 days out, we had 23 up and 23 down for an average loss of -.12%, compared to an average gain of +.92% for the remainder of the sample.

The takeaway here is that context matters.  One of the better predictors of momentum that I've found is not the presence of lots of stocks making new highs, but the absence of new lows.  If no individual segment of the market is weak, it's tough to get overall market weakness going forward.  If, however, a market has been strong, but many of its components have been rolling over, that weakness can spread to the broad indexes.  

As I recently wrote, we're currently dealing with a unique situation in China that is likely to dominate price action going forward.  When we have unique events of this nature, historical models are of limited relevance.  That is why I'm always open to considering historical evidence as hypotheses, but reluctant to embrace it as conclusions.

Further Reading:


Monday, January 27, 2020

Trading a Market Panicked by the China Virus

Panic is a strange emotion.  We can have extreme reactions to minor events if our minds blow those up into catastrophes.  We can also go into denial about genuine threats.  Panicky markets create opportunity, as good assets are dumped alongside the not-so-good ones.  What we don't know is whether panic is justified.  As the saying goes, if you can keep your head about you when everyone else is losing theirs, perhaps you're not aware of the situation!

The current situation with the coronavirus in China is a great example of a fear-filled scenario, as uncertainty is built into the situation and the possibility of a horrendous outcome is present.  Here are a few observations that may be helpful for traders adjusting to markets quite different from what we've seen so far this year:

Volatility and Correlation - This is a different market regime.  Volume and volatility are greatly increased and correlations among markets will be higher than recently has been the case.  When markets are more volatile, the price movement is sizing up positions for you:  risk and reward are much higher for a given position.  Adjusting sizing of positions to account for this change is essential.  Adjusting existing hedges to positions may also be important, given shifts in correlations.  For investors, portfolios that looked invincible a week or so ago (think stocks and high-yield bonds) may suddenly seem quite vulnerable.  

Following the Story Closely - I'm watching to see if the virus story gains significant traction in the media outside Asia.  I have concerns.  One data point:  if you go online and try to order surgical respirator masks, you'll see a lot of sites and retailers that are sold out.  Another data point:  China is treating this as a genuine emergency.  You don't lock down tens of millions of people and build a new, large hospital for nothing.  Still another data point:  Wuhan, the epicenter of the viral outbreak, is also the location for China's only bio-lab designed to study BSL-4 level pathogens.  Concerns about the safety of the lab were voiced as early as 2017.  And I'm not sure we'll ever know whether that lab has been involved in the design and manufacturing of bio-weapons.  Bottom line:  when the country closest to the situation is reacting the strongest, that situation has to be taken seriously, especially given the mathematics of viral contagions.

Thinking Through Broad Market Impacts - Increases in volatility measures; flight to safe assets; and a new reason for central banks to stick with low rate policies are some expectable impacts.  To the degree that this hampers growth in China, we can also expect some re-rating of global growth estimates.  If we thought tariffs could slow China, this could have a far greater impact on the economic activity of Chinese citizens and companies doing business in China.  Recall how Asian crises impacted the equity markets in the late 1990s.  That didn't stop markets from rising to major highs by early 2000, but that rise was punctuated by sharp declines and increased volatility.  I'm watching equity prices in China especially closely.  Note that we broke out to new highs earlier in the year and now have returned to the prior trading range in FXI.  Tough to imagine a roaring global bull market and China not participating.  Even tougher to imagine should contagion meaningfully spread beyond China.  

Timing is Everything - Money managers who are paid on annual performance had started 2020 nicely in the green with the bull market in stocks and handsome returns from risk parity strategies.  Are they really going to want to go red on the year and face investors already wondering why they don't just invest passively in low-cost ETFs?  Just as we saw quite an unwind in January, 2018 following great strength, a similar dynamic may be at work at present.  Everyone goes for exits at the same time when payouts are at risk.  That created opportunity later in 2018, but it was not a one and done day or two of weakness either.

Sometimes This Time Really *Is* Different - I recently wrote about the value of historical market analyses and how those can illuminate current market scenarios.  I also noted how, historically, very strong equity markets tend to be followed by strength in the bigger picture.  Market history is probably the best guide we have to an uncertain future, but idiosyncratic influences can make the present quite different from the past.  Blindly following the past can be dangerous for traders when they face unique situations such as the September, 2001 attack.  

If history plays out, the current situation could lead to a great investment opportunity, such as those corrections in the late 1990s, but could also last longer--and can be deeper--than investors can tolerate in the short run.  The one thing we know is that we are facing a more uncertain global landscape, and that will likely be reflected in volatility and increased herd behavior.

Further Reading:


Friday, January 24, 2020

Coming in 2020: A Video-Based Course in Trading Psychology

All of us go through changes.  The role of psychology is to direct those changes, so that we are continually growing.  There has been an explosion of outcome research documenting the effectiveness of techniques that help us change in positive ways.  Some of this research is about methods that help us change negative patterns, so that they no longer dominate our lives.  Some of this research concerns methods that help us achieve new, positive states in our lives.  The average person (and, sadly, the average coach or therapist) has limited access to this research and ends up pursuing change in inefficient and often ineffective ways.  What the research tells us is that it is relatively easy to make initial changes in our lives.  More difficult is sustaining these changes and building upon those.  That's what growth is all about.

