Monday, March 30, 2020

Two Charts That Concern Me Right Now

I encourage readers to take a look at the most recent Forbes article.  I've identified several excellent sources of information for the evolving coronavirus/COVID-19 situation, and I've also linked to excellent sites and services that track quantitative patterns in the markets.  Both of these sources of information can help us navigate risk and reward going forward, so that we focus on what we *know* and don't get carried away with emotional headlines and politicized commentaries in the media.

OK, let's talk about the market.

It indeed appears that we have put in a momentum low in stocks.  On March 16th, across all exchanges, we registered 3421 stocks making fresh 3-month lows against only 11 highs.  (Data from  When we made a closing price low on the 23rd, we saw 9 new highs against 1272 fresh lows.  That divergence preceded the rally of last week.  If we look only at the Standard and Poor's 500 Index, we see new 52-week highs outnumber new highs by an amazing 437 issues on March 12th.  (Data from Index Indicators).  That spread narrowed to 310 issues at the price low on the 23rd prior to the recent rally.  

That seeming momentum low in stocks has a number of traders looking for (successful) tests of the lows in future price action.  Such a scenario may well unfold, particularly if news regarding the virus (and successful therapeutics) turns positive.  A caveat to that view is that such bottoming processes can take a while.  When we made momentum lows in October, 2008, for example, it wasn't until March of 2009 that we saw price lows.  There is considerable variability from cycle to cycle in the timing between momentum lows and ultimate price lows, with months often intervening between the two.

There are a couple of factors in the current market that have me cautious regarding the future and the scenario of an imminent bottom.  The first is the course of the viral outbreak, as we can see below:

Here we see a chart of COVID-19 cases per day in the U.S. (Data from the COVID Tracking Project and YCharts).  Note that the curve is not flattening and, indeed, seems to be in its exponential rise.  Similarly, new cases in Italy and Spain have been on the increase.  It is not at all clear to me that the social distancing efforts to this point will stop this curve from getting quite scary, with exponential strains on the economy and the healthcare system.

The second chart tracks credit spreads between the highest and lowest rated investment-grade corporate bonds through March 26th.  (Data from Federal Reserve and YCharts).

Note that, even with the stock market rally last week (blue line), the yield spreads between lowest and highest rated investment grade bonds (red line) continued to rise.  Quite simply, the corporate fixed income market is continuing to warn us of possible defaults as part of business failures.  That is not what we want to be seeing in markets anticipating recovery.

The theme of the Forbes article is that we want to be as evidence-based as possible in handicapping the odds of future market moves.  The two charts above are among the variables I'll be tracking going forward to see if we're seeing light at the end of the bear market tunnel or just the headlights of an oncoming train.

Friday, March 27, 2020

A Great Trading Psychology Exercise For This Market

Here's a great use of your time this weekend:

Get sleep.  Get exercise.  Get sunshine.  Get connected with the people who matter to you.  Reach out to help and encourage those you care about.  Reach out to those you love and trust for help and encouragement.  Get your life--your well-being--in order.  

Then, and only then:

Review your trading from the start of this volatile downturn.  Calculate your P/L during this period.  Ask yourself the question:  Did you perform well given the opportunities (and risks) afforded by the market?

Find the one biggest mistake you've made during this period and cement a plan to identify in real time when it is occurring again, so that you can avoid going down that path.  One technique that I've found especially helpful in that regard is creating a simple checklist of all the things you do when you're not trading well, including mindset, market biases, chasing moves, etc.  Before placing any trade, you need to mentally review that checklist and make sure you can honestly check all the boxes to actively identify that you are *not* making those mistakes here and now.  That "to-don't" checklist is a tool to inject mindfulness and self-awareness in your decision-making and actions.

Then find the one thing you've done best during this period.  Find the kind of opportunity you've been best able to identify and exploit.  Examine your best trades and create a list of what you've done well on those.  Those "best practices" can feed a second, "to-do" checklist.  Just as you need to quickly, mindfully review your "to-don'ts", it's important to be aware that you are checking all the boxes of the "to-do's".  These are short checklists and should not take much time to review.  But, repeated over time, those reviews cement in your head what you need to be doing--and not doing--to succeed going forward.

