Sunday, March 26, 2023

Understanding Market Themes From Sector Breadth


For years, I have kept breadth data on the overall stock market, tracking shares making fresh highs and lows over various periods and the percentages of stocks trading above their short, medium, and longer-term moving averages.  What I've found is that shifts in breadth often precede shifts in overall market direction.  This is because certain parts of the market will break down or rebound ahead of the market averages.  Conversely, during trending moves, we will see the great majority of shares participate in market rises or declines.  The breadth extremes are an excellent alert for overall market momentum.

This is a good example of how trading psychology is about the market's psychology, not just about our personal emotions and behaviors.  Breadth data are helpful in tracking changes in the sentiment of market participants.  

Recently, I have built out spreadsheets that track breadth on a sector by sector basis, as well as breadth for various factors such as small cap vs. large cap and growth vs. value.  The idea is that the patterning of breadth changes among the sectors helps us track market themes.  

So let's take an example from the recent market (data from the excellent Barchart site):

In the last two trading sessions of the past week, the overall SPX moved higher by almost 1%.  Overall short-term breadth (stocks trading above their five-day moving averages), rose from about 26% to about 45%.  Interestingly, over that same time, the same breadth for consumer discretionary stocks went from about 20% to 25%.  The breadth for consumer staples shares went from 27% to 85%.  The breadth of energy stocks went from 61% to 22%; the breadth of financial shares went from 25% to 17% and the breadth of utility stocks rose from 0% to 73%.  

This tells us several important things:

1)  The move higher has not been a broad trending move.  It is quite mixed.

2)  The move higher has benefited more defensive sectors (consumer staples, utilities) and not sectors that reflect economic growth (consumer discretionary, energy).

3)  The recent reassurances regarding the banking sector of the economy have not yet pushed financial shares meaningfully higher.

When we couple the pattern of market breadth with the movement of interest rates (lower), we again see defensive buying (bonds).  Interestingly, large cap tech stocks have similarly acted as a relative safe haven, with breadth over the past two sessions moving from 26% to 54%.

The bottom line is that the patterning of breadth reflects a defensive market with lower rates, suggesting concerns regarding recession.  In tracking breadth going forward, I will want to see if the recessionary hypothesis/theme gains traction or reverses.  The shifts in the patterning of breadth among equities, as well as the shifts among asset classes and geographic regions, allow us to update our forecasts for markets and economies.  This enables us to be open-minded and flexible, even as we assertively pursue themes in play.

Further Reading:


Sunday, March 19, 2023

Making Passion Your Purpose

This post begins with a music video, old concert footage of Neil Young and company doing "Like a Hurricane".  It's a great song, but the important thing is to watch Neil during the two extended guitar solos.  This is not someone playing a song; it's the song playing itself through him.  The passion with which he plays is tangible.  Living life passionately is not easy, but as Neil observed, "It's better to burn out than to fade away".

A lot of us are fading away.  We're doing the same things.  We do the same things the same way and glorify it as "discipline" and "process".  We focus on working harder until we forget how to truly play.  We track all that we do in efforts at improvement until little is left to spontaneity.  If we approached romantic relationships the way the approach markets, we would quickly lose all passion and life together would become little more than a well-oiled routine.

If we are to make passion our purpose, then we have to make time for the new and different:  new experiences, fresh perspectives, expanded relationships, and opportunities to truly feel what we're doing.  The challenge of peak performance is maintaining the spirit and energy of what we're doing even as we work on improvement and mastery.  That is why the practice sessions of great teams--athletic teams, military teams--combine exercises that rouse motivation and teamwork with exercises that build skills.  Go into any locker room at halftime:  the great teams will fire themselves up, not unlike Neil Young's absorption in his music.

Wanting to make money is not passion.  Filling out trading journals and reviewing performance is not passion.  All these are necessary, but not sufficient for peak performance.  Passion comes from absorbing ourselves in what we love.

What do you love about markets?  How can you so absorb yourself in that love that your trading takes on the quality of Neil Young's guitar solos?  

Or are you working so hard to take emotion out of your trading that your trading career is fast-becoming a passionless romance?

This past week I've created a historical database of breadth statistics for a wide variety of market sectors, so that it's possible to see where money is flowing in and out of the market--and then backtest the significance of such shifts.  That is leading to new discoveries--new ways of detecting market regime changes in real time--and that fires up the passion.  More to come--

Further Reading:

Passion, Purpose, and Why Traders Fail


Saturday, March 11, 2023

Broad Stock Market Selloff: What Comes Next?

If everyone agreed on the value of an asset, there would be no price movement.  When price movement becomes volatile, we know that there is meaningful disagreement regarding value.  This was an important dynamic in the stock market this past week.  Let's see if we can look at the market from a data-driven perspective and gain some insight into what was going on--and what that could mean going forward.

The first important piece of information was that the past week's selloff was indeed broad.  Consider the following:  Out of the 500 stocks in the SPX average, the number making five-day new lows minus the number making five-day new highs was 442, and the number making twenty-day new lows minus new highs was 331.  The percentage of stocks in the SPX universe closing above their five-day moving averages was 1.98.  Only a little over 6% of stocks closed above their five-day averages.  Everything.  Was.  Weak.

The second important piece of information was that trading following the news of the SVB failure significantly differed from the trading up to that point.  Prior to the news, we were seeing weak stocks and weak bonds, as traders feared that inflation would be "sticky" and that the Federal Reserve Bank would need to raise rates more than expected earlier.  Following the news, selling became much more intense.  We saw elevated volume, elevated implied volatility readings (VIX), and elevated negative NYSE TICK numbers.  Indeed, the first tell that the SVB news was a game changer was the persistent TICK readings below -1000.  That can only occur when there is aggressive selling of large baskets of stocks.

The third important piece of information was that correlations within and across markets shifted dramatically.  Financial shares, such as those making up the XLF ETF, aggressively led the downside.  Fixed income, which had been trading lower in anticipation of higher yields, became a safe haven and rallied aggressively.  The market's narrative had changed from strong economy/inflation/higher rates to bank failure/economic uncertainty.  It would have been difficult for market participants to detect this regime change if they were not tracking volatility, volume, breadth, and market correlations.

So what might follow from such a selloff?  I went to my breadth database, which goes back to 2010, and I identified all occasions in which over 400 of the SPX 500 stocks closed at five-day lows and over half closed at 20-day lows.  Out of 3298 market days, only 38 met these criteria.  In other words, such broad selloffs have been rare.  Interestingly, instances of these selloffs have tended to cluster.  We had four occasions in early 2020; four in late 2018; three in August of 2015; and seven from August to November, 2011.  Across all 38 instances, there was a tendency to bounce the next day (24 up, 14 down for an average gain of +.93% vs. +.03% for the rest of the sample).  By ten days later, there was no upside edge whatsoever.  What was striking was that, over the next ten days, the market moved up or down more than 4% on fifteen of the occasions.  In other words, volatility tended to persist; direction was a crapshoot.

There is a temptation among short-term traders to look for bounces in assets that are oversold.  The problem with this idea is that we need to understand *why* we have gotten to such an oversold point.  The recent market activity has been abnormal.  That is why only a little more than 1% of days since 2010 have shown such weakness.  When a bank is at risk of failing and other banks are moving lower in sympathy, the result is a level of volatility that tells us that investors are questioning underlying value.  The first step in charting a trading or investing strategy is to recognize that we have entered relatively uncharted waters.  Trading with "discipline" and blindly following the "setups" and ideas from earlier this month is dangerous indeed.

Further Reading:

Using Breadth and Strength to Track Market Cycles


Sunday, March 05, 2023

The Most Important Factor in Successful Relationships


As I emphasized in the Trading Psychology 2.0 book, research in psychology is clear that we are most productive, creative, and successful when we experience high levels of happiness, fulfillment, energy, and closeness to others.  This is an important reason why burnout is such a risk in high performance fields.  Once we prioritize tasks over our well-being, we drain ourselves of the very things that we need to be at our best.  Imagine if someone cared about you and said, "I want to spend more time with you" and you responded, "I don't have time for you!"  That would never happen in a truly loving relationship, but it's basically how many of us relate to ourselves.  

Abraham Maslow, the well-known psychologist, made the distinction between deficit needs and being needs.  A deficit need is one in which I try to fill something missing in myself.  For example, if I don't feel that I am lovable as I am, I may seek a partner who is so needy that they will stay with me.  I am filling a gap in my life--and in my self-esteem.  If I am secure and want to maximize my life, I will seek a partner for their values, strengths, and achievements.  Indeed, in a good relationship, a partner typically possesses strengths that we lack.  That is how relationships make us better:  we absorb the positive qualities of who we are with.  If, however, I'm threatened by the strengths of the other person, I will respond to them with insecurity and defensiveness and, eventually, the relationship will fail.

Good relationships are built on a foundation of positives.  Unsuccessful relationships are fundamentally self-focused, using other people to (vainly) fill our gaps.  When we seek out people based on their needs, their growth and development become threats to us.  That is how many marriages end.

This is as true in work relationships as personal ones.  A great hire for a team is someone who makes everyone else better with unique skills and experience.  A secure manager looks for people who make them better; an insecure manager looks for people who won't leave them.  A secure leader celebrates the successes of others; an insecure manager responds with envy.

The most important factor in successful relationships is the desire to find people who are better than us in some areas of life.  We become who we surround ourselves by.  Our approach to relationships can either become an engine of growth or a prison of insecurity.

Further Reading:

Our Relationships Shape Our Relationship With Ourselves