The Art of Asking the Right Questions

Note the premise of the Cooperrider quote above:  our questions create our world.  If you want to know--truly know--someone, find out the questions they are asking.  For years, I've participated in recruitment at hedge funds,  helping hire portfolio managers and members of portfolio management teams.  In their interviews, many candidates want to talk about what they know.  Instead, it's worthwhile probing about their questions.  What answers are they seeking?  

Research at multiple money management organizations finds that the number one trait of successful traders is intellectual curiosity.  Not discipline.  Not achievement motivation.  Not the ability to control emotions.  What makes for greatness is the unquenchable desire to learn and know.  Show me a person who isn't actively asking questions and I'll show you someone with a limited capacity to learn and develop.

An important role of trading coaches is helping market participants ask the right questions.  Many times, the questions we find ourselves asking are ones about ourselves:  mistakes we've made, ways we can make more money.  The right questions, however, are often about markets:  how they are moving, what is driving them, the patterns they are displaying.  The focus on trading psychology naturally leads traders to look inward, but the best questions involve the markets and the unique opportunities they are displaying.  It's from new questions that we can generate fresh answers and directions.  I recently began to explore rotational flows within the equity markets: which sectors and industries are strong and weak, and the degree to which they are moving together or separately.  It turns out rotational days display very different opportunities from trending days and need to be traded quite differently.  Focusing on what I think the market will do--and especially on what I want it to do--is a great way to blind myself to what it's actually doing in real time.

What two or three things can I do today to make my day successful and fulfilling?  What can I do to make the week a success, personally and professionally?  What is the one change I can make in my life to improve my relationships?  My energy level?  My connection to my community?  When we ask the right questions, we become more able to live life intentionally. 

Against that backdrop, the one true failure in life is to live an unquestioned--and unquestioning--life.  Life on autopilot is a static life, a life that falls far short of our potential.  Recently I found myself wanting to wake up earlier in the morning and get more accomplished before my usual appointments.  I asked plenty of questions about how I could get myself to start my day earlier.  All were the wrong questions.  Eventually, the right question came to mind:  What could I tackle first thing in the morning that would be so challenging, interesting, and stimulating that I would *have* to wake up early?  The wrong question was about time management.  The right question was about establishing the right priorities.

What are the questions you're asking about your trading?  Your relationships?  Your life?  Those questions will define the answers you find and, ultimately, they will shape the world in which you live.  

Further Reading:

Purpose, Passion, and Why Traders Fail

Is Your Trading Purpose-Full? 

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Three Best Practices for Making Lasting Life Changes

 

When my colleagues and I reviewed the research literature on psychological change processes, an interesting finding came to light:  It's relatively easy to make changes and relatively difficult to sustain those changes.  This is best appreciated in the field of addiction psychology, where relapse is viewed as an intrinsic part of the change process.  Much of what is written in the area of trading psychology focuses on making changes, with less focus on ways of making those changes stick.  Too often, our efforts at change are like our New Year's resolutions:  well-intended, but fleeting.  Fortunately, research in psychology points the way to making changes last.  Here are three best practices that can help us turn negative patterns around, build new and healthy patterns, and make those changes enduring parts of our lives:

1)  Associate your desired changes with distinctive states of mind and body - Perhaps the most important finding from the aforementioned review was that change is much more likely to last if it is accompanied by shifts in emotional experiencing.  In counseling and therapy, for example, people are most likely to change and hold onto their changes if they are  frustrated by their old patterns and enthusiastically involved in the change process.  Simple talk with a coach or counselor, in itself, is not enough.  It's when we acutely feel the need for change and are eagerly involved in making changes that we are most likely to internalize new ways of doing and viewing.  I recently spoke with my grandson, Ed, who has made a daily commitment to hitting the gym and engaging in rigorous workouts.  Interestingly, as his body has developed, so has his mindset.  In the pumped up state, he internalizes a new sense of himself--and that carries over to many areas of his life.  Similarly, traders I've worked with have reached out to teammates and peers to make a new process a shared experience, creating a fresh social/interactive source of motivation.  Energized by the experience of mutual discovery, those traders find themselves more focused and energized in their trading.