I've studied past markets when we've had major, broad declines.  Those include the markets post 1929, the large bear markets of 1972-1974 and 1976-1982, as well as more recent declines that began in 2000 and 2007.  In the great, great majority of cases, even after there has been a momentum washout of declines, there has been continued volatility and sharp moves in both directions, often as part of bottoming processes.  The bottom line from those studies is that there have been great trading opportunities following those oversold times, not always great investing opportunities.  Finding the patterns that work in these volatile markets, and "playbooking" them, as Mike Bellafiore describes, is helpful in structuring your risk taking.  

We can't change the past, but we *can* learn from it.  The bulk of the opportunity set lies ahead of us.  Let's use the past to prepare for the future!

Further Reading:


Wednesday, March 25, 2020

Finding Unique Opportunity In The Current Market

Here's a helpful pattern for developing traders looking for edges in the current market.  It's a great way of looking underneath price charts to see what is actually happening in the marketplace.

The key idea is that time of day matters.  The execution desks of the largest trading firms are most active when they have the greatest liquidity.  Liquidity has been in short supply in recent markets, with thin order books.  That means that at the times of day when large traders most need to move size, they're forced to lift offers and hit bids.  That shows up as quite high or quite low readings in the NYSE TICK, the continuous measure of the number of stocks trading on upticks minus the number trading on downticks.  When we see a very positive distribution of TICK readings during early and late session--the two periods of greatest institutional activity--we know that they are actively buying, and we can use short-term pullbacks to ride those waves.

Above we see the one-minute values of TICK for yesterday's market in the top panel, with a pink line showing the zero level and a green line tracking a 10-period moving average.  (Data from Sierra Chart).  In the bottom panel, we see the SPY ETF.  Note the very positive distribution of TICK values during early morning, even when we have a pullback.  Those pullbacks were meaningful buying opportunities for strength through the day.  (Note how pullbacks in TICK in the first 45 minutes of trading couldn't push SPY to new lows and indeed how we stayed above the open.  We saw similar inability of pullbacks to generate new lows during the 11 AM hour).

By tracking TICK during key periods during the day, we can see if buying or selling is dominating and we can determine if buyers or sellers are becoming more aggressive from minute to minute.  In relatively illiquid markets, it's more difficult for participants to hide their intentions.  That becomes a subtle source of edge for savvy traders.

Further Reading:


Monday, March 23, 2020

The Most Powerful Psychological Strategy For Uncertain Times

There is a great deal going on right now that we cannot control:  the spread of the virus, the uncertainty of health, the uncertainty of markets.  This is the first time ever where traders calling me are spending more time discussing their personal challenges and the challenges of their families than discussing markets.

Here is the strategy I'm finding most effective for staying emotionally grounded and constructively focused:  Reaching out and helping others.

The underlying principle is this:  We cannot feel helpless if we're actively helping.  The antidote to uncertainty is to take on projects with certain rewards.

I recently went shopping at a department store and was surprised to find more of the things I needed on the shelves than I expected.  I asked the checkout clerk if I could quickly run to my car and get extra bags and she said of course.  She seemed quite upbeat and happy, which was nice to see.  When I came home to unpack my bags, I discovered to my surprise that she had slipped into my bag an extra four-pack of toilet paper.  It was a little thing, but it meant a lot--and I expressed my appreciation.

Similarly, I've noticed how traders are making more use of teamwork than ever before, particularly now that many are trading from home.  They are using the teams not just to share ideas through the day, but to actively help each other review performance, set goals, and stay on track with those goals.  It reminds me of the Navy SEALs and their ethic of leaving no one behind.  It's tough to feel sorry for ourselves when we're reaching out to others.  Who can you make sure isn't left behind:  in your circle of friends, in your family, in your neighborhood? 

In my own work, I've opened my calendar to early morning and evening calls, as well as calls on weekends.  I have resumed doing talks (online!) for trading communities and trading firms.  Social distance does not have to mean social isolation!  Some of the best helping I've been doing is simply letting people know what is working in this new environment:  what is working in trading and what is working in people's personal lives.  There's a lot to be said for just staying constructively focused!  

It's a psychological reality:  In giving, we become wealthy.  Who can you reach out to and create a buddy system to reach that next level of trading success?  Who might benefit from your ideas and what you're doing that is proving successful?  Stay safe, stay well, but stay engaged.  Challenges can overwhelm us, or they can bring out the best in us--

Further Reading:


Friday, March 20, 2020

Making the Most of These Challenging Times

Here are some important ideas I'm sharing with the traders I'm meeting with (in virtual mode!):

*  I see where California is going into stay at home mode, and I expect other states to follow.  This, on top of shortages at grocery stores and fears regarding health, is proving stressful for traders and their families.  This recent Forbes article outlines very specific strategies I'm seeing traders engage in to make the most of this period of "social distancing".  It especially addresses the issue of how to stay in a peak performance mindset even when we're dealing with unique stresses and changes in our work routines.

*  I am working with traders who are doing incredibly well in these volatile markets.  Videos from SMB are outlining some of what these traders are doing.  A key has been staying short-term and nimble, seeing opportunity on both sides of the market and not getting locked into opinions, and taking profits opportunistically.  Trading "move to move" and following the shifts in buying and selling on an intraday basis has been quite useful.

*  I am hopeful about efforts being made to develop a drug to control coronavirus symptoms and efforts to develop a vaccine.  The people I speak with who are far more on top of the science of the virus than I will ever be suggest that these efforts could take a while and, indeed, we're not doing enough to separate people and prevent mass viral spread.  The fight against the virus could be a longer-term warlike endeavor, with ongoing social impacts and impacts on markets.  Particularly if illness is widespread and helps further disrupt supply chains, being prepared by having medications, food, and supplies on hand will be super important.  This is an issue of prudent preparation, not "hoarding".  Please take the time to read this.

*  What to watch:  The excellent SentimenTrader service notes that the RSI for corporate bonds is at an all-time low.  (See HYG).  That means we're pricing in an increasing set of odds of defaults and possible bankruptcies.  Note that the same dynamic is hitting municipal bonds (MUB).  People I speak with are keeping their eyes on these markets for signs that things are improving or getting worse.

*  Twitter has been an amazing resource during this time, both for following markets and for following informed commentary and research on the virus.  I am retweeting articles and comments that I find particularly enlightening.  I do not watch television networks or follow politicized commentary.  Not helpful at this time.

Stay safe and stay together even when we're not physically together!!



Tuesday, March 17, 2020

A Pattern That Has Been Worth Tracking In This Market

I recently posted on the topic of finding trade ideas by tracking shifts in the psychology of the market itself.  There are two sets of indicators that I utilize for this purpose.  The first is the TICK indicator, which is a moment to moment measure of how many stocks are trading on upticks versus downticks.  By watching the distribution of TICK values over time, we can determine whether buyers or sellers have been dominant in the market.  

The second measure is the Delta measure that takes each transaction in a particular instrument, such as the ES futures, and identifies whether those transactions are occurring at the market's bid price at the time or at the offer price.  Again, we're gauging the sentiment of market participants and how that shifts over time.

The pattern that has been quite helpful in the recent, higher volatility market is one in which there is persistent buying or selling (upticks or downticks dominate; volume at offer or at bid dominates), but that activity no longer moves the market significantly higher or lower.  So why is this important?

In the current market, volatility is so high that even professional money managers at hedge funds have to size down and reduce their holding periods.  Quite simply, in a market with daily ranges around 8%, these managers do not have a mandate to lose that much at all, not to mention in a single day.  High volume and high volatility makes daytraders of many of us.  When the ranges are so wide, no one can take the heat of adverse moves over a multiday period.

So what that means is that when buyers cannot move the market higher or sellers cannot push price to new sustained lows, those buyers and sellers are going to have to cover their positions--and they'll have to do it quickly, given the violence of moves we've been seeing.  It's that "trapped volume" that creates the sellers and buyers for the reversal moves.  The greater the trapped volume, the greater the subsequent move in the other direction.

What we see above is a chart of late yesterday's trade in the Russell 2000 ETF, IWM (bottom panel; one minute bars).  (Chart created in Sierra Charts).  Above the Russell is a TICK measure specific to the Russell 2000 stocks.  I've drawn a 10-period moving average through the TICK bars (green line) and a red horizontal line at the zero level, so that you can readily see when we have net buying (green line above the zero line) and net selling pressure (green line below the zero line).  Notice how we have net buying late in the day, but are not able to make and sustain fresh price highs in IWM.  That alerts me to the potential that we could have some trapped longs in the overnight and next day's trade.

This, of course, is just a hypothesis, albeit one supported with data.  If we see price action going forward in which buying cannot take out the prior day's high, that would support the hypothesis and could help us frame a winning trade.

Two points are important here:  1)  the psychology/sentiment of the marketplace matters and sets up valuable trade ideas; 2) some of the best trade ideas come from following data that few others track.  It is very difficult to achieve distinctive results by looking at the same things as everyone else.

Further Reading:


Monday, March 16, 2020

The Real Tough Questions About This Market

The last post asked an important question:  Are we seeing a nasty correction or part of a larger bear market?  This post asks a very tough question:  Are we seeing the opening phases of something worse than a nasty recession?

As a psychologist working with traders and investors, my job is to ask the tough questions that, in our desire for comfort, we may not be asking ourselves.  The goal is not to convince anyone and certainly not to frighten them.  Rather, the objective is to encourage open-minded awareness of ourselves and the world around us.  Whatever decisions we make, we want to do so with open eyes.  As I've noted in the past, my role is not just to comfort the afflicted, but also afflict the comfortable.  Unquestioned answers and assumptions are part of our (sometimes false) comfort.

Prior to the Great Depression in 1929, financial markets experienced many "panics", indeed every 20-30 years or so.  With the strengthening of the banking system, including the role of central banks in economies, we have been without a "panic" for a record number of years.  Yes, there have been shocks like in 1987 and major recessions as in 2008, but nothing like a depression that not only wipes out investor wealth, but impacts the entire social structure through shortages, unemployment, and day-to-day insecurity.  My grandparents lived through the Great Depression, and it affected their outlook and behavior for the rest of their lives.

Recently, we're starting to see hints of such impact with the coronavirus pandemic.  Falling markets--even in the face of coordinated central bank action--are certainly part of it, as are reports of overrun supermarkets and hospitals.  Recently, I'm hearing more about concern for failing markets, as speculation about complete market shutdowns increase.  Businesses--from restaurants and bars to cruise lines, hotels, airlines, entertainment venues, and schools--are in shutdown mode, almost certainly creating a quick shock to the economy through unemployment.  In a short time, we've gone from complacency (It's just another flu) to the hoarding of food and supplies.

How do municipalities and companies pay off their debt if money isn't coming in?  What happens to bondholders who are already battered by falling stock prices?  Suddenly we have "risk parity" in reverse--and a phenomenal loss of wealth for families and institutions.  

And how does all this unemployment, social distancing, and broad financial loss *not* affect young people for years to come, particularly if the virus--like Spanish Flu--comes back a second year in an even more virulent form?

So, yes, it's a good question to ask whether this is a nasty correction or a bear market.  It's also a worthwhile question to ask whether this is a recession in the making or something more generational in its impact.

Additional sources:

Further Reading:


Saturday, March 14, 2020

Is This A Correction Or A Bear Market?

On Thursday of this past week, we hit a particularly oversold level in the stock market.  As the stats from Index Indicators pointed out, we had fewer than 10% of stocks in the Standard and Poor's 500 Index trading above their 3, 5, 10, 20, 50, 100, and 200-day moving averages.  In other words, the market was oversold on most every time frame that traders typically look at.  

Now here's the interesting thing:  When this happened on August 8, 2011, the market ultimately moved higher by over 9% in the next 50 trading days.  To be sure, there were volatile upmoves and downmoves over that period as the market found a base early in October and late November of that year, but the basic direction was significantly higher by the start of 2012.  In December of 2018, we similarly hit a point where the market was oversold across all the aforementioned time frames.  Fifty days later, we were up more than 23%.  That very oversold level marked the bottom of the move to the day!

On the other hand, we first hit the broadly oversold level during the 2008 bear market on October 6th, with the SPX average at 1056.89.  Before the month was up, we had dropped another 200 points and eventually did not make a price low until March 9, 2009 at 676.53.  In other words, oversold in the big bear market was followed by more oversold for quite a few months.  The value buyer in early October, 2008 was gored by the bear for another 30+%.  

So now we've hit a broad oversold level this past week and bounced sharply the next day on news of policy interventions.  Have we seen the capitulation phase of a correction or is this simply part of a waterfall in a bear market?

As I am writing this, I am receiving numerous emails from colleagues describing the start of shortages at supermarkets.  I am also hearing from parents dealing with the closings of their children's schools and colleges.  And I am hearing from small business owners, such as restaurant entrepreneurs, that business is way down.  If that continues, we can count on layoffs and real economic pain.  Small business and the service sector are important engines of the economy.  Increasingly, as Duke finance professor Campbell Harvey has noted, we're facing the likelihood of a nasty recession--and that's what rates markets are telling us.  

Historically, important bear markets have taken months to find bottoms.  This happened between late May and late October of 1962; between August and late December of 1966; between January and June of 1970; between August and December of 1974; between October of 1981 and August of 1982; between October of 1987 and October of 1988; between August of 2002 and March of 2003; and of course between October of 2008 and March of 2009. 

The virus has yet to run its course in the U.S.  We've yet to see any bond default and/or bankruptcy fallout from the recent energy spat between Russia and Saudi Arabia.  We've yet to see how well we succeed at flattening the pandemic curve and how well we succeed at providing adequate support for laid-off workers and battered sectors of the economy.  It's difficult to believe that public perception and psychology will change on a dime.  The lifestyle and economic impact of the coronavirus outbreak are likely to be with us for a while.  That is why I'm open to the bear market hypothesis and not betting my life savings on a V bottom.

Further Reading:

Friday, March 13, 2020

Dealing With Toxic People

Some of the most powerful mirrors in our lives are relationships.  When we experience ourselves through relationships over time, we absorb that experience.  What we call the "self" is continually constructed, continually shaped by our social experience.  I am not the same person that married my wife 36 years ago.  I've absorbed aspects of her values, personality, and mindset and I'm better off for that experience.

Not all relationships are positive mirrors.  Some are downright toxic.  Among those are:

*  People who want to use you for their own agendas;
*  People who reach out to you to hear about the bad things that have happened to you;
*  People who cannot share your happiness or success;
*  People who are so dependent upon you that you cannot depend upon them.

Those are the dead plants in your life garden. 

My favorite strategy is to share some piece of joy with another person and see how they respond.  People who want the best for you will celebrate with you.  People who don't want the best for you...crickets.  No celebration.  

In a good relationship, your partner wants you to grow.  In a toxic relationship, growth is a threat.

Water your garden often.  Remove all dead plants and replant.  It's a great strategy for fulfillment in life.

Further Readings:


Wednesday, March 11, 2020

Trading The Market's Psychology

If you were to look at a daily chart of the recent stock index market, you might be tempted to conclude that all we have are sellers, with few if any buyers.  Nothing could be further from the truth, however.  Many buyers are trying to scoop up bargains here.  So far, their buying activity has not been able to move the market meaningfully higher.  That means that bounces, while traveling quite a few points, ultimately only retrace a portion of prior declines.  That's what happens in a downtrend.  

Here and here I pointed recently to the Delta measure that tracks the amount of volume trading at the market's offer price vs. the amount trading at the bid price.  That tells us something about the market's psychology:  specifically, whether buyers or sellers are more aggressive.  When we examine the ability of this aggressive execution to actually move market prices, we can get a feel for markets where hidden, resting orders are able to absorb the aggressive activity and ultimately fuel a move the other way.  It's when aggressive buyers or sellers get trapped by such resting institutional supply/demand that we can get nice intraday moves.

Above we can see this pattern play out on a micro basis.  The chart (top region) represents the upticks vs. downticks specific to the stocks in the Standard and Poor's 500 Index.  It moves differently from the more familiar NYSE TICK.  (SP TICK data from Sierra Chart).  The above screen shot is a 15-second set of bars for SP TICK with a 10 period moving average overlaid (green line).  The horizontal red line represents the zero line where upticks and downticks among the SPX stocks are balanced.  Note the occasions when we have net buying aggressiveness (upticks) with the moving average line staying above zero.  Notice how those buying episodes are often occurring at lower price highs (pink arrows).  It's a great indication that buyers are trying to scoop up fallen prices but ultimately are unable to move the market higher and become trapped, fueling the next down move.

This pattern shows up on multiple time frames with different measures of buying and selling pressure.  It's a great way to identify the moment-to-moment psychology of the market and align your trading accordingly.  

