Lessons From The Recent Trading Craze

 

Aristotle had a good point:  Without a touch of madness, we would all be secure in our consensus thinking and that's not helpful for innovation.  Often, it's the seemingly crazy question that leads to new ideas and fresh ways of tackling old problems.  For a long time, algorithm developers have been able to examine individual transactions, volume, and price levels and estimate how much volume is long and short at various points in the market.  At key points, these programs can push prices beyond a pain point, forcing shorts to cover and longs to scramble from their positions.  Figuring out where buyers can't push prices higher and sellers cannot move markets lower is a durable source of edge, in part because market participants tend to be leveraged and cannot take heat on their positions.  

So along comes a touch of madness saying that this same dynamic could be implemented by large groups of traders aligned in social networks.  Some large market players specialize in short-selling strategies, seeking to profit when individual stocks are overpriced.  They then leverage bets that these high flyers will return to earth.  But what happens when networks of individual traders take the other side of that bet, pushing prices higher than the short sellers can bear?  The result is that overbought stocks become insanely overbought, but over the short time frame the inability to take heat has created yet another trading edge.

You don't have to be a whale to dominate the seas.  Piranha in sufficient numbers can take down the largest creatures.  It just takes the madness of a few lead piranha to see what can be possible.

Ultimately, markets will absorb the participation of trader networks as they have absorbed the participation of computers:  through regulation and oversight.  But I'm not sure the genie gets back in the bottle once unleashed.  Networks are likely to be here for good, introducing elements of madness in politics and finance, sometimes for better, sometime for worse.

The untold story is less dramatic, but perhaps more important.  I have record numbers of traders reaching out to me, interested in learning trading.  They are not simply wanting advice on $GME or $AMC; they truly want to learn how to trade.  The current market turmoil is bringing an entire new generation into markets, and that will shape market activity for years to come.

The opportunities are immense for trading firms dedicated to training new traders, such as the groups I work with at SMB Capital and Kershner Trading.  They are also profound for online trading communities that are truly dedicated to teaching trading and growing a new generation of market participants.  Take a look at Investors Underground, with its trading courses, video library, and real time chatroom for developing traders.  Take a look at Traders4ACause, with its annual programs and networking events.  Take a look at BearBullTraders, a community of mentors and training resources that is in the process of teaming up with TradingSim, developer of a platform where traders can actively practice trading skills.  

As responsible and successful trader development networks take hold, they will change the face of trading psychology.  The emphasis will be less on one-to-one meetings and more on group programs that teach concrete skills specifically tied to trading practices.  Each network will have its own curriculum and its own group of experts to provide that curriculum.  Trading networks will look far less crazy and increasingly look like professional training platforms: next generation vehicles for the development of market participants.

I recently offered a simple three-item checklist that traders can use each day to ensure they are performing at their best.  In a networked trading world, the goal is not for people like me to coach traders.  It's for people like me to provide resources that enable traders to coach themselves.  Once you have your checklist and a robust process for utilizing it, you can take control of your own development.  The goal is not to find the next bright shiny object to chase in the trading world.  The goal is to find within markets your strengths and your interests and learn how to guide your own development, your own heroic path.

Further Resources:

The Three Minute Trading Coach video series on trading psychology

The collection of Forbes articles on performance psychology

The free blog-based book on the spirituality of trading and how to remove our egos from the decisions we make

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Self-Esteem: Our Relationships Shape Our Relationship With Ourselves

  

Self-esteem is our relationship with ourselves:  how we view ourselves, how we treat ourselves, how we talk with ourselves, what we expect from ourselves, what we desire for ourselves, what we most respect, what we most admire.  Self-esteem is destiny: it determines what we seek, and that determines what we achieve.

Every relationship we have is a mirror, reflecting ourselves, providing an experience of ourselves.  Over time, we absorb what is mirrored to us: we internalize what we experience in relationships.  In positive relationships, we experience ourselves as worthy, capable, and special.  Through positive relationships, we internalize positive experiences of ourselves.