My work places me at the center of evidence-based methods of psychological change.  I coordinate a medical school course for mental health professionals in research-backed short-term approaches to therapy.  I have also reviewed the major approaches to brief therapies and co-authored a standard textbook in the field.  Much of that work reflects my practical experience coordinating student counseling programs and delivering performance coaching help to traders and portfolio managers.  Over that time, I have focused my efforts on "therapies for the mentally well":  ways of helping normal people achieve supernormal lives and careers.

Psychology is a perennial topic in the trading world, but rarely is it possible to find solid, evidence-based, how-to methods for achieving lasting growth.  Much of what is written is well-intended advice that falls well short of helping people navigate the growth process.  It was because of this vacuum that I wrote the Daily Trading Coach book/audiobook to help traders help themselves.  But a book is not a course.  Increasingly, I've felt the desire to directly teach traders how to act as their own performance psychologists.

It's for that reason that, starting the new decade, I will be teaming up with videographer Eli Francoeur to produce a video-based course on the how-to's of trading psychology.  Accompanying the videos will be a workbook that walks traders through various exercises and activities.  The stark truth is that many traders live in areas where they do not have access to trading psychologists.  Also, many cannot afford those services.  Having taught brief therapy methods for years at the medical school in Syracuse, I am convinced that it is possible to help people help themselves with state-of-the-art psychological methods.

The video series and workbook will be posted online, available free of charge anywhere in the world for traders with online connections.  There will be no promotions or sales pitches, but lots of how-to's.  My hope is to have this available by mid-year.  I look forward to working with video whiz Francoeur in creating a resource that can help us become our best selves--in markets, and in all of life.


Tuesday, January 21, 2020

The Right Way to Lose in Trading

The recent Forbes article is one of the better ones I've written, describing how we can best deal with major setbacks in life.  There are few better arenas for learning to deal with loss than trading, because trading is by its very nature a probabilistic game.  Losses are normal and expectable, even for the best traders.  Your win percentage can be 60% and you will still have better than 6% odds of three consecutive losses.  That may not seem very high until you calculate how many trades active traders might place in a year's time.  For that active trader, losing streaks are guaranteed.

Of course, the issue is more complicated than that because market conditions change and our win rate itself has a degree of variability.  That 60% trader may go for stretches of time winning 75% of the time and stretches of 45%.  This further ensures the presence of winning and losing streaks that are guaranteed even with the best processes and psychology.

So a major challenge in trading is learning to lose the right way.  If we change how we trade after every random loss, we will become incoherent in our approach to markets.  If we fail to recognize when we are trading poorly, we can turn expectable setbacks into prolonged slumps.  If we become overconfident after every random winning streak and underconfident after every normal losing period, we'll be sized largest when things turn for the worse and smallest when we're ready to rebound.

So what is the right way to lose in trading?

The right way means that we make a hard distinction between making money and trading well.  Trading well means that we understand what we do when we're successful and that we follow those best practices, including the best practices that allow us to adapt to changing market conditions.  The goal is to be consistent in trading well, not focused on the random ups and downs of daily P/L.  If we lose money and trade well, there may be a message in that about a changing market.  If we lose money and trade poorly, there is probably a message in that to take actions that align us with our best selves.  But, like the surgeon and like the baseball pitcher, we focus on doing the right things and let the probabilities play themselves out.  It's when we lose for the wrong reasons that losses can become fuel for making us better.  

All of this highlights the importance of detailed and intellectually honest review practices.  The trader that does not review and learn from performance is not a trader who is growing.  I consistently find that the traders who show the most longevity in the business are the ones who are always learning, always losing for the right reasons.  Anything less is a deathblow to our potential.  And that's the greatest loss of all.

Further Reading:


Friday, January 17, 2020

Is A Very Strong Market "Due For A Correction"?

I've been hearing a lot from people who loudly assert that a strong stock market such as we've recently witnessed is "due for a correction".  Those making the assertion have several things in common:  1) a strong conviction that a bearish move is on the horizon; 2) a total absence of any statistical evidence supporting their view; and 3) dramatic underperformance during the recent market period.  

So let's look at a little bit of evidence.  (Eye-opening evidence, by the way, was published overnight by Market Tells, SentimenTrader, and Quantifiable Edges).

We'll go back to 2005 and identify occasions in which more than 80% of stocks in the SPX have been trading above their 3, 5, and 10-day moving averages and in which more than 80% have been trading above their 100-day moving averages.  (Data from the excellent Index Indicators site).  So we're looking at short-term strength in a longer-term strong market.

There have been only 39 such daily occasions out of over 3300 trading days.  That alone tells you that such broad strength is rare, even in a market that has risen over the lookback period.  Out of the 39 occasions, 22 occurred in 2009 and early 2010.  Note that this was a new bull market period following an important bear market.  During such periods, as I noted back in March, we tend to see momentum conditions.  It's easier to see that we have emerged from a bear market when we look at weekly price charts for small caps and overseas stocks, both of which declined from early 2018 through well into 2019.  

After the strength noted above, in 33 of the 39 occasions we posted a lower daily close within the next three trading days.  So, yes, a pause in the rise after unusual strength has been normal.  However, if we look 20 days out, the average market gain has been +1.43% versus an average gain of +.61% for the rest of the sample.  Over that next 20-day period, 27 occasions were up and 12 down.

History is not guaranteed to repeat itself, but formulating strong views in the absence of any knowledge of history is not trading: It is malpractice.  History provides a rich source of hypotheses and an understanding of market flows can tell us if history is, indeed, playing out.  Markets dance to the rhythms of momentum and value; edges occur because so many participants can't hear the music.

Further Reading: