Creativity in Finding Market Opportunity

 

As I've emphasized in the Trading Psychology 2.0 book, creativity is essential to success in trading financial markets.  Finding opportunity that others don't perceive is the heart of what great traders do.  That requires looking at new things and viewing old things in new ways.  The very successful participants in markets enjoy creative discovery, and that keeps them excited about markets regardless of recent profitability.

Consider a standard technical indicator such as Bollinger Bands.  We could view the market--or a stock--to be a buy when it closes above its upper band and a sell when it closes below its lower band.  The idea is that if the market is more or less than two standard deviations from its recent average price, that is indicative of a trend.

But suppose we view the bands differently.  Suppose we look at every stock in the NYSE universe and identify how many close each day above and below their upper and lower bands.  Now we've turned the strength/weakness measure into a breadth measure.  

I've collected those data for about three years and have noticed a pattern that no one talks about.  It's when we have very few stocks trading above their bands that next 5-20 day returns are most favorable.  And when we have very few stocks trading below their bands, the next 3-5 day returns are most favorable.  Interestingly, the correlation between the daily number of stocks trading above and below their bands is a very modest -.20.  In other words, breadth strength and breadth weakness are independent variables.

Now the door is open to similar analyses using common technical indicators.  By viewing presence/absence of strength/weakness uniquely, we can find unique relationships.  The absence of strength or weakness may be as important to markets as their presence.

This is what trading psychology is meant to be.  Not a stale rehashing of the need to be disciplined, but the positive development of our greatest cognitive and behavioral capacities.  Creativity is all about asking new and better questions.

Further Reading:

The Role of Creative Insight in Trading

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Very Oversold Stock Market: Is It Time To Buy?

 

The U.S. stock market is dramatically oversold, with very negative breadth.  One way of capturing that is to look at the percentage of stocks in the SPX that are trading above their 3, 5, 10, 20, and 50-day moving averages.  That percentage, in each case, is below 10.  More than 90% of all stocks are in bear modes.

This is an unusual condition.  I went back to 2006 (almost 4000 trading days) and could only find 26 examples of such uniform bearishness.  The occasions tended to cluster:  eight of them occurred in the latter part of 2008; five of them in the February-March period of 2020; four of them in May and June of 2010.  

Did broadly oversold lead to trading opportunity?

Twenty days later, the market was up 17 times, down 9 for an average gain of +2.42%.  That compares with an average 20-day gain of +.67% for all other occasions.  The average gain for the oversold markets was even greater when looking 50 days out:  +8.20% versus +1.98%, with 21 occasions up, 5 down.

That did not mean that we rose in a straight line.  Twenty of the 26 occasions posted a lower close within a ten-day period; 15 of those 20 occasions dropped more than 2%.  The occasions in September and October, 2008 and the 2020 occasions were especially problematic, dropping another double-digit amount before stabilizing.

We've all heard about the person who couldn't swim and who jumped into the water because it averaged only 4 feet in depth.  Averages, in themselves, don't tell us about the variability around those averages.  What we've seen after broadly oversold markets is average gains on an intermediate-term basis, but significant variability in the short-term and further weakness on some occasions further out.

Positive average returns don't mitigate the need for sound risk management.  If central banks need to see significantly weaker economies to crush inflation, then stock markets can be expected to anticipate that weakness.  The average individual investor is long stocks and long bonds.  Both positions are getting crushed and could see real disaster if central banks need to continue to administer harsh medicine.

Further Readings:

Using Breadth and Strength to Track Market Cycles

Understanding Market Cycles

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Four Reasons You May Not Be Succeeding In Your Trading

 

It is not at all uncommon for traders to feel as though they are falling short of their expectations.  Trading is all about risk and reward, and all of us have finite hit and Sharpe ratios.  That all but guarantees that there will be periods of drawdown and suboptimal performance.  When we chronically underperform our expectations, that itself can lead to a frustrated mindset that ensures future trading challenges.  Here are four reasons you might be underperforming your expectations over significant periods of time and what you can do about them:

1)    Your expectations are unrealistic - It is not at all uncommon that developing traders attempt to take shortcuts in their learning process and take too much risk, too soon.  Often, this is because they *need* to make money and can't allow themselves to travel the learning curve of developing experience and expertise.  Think of any performance field, from athletics to music to acting.  No one achieves consistent expertise and success in a matter of months.  In the field of medicine, a student goes through four years of study to become a doctor--and then goes through multiple years of graduate study to master a specialty.  Our expectations should be about learning and development; we need to grade ourselves on our progress, not on whether we can hit our end point quickly.