Further Reading:


A Useful Trading Psychology Exercise

In a helpful blog post, Michael Berkowitz expands upon the idea of making friends with your weaknesses. Many times, if you view the things you did wrong during a trading day, you'll find that the weakness is actually a misdirected strength.  In other words, when we over-utilize our strengths, they become vulnerabilities.

Being able to listen to others is an important strength that allows me to be a caring psychologist, parent, and spouse.  If I use that strength excessively and in the wrong way, I can end up being swayed by others and not listening to my own intuition.  I have made too many losing trades that way!

Similarly, I don't know of great traders who aren't greatly competitive.  But that same drive can lead them to not accept defeat and blow through stop levels, creating massive drawdowns.  Is it a lack of discipline that causes the losses or a lack of balance to the competitive strength?

Every great strength needs a great balance.  It's a very important trading psychology lesson.

A useful exercise is reviewing your worst trades during the day or week and ask yourself:  What was the strength that I drew too much upon?  And then review your best trades and identify the balancing element that enabled you to make proper use of that strength.   It is very hard to battle something we take as a weakness; indeed, the very effort reinforces the notion that we're weak.  It's much easier to activate an existing, balancing strength.

Mike Bellafiore recently linked several posts relevant to the record performance of SMB traders during the volatile month of February, noting flexible trading as one of the common ingredients of success.  What I've seen first hand is that the top performers did not hit records by focusing on their weaknesses.  One of them was drawing too much on his ambition to make money and hold positions for longer periods and so balanced that with his strength at identifying and pouncing upon shorter-term patterns.  Another found himself getting too eager and excited over the opportunity afforded by the volatility and balanced that with his ability to focus on a more limited opportunity set and draw upon his capacity for focus and patience.

In all those cases, the traders overcame their worst trading by accepting the strengths that were misdirected and balancing them with other strengths.  Note:  They had all the elements for success already; they just needed to channel them differently.

Further Reading:


Tuesday, March 10, 2020

Live Interview After the Close Today

I only half joke when I tell people my volume of emails and calls is positively correlated with VIX.  It's in these rapidly moving markets that we can find great opportunity and accentuated risk.  In my interview with Anthony Drager of Edge Trading Group after the market close today, I will address the current market situation, takeaways from research on the coronavirus, psychological strategies for successfully navigating the volatility, and a historical study of what happens in the market when the number of stocks making fresh 52-week lows explodes to extreme levels.  Anthony will kick things off with the market takeaways he's been sharing with his online community.

Here is the link to register for the free event.

I look forward to seeing you there!



Sunday, March 08, 2020

Useful Scientific Resources for the Coronavirus Outbreak

The coronavirus situation has roiled financial markets and created quite a bit of social concern.  I'm noticing quite a bit of misinformation and misguided decision making on the topic.  Below are sources that I have found helpful in following the science behind the outbreak and what that means going forward:

This Bedford Lab blog post tracks the history of the spread of the virus and notes what can be done to control it.  An important takeaway is that "social distancing" is essential to slowing and stopping the spread of the virus.  Lots of excellent links, including this one to the Nextstrain platform that is tracking the virus in real time.  Here is the Twitter link for Trevor Bedford.  Worth following.

*  Thanks to the Threadreader app, here's a compilation of recent tweets from Liz Specht, and here's her Twitter link.  Specht, from the Good Food Institute, lays out the implications of the math of viral transmission, especially in terms of strains on our healthcare system.  Note the difference between her analysis and that of Shang-You Tee below, based upon the dynamics of decay following exponential growth.

*  Here are a number of helpful perspectives from Scott Gottleib, MD, a former Food and Drug Administration commissioner, including needed prevention measures.  

A valuable perspective based upon the slowing of cases in China is offered by data scientist Shang-You Tee, who tracks exponential increases in cases followed by rapid decay.  He emphasizes the importance of strong public health measures to contain viral spread, particularly the measures recently utilized in Singapore and Taiwan.  Worth reading.

There are lots of valuable takeaways from these sources.  The longer we delay personal and public prevention measures, the greater the spread will ultimately become.  As long as the spread becomes greater and wider, we can expect greater impacts on daily life and continued volatility in financial markets.  As in Taiwan, strong public health practices may limit the impact of the virus.  