2)  Integrate your desired changes into your daily routine - Ultimately, we want to turn our changes into positive habit patterns, so that we don't have to rely on motivation to do the right things.  What I have found most helpful is to make my desired actions a part of my early morning routine, so that each day begins as a change experience.  Suppose, for instance, that we wanted to develop ourselves spiritually.  Simply thinking spiritual things or reading spiritual texts won't necessarily help us internalize our own spirituality.  Engaging in active prayer or meditation each morning, on the other hand, provides us with a daily, positive, soul-full experience.  Similarly, if we want to become a more caring and loving family member, we have to go beyond good intentions and thoughts and actively set aside time each day for quality time with our loved ones.  Yes, I wake up early in the morning and give my cats food and water and hugs because I love them, but it's equally true that I love them because I spend committed time with them each day.  We become what we do.  A great way to make large changes is to make small changes consistently and build on those.

3)  Keep doing new things - Routine is necessary to build positive habit patterns, but life becomes stale when it is dominated by routine.  Yes, we have reliable and consistent trading processes--and we need those--but we grow when we tackle fresh ways of trading, new markets, and different strategies.  Of course, we engage in those new efforts with small size initially so that we can survive our learning curves, but the joy of discovery and learning pays significant dividends that energize all of our work.  When we make innovation part of our personal and professional lives, we engage in an evolutionary process, where each new thing that we do is a "mutation".  Many of these novelties will not have adaptive value--hence the wisdom of "fail fast"--but the few that thrive will sustain our development and become springboards for yet further innovations.  Imagine tackling one innovation each week.  If only 10% of those efforts prove useful in the long run, we will have gained five profitable additions to our trading.  There are other benefits as well.  Psychologically, the excitement of discovery provides us with the fuel to sustain new learning and, over time, enables us to internalize a sense of creativity and productivity.

There is so much more to changing our lives--and our trading--than writing in a journal and adding items to our "to-do" lists.  Expanding our routine keeps us locked in routine.  Change comes from fresh experience:  it's a function of doing new things in new ways and regularly reshaping our routines.  To build on Churchill's insight above, to change often--and find our perfection--we must live life creatively. 

Further Reading:

Cultivating Winning Habits

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How to Assess the Personality of the Stock Market

 

Unsuccessful traders look for markets to trade in a style that fits *their* personality.  They look for momentum or trend or reversals of "overbought" or "oversold" moves.  By imposing their biases on markets, they become inflexible and unable to adapt when the market's personality changes.  

Lately, we've seen the stock market's personality shift literally from day to day, as range-bound action has alternated with strong directional moves.  Traders who expect the market to follow themes related to macro and fundamental developments (shifts in inflation, interest rates, economic data, earnings, etc.) have found this rapid shifting of market action to be challenging.  Many traders look for consistency from day to day--thematic continuity--when the market is behaving more like a market of stocks than a unified stock market.  Consider:  over 70% of consumer discretionary stocks (XLY) and energy shares (XLE) closed over their respective five-day moving averages on Friday, but that was true for only a bit over 30% of consumer staples stocks (XLP) and only 20% of real-estate shares (XLRE).

The opposite of a trending stock market is not a choppy market.  The opposite of a trending market is a rotational market.  Many times, the market will indeed follow themes, but the themes play themselves out in relative terms.  Perhaps growth stocks are outperforming defensive sectors; perhaps small caps are outperforming large cap stocks.  The patterns of what is strong and what is weak define the themes for a given market session.  

Part of the challenge of short-term trading is that we cannot blindly assume that yesterday's patterns of strength and weakness will play themselves out today.  Rather, we have to first sit back and observe the various components of the market and how they're behaving to identify today's market personality.  This is key to trading psychology:  an active trader (as opposed to an investor) does not attempt to predict market action based on top-down criteria.  The active trader waits to see the bottom-up activity that reveals the patterns of trading here and now.

Several tools are helpful in assessing the market's personality from day to day:

1)  Volume (and especially relative volume) - How does the volume at a give time of day today compare to yesterday's volume at that time of day and the usual volume at that time of day?  If volume expands meaningfully, we want to see how stocks are behaving with the new market participation.  This will tell us who is participating and whether that participation is showing up in trending behavior or in the relative strength of one market segment vs. another.  Conversely, when volume dries up, we want to see how different parts of the market are impacted by the lack of participation.  What moves directionally in a quiet market tells us an important story.

2)  NYSE TICK - How many stocks are trading on upticks vs. downticks as we move forward in the session and--most crucially--how is the upticking or downticking impacting the price of various segments of the market?  We recently had a range-bound day in the morning that displayed strong selling pressure with negative TICK numbers.  Many parts of the market failed to make new lows on this selling.  The absorption of the selling pressure alerted the savvy trader that sellers would be trapped and, sure enough, their covering helped create a trending move during the day.  Very often, new extremes in the TICK numbers alert us to strong buying or selling interest--and how that interest moves the market (and different parts of the market) tells an important story.

3)  Short-term overbought/oversold readings - I use the adaptive moving average system from John Ehlers, which shows how shorter-term moving averages cross below and above longer-term ones.  The adaptive part is that the readings for short-term and longer-term change depending upon the cyclical character of the market.  As Ehlers has pointed out, this helps remove whipsaws from the indicator.  Basically I want to see short-term oversold levels occurring at successively higher price lows or short-term overbought levels occurring at successively lower price highs.  When sector ETFs show different patterns of overbought and oversold, that highlights a rotational market.  In a strongly trending market, the cyclical quality of the price action will break down and we will get prolonged overbought or oversold readings across multiple market sectors.

An important edge comes from being quicker than other participants to see how the market's character is playing itself out--and how it might be changing over time.  Many traders underperform because they fail to see relative themes playing out in real time.  If your trading is habitually bullish or bearish, you know that you're not doing a good job of assessing and following the personality of the market.

Further Reading:

Adapting to Changing Markets

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What Makes for Success: Five Perspectives From Trading Psychology

 

Here are a few observations from my recent research and work with traders:

1)  The success of a trader is directly related to the speed by which they turn losing trades and drawdowns into actionable improvements.  The best traders engage in active review processes to ensure that they learn from setbacks.  Those reviews also allow them to learn from successes.  A major source of poor performance among traders is failing to engage in timely and regular deliberate practice.  Successful market participants study themselves intensively, just as they study markets intensively.  Unsuccessful participants don't study; they are too busy trading.

2)  There are two types of traders:  a) those who are risk-takers and need to learn to limit losses; and b) those who are risk-minimizers and need to expand gains.  We tend to manage our trading the way we manage risks and rewards in other areas of life, because--ultimately--we are managing ourselves emotionally.  The challenge is to understand how we are wired and how to best express and manage that in our trading.  Many trading problems occur when we attempt to take risk in ways that interfere with our self-management.

3)  I'm hearing more from relatively inexperienced traders who are harvesting money by selling option premium.  It makes me cautious.  The history of 2023 thus far has been for game-changing news to greatly impact how markets trade--and how they trade relative to one another.  Note the recent interest in the shadow banking system and its vulnerabilities:  here, here, and here.  After recent banking concerns, it wouldn't take much of a headline to throw markets into a tizzy.  The idea is to maintain flexibility even when acting decisively.  Maintaining "conviction" has not worked well for many traders thus far this year.

4)  Recent posts have focused on breadth as measured sector-by-sector--and especially the phenomenon of breadth thrusts.  My latest research examines differences in breadth between U.S. sectors and how these are related to SPX returns going forward.  At present, consumer staples shares are outperforming consumer discretionary stocks by a pretty good margin over 5 and 20-day periods.  Going back to 2020, when that has occurred, next 10-20 day SPX returns have been negative and significantly below average.  Shifts to more defensive positioning among sectors appear to precede overall market weakness, an idea I'll be exploring in detail going forward.  Breadth shifts may be as important to forward returns as breadth thrusts.

5)  Imagine that you are at a racetrack and you are allowed to alter your bets at set intervals during the race.  No doubt you would alter your risk taking as the race evolves.  The best traders develop good bets, but then actively update risk and reward over the life of the trade to maximize gains and minimize losses.  The inability to update one's "bets" in the face of changing market conditions has been a major source of performance problems so far this year.  Many traders lack a robust process for walking forward and updating risk and reward in real time.

Further Reading:

Overcoming Self-Criticism and Trading on Tilt

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Breadth Thrusts in the Stock Market: What Comes Next?

 

The previous post noted a late week bounce in stocks that had a defensive quality, with consumer staples and utility shares outpacing stocks in such sectors as energy and consumer discretionary.  On Monday there was another bounce, but the percentage of energy shares above their five-day moving averages went from about 22% to almost 96%.  The beaten down real estate stocks went from 43% to 63%; financials went from 17% to 58%.  Consumer discretionary shares went from 25% to 46%.  Tuesday the overall market (SPY) dipped, but again we saw a rising percentage of XLY, XLE, XLF, and XLRE stocks above their five-day averages.  By Wednesday, fully 94% of all SPX stocks were trading above their five-day moving averages.  In other words, we went from a defensive market theme to an aggressive one, creating a breadth thrust:  the great majority of shares participated to the upside.  This strength continued through the week.  The change of market theme was signaled by a shift in the patterning of market breadth.

So what does this market breadth thrust suggest going forward?  We can look from two perspectives:

1)  The presence of strength - I went back to 2006 and identified all market occasions in which more than 90% of SPX stocks were above their 3, 5, and 10-day moving averages at the same time.  Interestingly, out of well over 4000 market days, this only occurred on 42 occasions.  Over the next five trading sessions, the market was down by an average of -.26%, compared with a gain of +.18% for the remainder of the sample.  No particular edge here, even going out 20 days.  Returns over a next 20-day period were volatile, with 17 of the 42 occasions rising or falling by over 5%.

2)  The absence of weakness - If we get a true breadth thrust, we should see very few stocks demonstrating weakness.  I track the number of NYSE stocks giving sell signals on two technical indicator measures:  the Bollinger Bands and the Parabolic SAR.  These track price action over differing time periods.   On Friday, we had 10 or fewer stocks giving sell signals on both measures.  Out of almost 900 market days in my database, this only occurred on 7 occasions.  Again, very unusual.  The number of occasions is too small for reliable statistical inference, but it is noteworthy that the market overall underperformed over the next ten trading sessions and outperformed 30 days out.  Most interesting, four of those seven instances occurred as a cluster in April of 2020.  The question this invites is whether the current period (possible Fed pivot in rate policy due to bank concerns) is similar to the 2020 period (Fed pivot in the face of COVID impact).

Analyses such as these are meant to help in the formulation of credible market hypotheses, not the generation of infallible ideas.  Breadth thrust may be most important in the context in which it occurs.  If it occurs as a "blowoff" following a period of strength, we would expect volatile and negative returns going forward.  If it occurs following a protracted selloff, we would expect volatile and positive returns going forward as a function of short-covering and new buying.  At present, I'm open to the notion that we are, indeed, seeing a regime shift in the stock market, reflecting a change in central bank policy.  If that is the case, near-term weakness could become an opportunity to participate in longer-term cyclical strength.

Further Reading:

What Market Strength Told Us Earlier This Year

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