2)  The markets have changed - I recently spoke with a trader who had been making money earlier this year and then stopped making money.  The frustration of the recent performance led to further trading problems.  When we examined his trading, it was clear that he had a bullish bias and made his money by fading extreme price moves.  In the higher volatility environment, price moves went from extreme to more extreme and, of course, the bullish bias stopped working once we transitioned to a macro environment of quantitative tightening, rising interest rates, and high inflation.  Our trader was underperforming because he, in relative terms, was a one-trick pony.  He needed to return to researching opportunities and add to his trading arsenal.  Failure is often a failure to adapt.

3)  You are not playing to your strengths - I often find that traders attempt to make money in ways that do not tap into what they are truly good at.  Active traders who recognize shifts in patterns in markets will develop longer-term "conviction" and lose their flexibility.  Big picture traders who excel at researching opportunities in markets will get caught up in the wiggles of short-term price movement and get "chopped up".  This is why it is so important to study your trading successes:  trades and periods of trading when you have been at your best.  We learn a lot by identifying our most fulfilling period of trading: these are usually the ones that reflect our distinctive strengths.  The goal is to become the best version of yourself, not to become someone else.

4)  Trading is not your path - This is the one possibility that you almost never hear from trading gurus and would-be mentors and coaches.  They seek your business, so it's toxic to suggest that maybe trading is not your best path to success and fulfillment.  The ability to make a significant living from a performance field--athletics, music, writing--is the rare exception, not the base case.  I have shared many times my attempt to become a full-time trader.  I made money--and I was miserable.  My deepest rewards come from connecting with and helping people:  that is why I became a psychologist.  Sitting in front of screens for hours at a time did not tap into the best of me, and that was a guarantee that I would never achieve my greatest success as a trader.

Failure is information.  When we fall short, there is usually an important lesson to be learned.  Understanding why we're falling short of expectations is the first step in setting ourselves on our best path.

Further Reading:

Overcoming Our Fear of Failure

Three Warning Signs of Trading Failure

Keeping Your Spirits Up When You Are Drawing Down

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Trading Lesson From a Social Psychology Experiment

 

I recently came across a classic social psychology experiment.  The subjects were seminary students and they were told to prepare a talk on the Good Samaritan.  Both groups were told that they would be delivering their talk to a group of mentors.  The first group was told that they running late to the talk and to get to the classroom as soon as possible.  The second group was told that they were on time and did not need to rush to deliver their talk.

Unknown to the subjects, along the way to the classroom was an actor lying on the ground, moaning, and in obvious discomfort.  The group of seminary students not in a rush to their talk was significantly more likely to stop to help the actor than the group in a rush.  Indeed, among the rushed group, there were students who literally stepped over the person in distress in order to get to the classroom!  

There is an important parallel to the trading world.  If a seminary student who has just been focusing on a parable about helping will not help a person in obvious distress because of their own immediate needs, how much more so will we fail to do what we are meant to do because of our own internal pressures!  The person lying on the ground in distress is our profit and loss statement.  No matter how much we rehearse our "process" and what we are meant to do, our best intentions can become hijacked by the needs of the moment.

The point is that it is not enough to merely look at what is out there:  we need to see.  If we truly see a person in need, we will stop and help, even if this makes us a bit late.  If we truly see the risk and reward in front of us, we can stop and do the right thing.  Overtrading is a failure of vision.  We are looking at the market, but not seeing opportunity and threat.  

Bringing unmet personal needs to trading is a great way to become like the seminary students who--on the way to a talk about helping!--rush by a person and fail to help.  It's another way of saying that great trading comes from the strengths of the soul and not the needs of the ego.

Further Reading:

Radical Renewal

The Main Ideas From Radical Renewal

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We Become What We Do

 

If a movie was being made of your life, what would be the story line?  Would it be interesting?  Would you want to watch that movie?

We do not change by setting goals.  Goals can direct the changes we wish to make, but we actually change by doing things differently.  What we do, day after day, is what we internalize.  We become what we do.  Day by day.

When we live a life of routine, our life becomes routine.  That's not a movie we're likely to watch.

When we tackle challenges each day, each day becomes a vehicle for growth.  We achieve successes, we encounter setbacks, we constantly live some part of the person we wish to become.  That provides a plot to our lives.  That can make for a worthwhile movie.

G.I. Gurdjieff understood that our greatest enemy in life is sleep.  When we live by habit and routine, we go through life asleep.  We cannot achieve our ideals if we live on autopilot.  That is why growth can only occur through daily, directed efforts.  

Imagine your life as a movie.  With each of your day's activities, you write the plot.  We become what we do.  What is your story line going to be?

Further Reading:

Overcoming Trading Challenges

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