I am watching overseas markets closely, particularly in Asia, where we've seen some stabilization in markets in China and Taiwan and continued weakness in Italy and Singapore.  Per my recent post, this crisis is likely to create great opportunity for equities going forward, given the collapse in bond yields.  Sound--and well informed--risk management, however, will be needed to profit from such a scenario.  Prevention is key: If we wait to act until things are bad, they are almost certain to get meaningfully worse.

Further Reading:


Saturday, March 07, 2020

The Single Greatest Life Lesson I've Learned From Markets

The single greatest life lesson I've learned from markets is that risks are not normally distributed.  The odds of very good and very bad outcomes are greater than they would be in a perfectly normally distributed world.  It's the presence of these "fat tails" that shape sound risk management.  We have to take risk to earn reward, but we have to manage risk to stay in the game long enough to reap our reward.

What that means in practice is that, wherever possible, we reduce or eliminate our tail risk to prevent catastrophic outcomes.  A simple example would be purchasing insurance on our homes.  No one complains about money "wasted" on home insurance just because our houses don't burn down or blow away in a tornado.  Similarly, we insure ourselves for hospitalization and routine healthcare even if we're perfectly healthy at the time.

On the other hand, we want exposure to the fat positive tails wherever possible.  It's that asymmetric exposure to positive versus negative outcomes that characterizes good portfolio management.

Many years ago, I changed jobs because I perceived that the workplace was not being managed properly and would eventually suffer because of it.  The tail risk, I believed, was greater than usual and I didn't want to be out of a job before finding a new one.  The position I moved to was growing significantly and there was a positive tail probability of growing within that company.  I learned those career moves from my time in financial markets.

When news of the coronavirus first hit in mid-January--and online mentions began to skyrocket, especially overseas--we did not yet hit our all time highs in the U.S. stock market and such precautions as hand sanitizer, nitrile gloves, and N95 respirator masks were readily available.  At the time I took such precautions, I was told that I was "overreacting".  From a risk management perspective, however, I was purchasing insurance.  I learned that, too, from trading markets.

Now, given the poor job of testing at-risk populations for the virus in the U.S. and new CDC advice for vulnerable populations to stay at home as much as possible, I'm taking further precautions and reducing time spent in public places.  Again, I'm told I'm overreacting.  What I'm doing, however, is managing my life the way I manage my investment portfolio, prioritizing staying in the game in order to eventually win the game.

The greatest life lesson I've learned from markets is to first mitigate risk, then aggressively pursue reward.

To be sure, there's a time to "go for it".  When I left a secure position at a medical school to work full-time with traders, it was quite a gamble.  I made sure I had a Plan B if the move to financial markets didn't work out and that allowed me to go all out to reap positive returns if things worked out well.  Similarly, in the current market, there is going to be a monster opportunity in stocks once it starts to become clear that the virus situation is abating.  With Treasury rates driven to all-time lows and the lack of yield in fixed income instruments, companies with strong balance sheets and decent dividends will become the new bonds.  There is a risk in ignoring the left tail of negative outcomes, but there is also a risk in not pursuing right hand opportunity tails as they become more probable.  

Good risk management is necessary for success, but not sufficient.  We also need good reward management.

The challenge of the current environment is that it calls for both.

Further Reading:


Wednesday, March 04, 2020

Observations During These Unusual Market Conditions

Below are a couple of fresh observations from the morning of March 5th:

*  In the chart below, going back to late January in the SPX futures, we can see the course of the recent market activity (each bar = 500,000 contracts traded).  Note the sequence of green bars in the middle display, showing net volume transacting at the market offer price (i.e., buyers more aggressive) vs. the market bid (sellers more aggressive).  Observe, however, that the aggressive buying could not move price above the March 3rd highs.  This pattern shows up in markets ready to reverse, and we can see how trapped buyers have been exiting overnight.    

SentimenTrader points out that all 10 major market sectors have traded in the same direction for six of the last eight sessions.  Usually, when we see market bottoming, we see a reduction in correlations among sectors, as some areas of the market hold up better than others.  That isn't happening yet.

*  A nice way to see if fixed income investors are anticipating economic weakness is to track the relative performance of investment grade bonds (AGG ETF is one example) versus high yield bonds (HYG ETF is an example).  When we see AGG notably outperforming HYG, we know that markets are pricing in increasing odds of default for the high yield issues due to anticipation of recession.  Of late, we've been seeing flight to safety, not speculative buying of higher yield bonds.