Our relationships are our psychological food.  Emotionally, they are what we absorb.  Just as the right foods nourish our bodies, the right relationships nourish our selves.  The love of parents for a child is internalized as that child's sense of self.  Abuse or neglect in a relationship is internalized as feeling unloved--and unlovable.

There are two simple ways to gauge a relationship.  The first is to share something painful you're going through, some great challenge that you're facing.  If the other person simply wants you for what you can provide them, they will not respond.  They are interested in taking, not giving.  If the other person actually cares about you, they will drop everything and reach out.  A good relationship is a secure shelter in the storm.

The second way to gauge a relationship is just the opposite.  Share something very positive that is happening in your life:  some joy, some success, some source of excitement and enthusiasm.  If the other person shares and cherishes your happiness, you know you have a potential soulmate.  If the other person is threatened by the best within you and does not respond to your joys and achievements, you know there is no true relationship. 

If I am by myself, I can either feel all-one or I can feel alone.  Self-esteem shapes how we experience our own company.  If being on your own feels like being alone, you know you've absorbed the wrong relationship experiences.  

Life is too short to settle and compromise.  When we accept those who resent us and secretly long to hear negative things about us, when we accept those who simply want to use us and cannot reach out to us, we lose pieces of ourselves.  You are living your life story, and you're the hero or heroine of that exciting drama.  Find the right people to share that story with and you'll have the life you truly deserve.

Further Resources:

Trading As A Heroic Enterprise - Video

Why I Am Proud To Be A Trader

Radical Renewal - The Role of Spirituality in Trading

The Three Minute Trading Coach - YouTube Trading Psychology Channel

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Can Intensive Practice Produce Trading Expertise?

 

One practice I have noted among successful discretionary traders is their review of price action in markets.  Some have used replay functions on their charting platforms to see patterns unfold in the market, making them more sensitive to the occurrence of these patterns in real time.  Especially among daytraders, I've noticed that their trading is largely based upon visual and numerical information on screens.  What they are looking at amounts to patterns in market behavior, just as physicians look for patterns among symptoms and test results to make diagnoses.  For instance, a trader might observe that prices are breaking out of a narrow range with increased volume and increased lifting of offers on a depth of market screen.  That might be an indication that the market is establishing a new, higher level of value.

Pattern recognition, however, is a trap as well as a gift.  We can identify patterns where nothing meaningful is actually occurring.  Many chart patterns that traders look for have no causal relationship to price movement and ultimately lead to frustrated and unprofitable trading.  Promising patterns in markets are ones that capture an understanding of what is going on between buyers and sellers.

Physicians learn the pattern recognition of diagnosis through repeated experience.  A radiologist may need to look at many, many images in order to detect malignant growths or hairline fractures.  A psychiatrist may need considerable experience to identify when a mood swing is part of a depressive disorder, anxiety disorder, or bipolar disorder.  Case studies and years of training provide the repeated exposure that allow for accurate pattern recognition.

What if a major reason for the failure of developing traders is not a lack of discipline or disruptive emotions, but rather the lack of repeated exposure to meaningful patterns?  Traders review their trading and look over charts, but is this really the same as training oneself to identify patterns in real time?  Would reading books or reviewing medical charts substitute for observing actual patients for doctors building expertise in diagnosis?

I recently had a worthwhile conversation with Al and Kunal, the principals of TradingSim, a platform that allows traders to replay stocks and markets from any recent period of time in order to practice trading skills. Joining us was Andrew, the leader of the BearBulls online trading community.  One of the intriguing topics we explored was the use of a feature-rich trading simulator as a way that independent traders could drill their trading skills.  This strikes me as having tremendous potential, as it potentially provides a level of intensive practice not typically available to individual traders.

I recently suggested that a major component of trading success is the capacity for sustained focus.  What if the right kinds of trading drills become ways of cultivating the capacity for focus, so that we become better pattern recognizers over time?  In that scenario, trading psychology follows from superior training.  Intensive practice may lead to trading expertise, and it also may build the brain states most likely to result in sound trading.

Further Resources:

The Three Minute Trading Coach Video Channel

Training Your Trading Psychology - video

Why Trading Psychology Techniques Don't Work

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Why Your Trading Psychology Exercises Don't Work

 

In the most recent Forbes article, I make the case for mastering our trading psychology by literally engaging in brain training. When I refer to brain training, I am not talking about online exercises or apps that walk you through visualizations, breathing exercises, etc.  Rather, I am talking about directly measuring our body's functioning and training ourselves to control those measures through real time biofeedback.

Over the past two weeks, I have conducted focused experiments with heart rate and heart rate variability, electrodermal activity, and brain wave patterns, using the Fitbit Sense and Muse S units that I referenced in the earlier article.

Here are a few observations that were unexpected:

1)  Taking a Break Doesn't Necessarily Break Our Stress - When I feel stressed and take a break, calming myself and deepening my breathing, I succeed in taking my attention from what is troubling me and I feel more settled, but my body has often not recovered. My heart rate remains elevated, my electrodermal activity and heart rate variability still record stress, and my brain waves are not calm.  Simply taking a break and saying nice things to oneself feels good when we've been frustrated, but may not significantly aid performance.

2)  Less Stress Does Not Equal Greater Focus - This has been dramatic in my experiments thus far.  I can remain still, breathe deeply, and engage in calm imagery and that will reduce my heart rate over time.  (It takes longer than most of us allot to trading breaks.)  When I measure my brain waves, however, they do not show that I'm more focused.  Indeed, to achieve high focus readings with the brain waves, what I need to do is concentrate, not relax.  Interestingly, when I do a meditation routine and do it well, it helps my stress measures (i.e., I'm more relaxed), but my brain waves don't register as being in the zone.  A few minutes of a meditative exercise is very different from mastering the discipline of meditation.

3)  A Few Minutes of High Focus Changes Our Psychology - Most of us are familiar with the feeling of being calm and unstressed. That relaxed state can be helpful in winding down from a period of trading.  A highly focused state feels quite different.  When I'm unusually focused (and the brain wave feedback registers such focus), I feel a slight tension in my forehead and I feel distanced from the world around me.  It doesn't feel relaxed, as one might feel after an alcoholic beverage.  It feels quiet and I feel separated from the world, more like an observer than a participant in what is going on.  Perception is different in this mode, clearer and not at all distracted.  I'll have more to say about this in the next Three Minute Trading Coach video, but my sense is that I see markets much better when I'm highly focused than when I am simply stress free.

So what does all this mean?  Perhaps we're managing our trading psychology the wrong way.  Perhaps we're trying to de-stress when we need to be intensely focusing.  Perhaps we are setting up our trading days and processes in ways that increase distraction and actually prevent us from achieving the focus needed to quickly process evolving market patterns.  Our efforts at improving our trading psychology might not work because we're focusing on our feelings rather than strengthening our brains.

Further Resources:

Mastering Your Trading Psychology

Wiring Our Brains For Trading Success

The Three Minute Trading Coach YouTube Channel

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What You Trade Is As Important As How You Trade

 

Happy 2021 to colleagues and readers!

In this new year, I'll be doing something different with my blog posts and making efforts to link to the work of trading educators and mentors whose work I enjoy and respect.  The goal is to highlight valuable lessons for traders and also to introduce ideas and contributors readers might not be familiar with.

This week's lesson is "what you trade is as important as how you trade".

Here's a straightforward example from my recent coaching experience:

A trader focused day to day on "catalyst" events that would provide directional opportunity.  For instance, he might trade breaking news from a central bank meeting, a data release, or a news headline.  He worked diligently on refining his entries and exits in these trades, hoping to generate quick profits that supplemented his longer-term, thematic macro trades.  Indeed, this focus on how he traded catalysts improved the Sharpe ratio of those trades over time.

During one of our meetings, he briefly noted some frustration that some of the catalyst trades went on to become great trending moves, but only after he had exited his positions.  So, we investigated his recent successful trades and examined which ones went on to become larger opportunities.  What we found was that it wasn't just the move in a single trading instrument in response to the catalyst that made a difference; it was the move across multiple, related instruments.  

A simple example would be a stock that moves higher on an earnings beat.  If the move is idiosyncratic--limited to that stock--it tended to make for a good short-term trading opportunity.  If the relevant sector moved higher on the earnings beat, this was a sign that the news signaled a broader opportunity for an entire industry and would be more likely to be picked up by equity investors.  On those occasions, it made sense to keep a portion of the position on, as long/short investors and trend followers were likely to join the bandwagon.

Another example would be an economic release that leads to a move lower in the U.S. dollar.  If the dollar moves lower across multiple crosses, this might have very different implications than a dollar move that occurs mostly against a single currency.  If the dollar move is accompanied by correlated moves across the interest rate curve, this, too, might suggest that the macro world is interpreting the news in a way that could lead to trending behavior.

The trader I met with thus focused his energy on *what* he traded, not just on the mechanics of entries and exits.  Prioritizing opportunities that displayed a breadth of response to a catalyst, he became more selective and achieved a higher quality of returns that included both short-term opportunistic profits and the profits from the holding of longer positions.

In 2020, if you were trading stocks, the sectors that you focused on made all the difference in your returns.  The growth stocks and IPOs emphasized by Kathy Donnelly, Eve Boboch, and colleagues, for example, have performed phenomenally versus more value-oriented shares.  Once focused on the area of opportunity--the *what* to trade--it then makes sense to refine the *how* to trade.  Indeed, that was the focus of Kathy's recent podcast with Richard Moglen:  how to decide upon exits in these large opportunities.  But as Kathy relates to Richard, the initial focus of their efforts was Eve's focus on finding the next Google--figuring out *what* to be trading.

A different example of focusing on what to trade came in my own trading, as I reviewed the work of Brian Shannon at Alphatrends.  He has pioneered the application of "anchored VWAP" in trading, including the use of multiple volume-weighted average price lines anchored by key market events.  What I found, based on Brian's work, is that when anchored VWAPs at different time frames converge--and when that convergence is occurring across multiple stocks in a sector--that often provided potential breakout opportunities that had real investment implications.  Those breakouts were ones that investors would be more likely to hop on, providing the longer-term potential.  Here the *what* to trade was defined by the intersection of technical criteria and the breadth of the market opportunity.

Finally, I have noted in the past that the unusual success of many traders at SMB Capital can be attributed to a focus on what they trade and not simply on their work on how to trade the opportunities.  An important tool in this regard is "relative volume".  When a stock displays unusually high volume relative to its past, that's an indication it is "in play" and drawing unusual trader and investor interest.  Because volume correlates highly with volatility, such stocks are more likely to display meaningful moves for short-term traders.  Interestingly, many of the best opportunities are found among smaller cap stocks that don't have a large institutional or algorithmic following.  It is easier to read the tape with those stocks, allowing for better identification of when buyers or sellers dominate.  The same trading techniques applied to widely traded vehicles, such as stock index ETFs, would be far less profitable.

Focusing on what to trade means becoming more selective in our trade selection, prioritizing the quality rather than quantity of opportunities.  As for any successful entrepreneur or oil driller, where to seek opportunity makes all the difference.  You can have the greatest drilling equipment in the world, but if you're looking in the wrong spots, all you'll get are dry holes.

Further Resources:

The Three Minute Trading Coach - 30+ short videos to help traders coach themselves

Forbes Articles - A large archive of articles on methods for improving performance

Trading Psychology 2.0 - Book outlining how we can find our best practices and turn those into repeatable processes   

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