I've had a record number of phone calls, emails, and Skype chats in recent days.  The uncertainty of the Coronavirus outbreak and volatility of market reactions has created unusual trading and psychological conditions.  Here are a few takeaways from the conversations:

1)  Many traders focus on the stock market, but the collapse in yields among Treasury instruments is perhaps even more significant.  Who would have thought a little while ago that we would be seeing a 10-year Treasury yield under 1%?  As SentimenTrader notes, this flight to safety has been associated with stock market rallies one to two months forward.

2)  Figuring out who is in control of the market is at least half the battle.  I like Brian Shannon's use of the anchored VWAP for this purpose.  When we see a potential turning point in the market, constructing a VWAP from that point provides a useful reference.  Take note:  That same anchored moving average concept can be applied to the NYSE TICK to identify the balance of buying and selling from a given point.  

3)  Keeping your holding period constant in a fast market exposes you to unexpected risk.  The market is moving much more per minute and per hour than it had last year.  There is more volume trading, and the market is moving more for each unit of volume tradedMike Bellafiore notes the value of "scalping" in this environment:  containing the holding period is a form of risk management for the flexible trader.  Getting stuck in fixed opinions has hurt traders recently.  Open mindedness has been every bit as valuable as conviction.

4)  Are we looking at the correct tail risk in the Coronavirus outbreak?  I hear a lot of people talk about the "overreaction" to the virus.  The great majority of people don't die from the virus, you might get sick for a while, and that's it.   But what if antibodies to the virus are weak and people who contract the virus:  a) continue to harbor the virus and spread it and b) are susceptible to reinfection?  A "biphasic" disease would mean that we could be dealing with the fallout from the virus for far longer than expected.  And, yes, we are getting reports of reinfection, which could complicate the burdens placed upon healthcare systems.

Operating with confidence in an uncertain environment is dangerous.  Knowledge begins with what we don't know--and the open-mindedness to continually revise our assumptions as new information emerges.

Further Reading:


Sunday, March 01, 2020

The Psychology of Trading Fast Markets

This past week has seen an explosion of market volatility, with VIX exceeding 40 and daily price ranges of several percent in major indexes.  Below is a chart of the ES futures (blue line), with each data point representing 50,000 contracts traded.  The red line is the 20 period volatility of those volume bars.  (Data go from September 16, 2019 to the present).  Volume in the market has expanded greatly.  For example, on Friday we had roughly 100 bars on the chart; at the start of the year, a day was comprised of about 30 bars.  But notice below that we're getting more price movement per bar currently.  So the market has become extremely fast, with more volume and more movement for each amount of volume traded. 

This can create great opportunity for short-term traders, but it can also create great problems for their trading psychology.  With so many things moving, it's easy to become distracted.  With so much movement, it's easy to quickly lose money.  Rarely do traders properly adjust their trading sizes for the increased movement.  Indeed, some may size up positions, thinking that this is a great trading environment.  With more size and more movement, the volatility of PL can challenge even the most experienced traders.

In the latest Forbes article, I outline three important psychological perspectives on trading the recent market decline.  One point that article makes is the importance of slowing down when markets speed up.  When we face more risk and reward, there is an activation of our fight or flight responses, impelling us to react, rather than act deliberately.  During those stressful occasions, blood flow actually shifts in relative terms away from the brain's frontal cortex--our executive center--and toward our brain's motor centers.  

When we focus our attention and slow down, we shift blood flow in the opposite direction.  Indeed, in hemoencephaolography (brain blood flow biofeedback), we actually measure that shift of blood flow via subtle changes in skin forehead temperature.  We can achieve similar benefits through meditation.  Even a brief break in the trading day in which we focus our attention on imagery, slow our breathing, and remain physically still can make significant changes in our patterns of arousal.  

A great trading psychology technique is to just take a couple of deep breaths and perform a quick gut check before placing each trade.  It introduces a moment of mindfulness in our decisions.  It is difficult to trade with FOMO if you're slowing yourself down and reflecting upon your actions.

The Forbes article highlights the likelihood that volatility will be with us for a while--and what that could mean for the market going forward.  If we speed up with markets, those markets control us.  Slowing ourselves down is a great way of staying in control, even in crazy market times.

Further Reading: