Three Best Practices of Successful Traders

 

With this post, I'll be taking an extended sabbatical in order to complete my next book and related projects.  I thought a worthy final post would summarize the best practices of traders who have experienced success in 2023, with the aim of improving yourself and your trading processes in 2024.

Best Practice #1:  Moving From Reactive Trading to Planned Trading

Very often, the psychological challenges that traders face occur because they are making trading decisions in the heat of the moment, when they are most likely to be stressed and impulsive.  Successful traders have intensively studied their most successful trading and know what they do best.  They then turn their best practices into trading rules, so that they know exactly what kinds of opportunities to look for in markets, how to express those opportunities, how to size the positions and manage them, etc.  The beauty of knowing what you do best and how you do it is that you can then mentally rehearse the right actions as part of preparation for the day.  Biofeedback and visualization methods can be helpful in that mental rehearsal.  Keeping the right kind of trading journal also helps greatly in focusing on your learning lessons.  Knowing your best trading also enables you to stand apart from markets when opportunity isn't present.  The best traders I work with patiently wait for their opportunity and don't feel a need to trade.  They are like the baseball batter who knows the pitcher well and is willing to wait for a good pitch in the strike zone.

Best Practice #2:  Drawing Upon Your Strengths     

Here is a short personality quiz designed to identify your strengths.  Here is a way of interpreting the results.  The successful traders I've worked with know who they are, what they're good at, and what excites and challenges them.  They also are aware of their flaws and can leverage those into strengths.  Because they find ways of trading that leverage their strengths and are meaningful to them, they have no problem staying engaged in markets during challenging times.  They also draw upon their strengths outside of their involvement in markets, so that their personal activities are an ongoing source of fulfillment.  The right work-life balance isn't just spending time in activities outside of trading; it's making use of the best of you in relationships and in personal pursuits.  The number one occupational hazard for full-time traders is burnout.  When we don't achieve work-life balance based on what is meaningful to us, we lose work efficiency and we become less creative.  I've often advised traders to always make sure they have passions in life that are greater than their passion for trading.  If your only strength is trading, that becomes a vulnerability.

Best Practice #3: Creativity   

The greatest weakness of traders overall is that they are looking at the same markets, processing the same information, and trading from the same charts and ideas as others.  There is very little original in their thinking or trading.  They are like the business owner who sets up a shop to compete with surrounding businesses, but who copies what they do.  If you don't do different and distinctive things in markets, you won't achieve different and distinctive results.  This is a topic I address in the Trading Psychology 2.0 book and that I've also tackled in the blog here and here.  As the book emphasizes, there are specific techniques and processes we can learn to become better and more differentiated idea generators.  The key is to look at new information and integrate information in new ways.  Teamwork--networking with others who have backgrounds and skills different from us--is a valuable practice that can help us expand our horizons.  In my own trading, I have found the best results by focusing on data that others don't look at, from high-frequency measures of buying and selling to patterns of breadth across time frames among equity sectors.    

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I hope this helps you coach yourself to greater success.  As further resources, please check out this series of articles on trading psychology techniques (links to all articles at the bottom of the post); this post on best practices; and this post on learning from our best trades.  If there is a specific trading psychology topic you are interested in, there's a good likelihood you can find something by doing a search for "TraderFeed topic".  So, for instance, a search for "TraderFeed trading discipline" yields relevant posts.  If you are interested in a collection of self-help techniques for your trading psychology, The Daily Trading Coach book might be most helpful.  Best of luck for a happy, healthy, and prosperous 2024!  

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Can This Market Rally Continue?

 

The U.S. stock market has rallied sharply off its late October lows, bringing us to fresh highs in several large cap indexes.  On Thursday we saw particular breadth strength with over 2500 stocks across the major indexes registering fresh monthly highs and over 1700 making new three-month highs.  At the same time, only 188 and 86 stocks hit new one- and three-month lows.  Thanks to the dovish shift by the Federal Reserve and a dramatic turn lower in interest rates, the buying was broad, lifting both small and large cap shares.  When we see large moves across asset classes--fixed income, currencies, equities--we know that something fundamental is afoot among macro investors.  But what comes next?  After such broad strength, do we see further upside momentum or reversal?  Let's take a look at recent market history.

As I have indicated in the past, strength (as measured by the number of shares making fresh new highs) and weakness (as measured by new lows) need to be considered as relatively independent variables.  To be sure, the two are related--since 2016 (almost 2000 market days), the correlation between 1 month new highs and lows is -.54 and between 3 month new highs and lows is -.46.  What this means is that only about 25% of the variance in new lows is accounted for by the number of new highs and vice versa.  (All data from Barchart.com).

When we examine the historical data since 2016, we can see the importance of considering strength and weakness separately.  For instance, we've only had 24 days in that time where three-month new highs exceeded 1000.  Over the next 10 trading sessions, SPY averaged a loss of -.11%, compared with  +.23% for the remainder of the sample.  Over the next 50 trading sessions, however, SPY gained an average of +3.81%, well more than the average gain of +2.39% for the remainder of the sample.  Indeed, when we have had an explosion of new highs, the market was up 21 times, down only 3 over the next 50 days.  Over the next 10 days, it was up 11 times, down 13.

Conversely, when three-month new lows are below 100 (N = 475), returns have been superior over the next 20 trading sessions, averaging a gain of +1.99% vs. an average gain of +.59% for the remainder of the sample.  In other words, when new highs are high, we have seen momentum over a longer time horizon; when new lows have been low, we see shorter-term upside momentum.  When new highs are high *and* new lows are low, the pattern has been similar to that for elevated new highs:  weak returns over the next ten trading sessions; superior returns over a 50-day horizon.

No doubt, forward news on inflation and growth will impact rates markets and that, in turn, could move stocks.  During rising trending/momentum markets, I have found it to be helpful to look for short-term oversold points in the market (points during which the majority of stocks close below their 3 and/or 5 day moving averages) that occur at higher price lows.  Those dips are opportunities to participate in the broader trend and also create logical spots to stop out if the uptrend is broken.  At least for now, markets are treating the Fed news as a game changer.  Recent historical evidence suggests that the rising tide lifting all boats often continues, though not necessarily in the short run.

Further Reading:

Using Emotion to Change Emotion

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Establishing Targets For Our Trades

 

Recently, I've heard from a number of traders regarding the challenge of establishing effective targets for their trades.  What has been happening in most of these situations is that a trade will go the trader's way and be profitable.  That leads the trader to hope for further gains and sometimes even add to the position.  At that point, the trade reverses and leaves the trader with no gain or even a loss.  The frustration caused by such "choppy" market conditions can then fuel subsequent poor decisions and excessive losses.

This is one of those situations in which the best psychological strategy is also the best trading strategy.  It is imperative to study the markets and instruments you're trading and identify clearly how far moves are likely to go in various regimes of volume and volatility.  If you're trading a stock index, such as the SPY ETF or the ES futures, the market VIX will be highly correlated with the average size of moves on any time frame.  Similarly, the volume of the instrument will be quite correlated with the size of market moves.  If SPY is trading an average of, say, 70 million shares per day, you can do very basic research and recognize that daily moves of much more than 1% will be difficult to achieve with such volume.  For a day trader, if today's volume is not significantly greater than recent volume and you get a breakout move of over half a percent in a 12 VIX market, you know that the conditional probability of the move going much further in your favor is pretty low.  If the VIX was greater than 20 and volume was exceeding 100 million shares, you'd be on firmer ground holding for further gains.

One thing I found very helpful in my own trading is to know what my anticipated holding period is for a trade and to know, precisely, how much directional movement can be expected during that period across different segments of the market day.  An expected holding period of an hour would lead to larger moves in stocks during early morning hours, for example, than at midday.  By studying the size of market moves for given holding periods, levels of volume and volatility, and for time of day, I can set rational, reasonable targets for profits.  That makes the exit process automatic, and it avoids the major pitfall of making execution decisions in the heat of battle.

The key is making trading planned and not reactive.  Once you have a plan, you can mentally rehearse it and base your exit on a reasonable goal, not a wish.  Trading becomes emotional when we act on hopes and fears and not hard information.  The trade exit should take into account what the market is typically giving you; expecting more is perfectionism and a setup for frustration.

Further Reading:

A Simple Strategy for Making Your Trading Better

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Where I See Opportunity: In The Market And In Ourselves

Note:  This post is a summary of the webinar I held with traders this past Monday.

I've been involved in trading the U.S. stock market since 1977.  My professional work with traders began in 2003 and continues to this day.  So I've seen my share of markets, and I've seen quite a bit in terms of what goes into trading success.

What I find noteworthy in recent markets is the degree to which more and more money is being put to work, seeking relatively short-term advantages in the marketplace.  Quite a few of the hedge funds and money management firms around the world have greatly increased their assets under management.  They have also expanded operations across markets and across geographic regions.  When I started my performance coaching, it was common that funds specialized in specific strategies and consisted of solo portfolio managers, sometimes aided by assistants.  Now, we find many funds trading multiple strategies ("multistrat") with large teams.  This means that each team acts as a miniature fund, building diversified portfolios.  Back in the day, my work was largely limited to traders in NY and London; now it's truly global.

At the same time that trading organizations have exploded, their tolerance of risk has gone down.  Back in the day, a manager could lose up to 20% in a year before being stopped out.  Now it's not unusual for that number to be 5-10%.  What happens in practice is that risk managers don't want to see their teams stopped out, so they reduce risk taking well before the downside limits are threatened.  Once a trader goes down a few percent, their allowable risk is often cut.  So, for instance, if my capital is cut in half when I go down 5%, I now have to make 10% on the new capital base just to break even.  That is daunting, so--in reality--no one wants to go down more than a very few percent. 

Over the years, I've seen the same dynamic among day traders and proprietary trading firms that largely engage in short-term trading.  They do not typically have large capital bases and thus need to manage risk tightly.  Historically, they've made their money by leveraging capital, further ensuring that risk had to be carefully managed.  As day trading has grown, especially since the period of the "meme stocks", we find more and more participants chasing moves, but with limited capacity for loss     

The net impact of these developments is that we have very crowded markets jumping in on moves and needing to bail out when the moves don't work out.  If a trend seems to be under way, there is a lot of "chasing" of the perceived opportunity, and when the trend reverses, there can be equally significant abandonment of the positions.  On balance, this has created choppier markets.  To the degree that this choppiness is a function of more and more capital managed more and more tightly, I expect this choppiness to continue.

So where does the spirituality of trading fit into all this?

My research has found that, at turning points in the market, we see clear shifts in the breadth of market moves, as well as changes in relative strength.  This occurred in late October, when heavy selling brought us over 1900 fresh one-month lows and over 1600 three-month lows among NYSE stocks.  For the next few days, we moved still lower--by about 2%--and yet fewer stocks registered new lows.  Indeed, we began to see relative strength emerging in a few sectors of the market.  That led to a burst of buying (and short covering!) and, by November 2nd, we suddenly had new highs outnumbering new lows.  This created a momentum move that now has taken us to new highs in a few parts of the market.  

(Interestingly, as we've moved higher the last few days, breadth has stalled out and we're seeing shifts in relative strength among sectors.  I'm watching the market closely for the possibility of reversal).

With the crowding of market participants and limits on allowable losses, the two trades that set up most clearly are momentum moves (the crowd chases a move) and reversal moves (there is initial bailing out of previously popular ideas).  The breadth and relative strength measures that I track daily--for the market as a whole and sector by sector--can be found on Barchart.com; StockCharts.com and MarketCharts.com.  Backtesting of momentum and reversal moves can be found via SentimenTrader.com and QuantifiableEdges.com.  Creating a database of market and sector breadth has been invaluable in detecting when there is momentum and when moves are stalling. 

As I stressed in the online book, Radical Renewal, our greatest trading problems occur when our egos take control of our market activity.  We impose *our* views on markets, and we trade--not because of distinctive opportunity--but because we *need* to be active and make money.  Once our egos are in control of what we do, we become poor listeners to what markets are actually doing.  As a psychologist, if I am filled with my own preoccupations while I'm speaking with a client in therapy, the odds are good I won't be very helpful to that person.  I need to listen to them and act based on deep understanding.  So it is with markets.

What I refer to as the spirituality of trading is putting ego aside and training ourselves to be sensitive listeners.  If we can master that in markets, it will be great training for our personal and work relationships.  The right trading makes us better as people.  The goal is to trade selectively, from the soul--not reactively, from the ego.

Thanks for your interest--

Brett

Further Reading:

Best Practices of Successful Traders

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Building Yourself By Building Your Trading

 

The common view in trading psychology is that we can work on ourselves and that will help us better weather the ups and downs, risks and rewards, of markets.  Certainly that is true:  as I describe in The Daily Trading Coach book, there are many research-backed techniques in psychology that provide tools for handling stress, uncertainty, overconfidence, and negativity.

A complementary perspective, not as well appreciated, is that by working on our trading, we end up developing our strengths and building our capacity for leading meaningful and purposeful lives.  Indeed, how we work on our trading helps shape our ability to achieve our life's goals.  For example, in cultivating our creativity as traders--training ourselves to perceive opportunities that others typically miss--we become more creative in guiding our lives, from our relationships to our careers.

This raises the important question;  What is the purpose of your trading?  How can our trading provide us with a life P/L and not only financial rewards?  The short answer to this question is that, like a good gymnasium, successful trading pushes us to develop strengths that we don't currently make use of.  Every day, every week in trading challenges us to broaden and build who we are.

Monday's webinar has filled up; I will likely hold another one in the not too distant future.  For those who could not make the webinar, the next TraderFeed post will summarize the main points of the session, as well as topics raised in discussion.  Thanks for your interest!

Brett        

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Developing Spirituality Through Our Trading - Free Webinar

 

Radical Renewal is an online book written in blog format.  Each blog post is a chapter, covering a topic we rarely consider:  the spirituality of trading.  About a year ago, I wrote a popular post on "Evidence-Based Spirituality", detailing how spiritual practices have been found to boost our emotional and physical well-being.  Still, the concept of trading spirituality almost seems like an oxymoron.  After all, isn't trading about making money?!

We know that emotions can get in the way of trading, but why do rational people suddenly face problems like "tilt" when they are immersed in markets?

The answer that Radical Renewal proposes is that problematic trading comes from the ego.  Successful trading comes from the soul.

So what is the soul?  How can we develop our soul-fullness?  How can we make trading a renewing, fulfilling activity and not an activity that takes over our lives and depletes us?  What does recent research evidence tell us about how we can live lives of fulfillment and meaning?

On Monday, November 27th at 4:15 PM ET after the NYSE close, I will host a free online webinar on the topic of trading spirituality.  We will look very specifically at ways in which we can develop spiritually through our work in financial markets.  Signup info will be following...stay tuned.

A few questions to leave you with:  

*  What are you doing in your trading right now that is making you a better person?  

*  How does your trading benefit your personal relationships?

*  What is so meaningful in your trading processes that you can feel fulfilled even during inevitable periods of drawdown?

I look forward to seeing you soon--

Brett

Best Practices in Trading Psychology: Consistency, Innovation, and Balance

 

Traders I've observed over the years who have achieved consistent success display three important qualities:

1)  They trade with repeatable processes, so that their trades are planned and not reactive.  They have clear, structured ways of generating ideas, and they have clear structured ways of finding optimal expressions of their ideas; sizing positions based on those expressions; and managing the risk of those trades.  What we do repeatedly becomes relatively automatic:  it becomes part of us.  A great way to minimize emotional, reactive trading is to follow trading practices that are well-defined.  If we can capture what we do as a set of rules, we have the makings of a checklist that can guide our decision-making in the heat of the moment.  A huge part of developing as a trader is finding coaches/mentors who can guide you in the discovery of the trading processes best suited for you.  What are your personality strengths?  Your cognitive strengths?  Those will help determine how you generate ideas and manage the trades based on those.  Ideally, the rules and practices that comprise your planned trading are derived from your trading successes, not simply borrowed from others.  

2)  They are always finding new ways to win.  Consider a basketball team.  They practice a range of offensive plays and defensive alignments.  They might run the ball against one opponent; they might move from a zone defense to man-to-man for another.  A big part of coaching is helping a team adapt what they do best to exploit the opponent's vulnerabilities.  Similarly, markets are ever-changing and the drivers of market behavior shift over time.  The best traders evolve.  The goal is not simply to find a trade an "edge", but to exploit ever-changing edges in dynamic markets.  The best traders will explore and research, just like any successful company that conducts R&D to meet the needs of a changing marketplace.  Successful traders will push the comfort zone and look for advantages over time frames, markets, and strategies that are unfamiliar.  If we're not challenging and scaring ourselves periodically, we're not growing.  

3)  They achieve a balance between work and life.  Over the years, I've seen many successful traders burn out.  Their burnout is not necessarily limited to their trading; they sometimes blow up in their relationships or in their physical health.  It's romantic to think about work as our passion and being involved day and night in our quest for success, but that is not what makes for a sustained, successful career.  The goal is to find a lifestyle that sustains energy and passion over time.  That lifestyle typically includes activities for physical well-being and the emotional well-being of relationships.  It is not clear to me that we can sustain our love for markets and trading if we cannot sustain love in our lives.  It is not clear that we can sustain our energy and passion for trading if we cannot sustain physical energy in our lives.  An Olympic athlete knows the importance of staying in peak conditioning as part of training and preparing for success.  Each of us needs to find the peak conditioning in our lives that can sustain our best efforts in markets.

Approaching our trading in the right way is the best way to cultivate a positive trading psychology.  It's not that you'll magically trade better if you're in a better frame of mind.  Rather, you'll be in your optimal mindset when you approach trading the right way.  

Develop routines based on your strengths.  Push the boundaries in finding fresh opportunity.  Live a full life that maximizes your energy and mindset.  Identify what you do that is truly great and build upon that.  You are not meant for a life of mediocrity.  Have the vision to dream and the practical sense to pursue that dream, step by step.

Further Reading:

Greatness in Life and Trading

What is Your Path to Greatness?

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Self Respect: The Missing Ingredient in Our Efforts to Grow

A friendship or romantic relationship can get through many ups and downs.  At times, during our hurt, it can feel as though our affection has vanished.  Often, however, we can return to closeness because our very hurt tells us we care.  Indeed, relationships can grow stronger from periods of disappointment.

What relationships cannot survive is a loss of respect.  When we feel disappointment and hurt, often it's because of actions that the other person has taken.  When we feel a loss of respect, it's because the other person's character has come into question.  We can tolerate a disagreement with a spouse or business partner and often grow from the resolution.  What is far more difficult to accept is betrayal and dishonesty.  The person we trusted is not the person we had hoped for.  The issue is not bad actions, but bad actors.

Once respect is lost, can there be genuine caring, liking, and love?

Missing in many discussions of personal growth and positive psychology is the element of self-respect.  If we value and respect ourselves, we naturally gravitate to what is good for us and avoid what is damaging.  In the past, I was offered opportunities to work with trading firms that I knew treated their traders badly.  I didn't bother to find out the compensation.  I said no.  It was exactly the same reason that I don't want to put harmful drugs in my body or maintain abusive relationships.  When we respect ourselves, our actions align with our well-being.

When we do things that we know to be bad for us or stay in situations we know to be harmful despite the presence of constructive alternatives, we act on the premise of self-disrespect.  How we treat ourselves is our relationship with our selves.  What we pursue in life is a reflection of what we ultimately desire for ourselves.  What we do with our lives mirrors our character.  An empty life, an indulgent life, a life without overarching purpose?  Without self-respect, there can be no positive psychology.

Self-respect grows from what we do.  It is when we act upon our values that we ultimately feel most valuable.  A great question for reflection:  What am I doing today that I would be proud to be acknowledged in my obituary?  If we're not doing something each day, each week that we are truly proud of, the result is self-betrayal and an erosion of self-respect.  

Life is a great gymnasium.  If each day exercises our character strengths, we grow the kind of self-respect that attracts the right opportunities and the right people.  We can't always be happy and we can't always be successful.  We can, however, always live today with integrity.  

Further Reading:

Trading and Self-Respect

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How To Transcend Trauma

Recently, I've been privileged to speak via Zoom with a number of those directly impacted by the Middle Eastern conflict.  It's been a dramatic reminder of how strong people can be, even when they feel overwhelmed and broken.  Most of us have been through a life event that has had traumatic impact, whether it be the loss of a loved one or an episode of threat and violence.  One of the real challenges of trading financial markets is that, if we don't exercise sound risk management, we can experience losses so great that they overwhelm us--personally, as well as financially.  Whenever an adverse event threatens what we value, the result can be stress and even trauma. 

As the group on Zoom reminded me, the above situations are different from what is happening now in the Middle East.  A traumatic event typically has a beginning and an end.  Once it's passed, we can focus on coping.  What do we do during a violent and scary war that has no foreseeable end?  How can we cope when we have no control whatsoever of what will happen today, tomorrow, and next week?

The eye-opening reality is that the people I'm speaking are, indeed, coping!  Yes, they cry and, yes, they feel unable to act at times, but they are doing what they can to be there for family, friends, and those they work with.  We sometimes fall into the trap of believing that being strong means being unemotional.  That's not at all the case.  Being strong is being empathic:  standing far enough from one's own concerns at times to feel with others and for others and share our experience with them.

The inspiring people on the Zoom call have helped me realize that transcending trauma involves three C's:  caring, connecting, and creating.  Caring means that we feel for others; connecting means we reach out to others; creating means we do for others.  It can be as simple as thinking about someone struggling, reaching out to them, and making them a meal.  The three C's take us for a time out of our own struggles and help us truly act from the soul.  

Amidst the loss of control that we feel during wartime, caring, connecting, and creating provide us with experiences of doing things that matter.  The most powerful thing we can do to transcend trauma is to gather the determination to not let events control us and to do things that make a difference.  Trauma is ultimately about powerlessness.  Transcending trauma is about finding islands of power in the midst of uncertainty.

I mentioned in an earlier post that Margie and I recently visited the World War II internment camp at Terezin in the Czech Republic.  There we heard about and saw the horrific conditions of the prisoners:  the overcrowding, the brutal punishment, the lack of health care, the death of friends and loved ones, and of course the constant fear of what would come next.  What was amazing was how the prisoners transformed a small living area into a place of worship where they could gather; how they were able to find materials to draw, write, and create artworks; and how they managed to support each other.  Caring, connecting, creating.  Even in a setting surrounded by death, they were able to affirm life.

I've come away from Terezin--and from my Zoom meetings--not confident that trauma won't happen, but reassured that, if it happens, I will have the role models and inspirations to transcend challenge and uncertainty.  All of us are likely to go through painful loss--in markets, in relationships, in our health.  As long as we can hold onto our humanity as caring and creative beings, we will be able to transcend--and eventually become role models for others.  

Forty years almost to the day, I was caught the wrong way in volatility and blew through my trading account, triggering far more than a loss of money.  Today I hit my high water mark amidst growing volatility.  

We can transcend.

Further Reading:

Emotional Trauma, Risk, and the Dark Side of Trading

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How to Achieve the Goals You Set

 

One of the most widely read TraderFeed posts in the last few years dealt with the topic of FIGS:  Focused, Intensive Goal Setting.  Too often, the goals that we set are not much more than good intentions.  New Year's resolutions are a notorious example.  How can we become better at actually achieving the goals we set?

As the previous post emphasized, when we focus our attention on fewer priorities and work consistently and intensively on those, we are much more likely to make progress than if we have a laundry list of changes to make and work on those as the need/desire arises.  So, for instance, if we want to get in good physical shape, dedicated daily time with gym equipment and running is a great start.  That time with lifting, stretching, and running has to challenge us, which means we always tackle more when a given level of effort becomes routine.  If our pursuit of goals is not focused, frequent, and intensive, we're unlikely to sustain a consistent growth path.

We are most likely to succeed if our goals become our commitments.  When I worked at a well-known hedge fund, the founder once commented that, "If it's not in your calendar, it's not part of your process".  This most certainly applies to our trading processes:  researching ideas, turning ideas into trades, monitoring markets, and managing risk/reward.  It equally applies to any of our purposeful activities, including the personal goals we set.

When we commit to our goal-seeking in the daily calendar and create a dedicated time for making efforts at improvement, we experience our desired future every day.  "Anyone who fights for the future lives in it today," Ayn Rand once observed.  Fighting for the future daily means that we experience a piece of our future consistently, making it an intrinsic part of ourselves.  What starts as passion and desire is expressed through regular effort and evolves into positive habit.  

Imagine that you have a single hour every day to pursue one goal that will dramatically benefit your trading, your health, your mindset, or your relationships.  Imagine that this is the first item to go into your calendar; routine work and home tasks have to fit around your one key objective.  Every day, without fail, you are going to use a slice of your day to be your own performance coach and bring your real self closer to your ideal self.  That way, you will spend a fraction of every day living in your future.

That is most likely to occur if we have very concrete targets to hit in pursuit of our goals.  If we want to lose weight, we want to define a challenging but doable objective.  If we are looking to improve our trading, we need to keep stats so that we can truly see our progress:  number of winning/losing trades, average sizes of winners/losers, overall profitability, etc.  If we are making improvements in our relationships, we want to very intentionally do more of the things that bring closeness, happiness, and fulfillment to our partners and to us.

Mental illness is when we live in the past every day.  Mundane life is when we simply live life each day at a time.  Greatness is when we live a consistent portion of each day in the future we are designing and building.

What future do you want to build?  How can you immerse yourself in that future today?

Further Reading:

A Cardinal Virtue of Trading

Blueprint for an Uncompromised Life

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Two Questions to Ask in a Weak Stock Market

 

I'm looking forward this week to speaking with developing traders at SMB Capital, where I will share many of the lessons I've learned working with successful portfolio managers and teams at top hedge funds.  For those interested in hearing some of those lessons, I'll also be talking with My Investing Club at 4:15 PM ET on Thursday the 28th; the link to register is here.  

As a rule, it's important to know what is happening at time frames larger than the ones you're trading and also to know what is happening at time frames shorter than your typical holding period.  The larger time frames place your trade idea into perspective, addressing whether--bigger picture--we are in range markets, trends, etc.  The shorter time frames provide you with the concrete information needed to turn a good idea into a good risk/reward trade.  So, for example, I might have the idea that stocks have entered a downturn due to "higher for longer" interest rates.  I might then wait for weak bounces at lower price highs to exhaust themselves to enter trades on the short side.  

When we become locked into single time frames, we can find good ideas but trade them poorly or we can find good trades that ultimately don't play out when they are swamped by what is happening in the bigger picture.  Success in markets requires the deeper thinking of idea generation *and* the faster thinking of trading.

The most successful traders, however, go beyond deep and fast.  They also see broadly.  They don't just look at their stock or market; they look at other stocks and markets to place what they see in context.  Specifically, there are two questions traders ask to think broadly:

1)  Is the price action I'm seeing correlated with what is going on in different markets?  Is this a move specific to a stock, sector, or overall stock market, or is there a bigger macro picture impacting currencies, rates, and international markets?

2)  Is the price action I'm seeing accompanied by significantly different volume, volatility, and breadth than we've been experiencing recently?  This gives us an idea of whether the market move is the result of new, larger participants entering the marketplace, which could help sustain a trend.

In the case of the recent stock market weakness, note that this began with the Fed announcement and subsequent conference call.  During that trading session, we saw sustained negative levels of the NYSE TICK that we had not experienced recently.  Following that session, we've seen very negative breadth and an expansion of stocks making fresh one- and three-month lows.  Most importantly, during this decline, we've seen a significant rise in longer-term interest rates and strength in the U.S. dollar.  In other words, the macro picture was perceived to have changed as a result of the central bank communications and larger institutions have acted upon this information.  Seeing such dynamics in real time is essential to both trading and investing.

I look forward to building on these ideas in my group coaching sessions this week.  If we can view markets deeply, quickly, and broadly, we'll be best positioned to know what to do and why we're doing it.  A good trade requires vision; great trading requires flexibility of vision.

Further Reading:

Short Term Trading With NYSE TICK - A Three Part Series

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Why Traders Are Losing Money In Recent Markets

 

We detect strength in the stock market and we buy.  We detect weakness and we sell.  Both occasions lose money.  What is going on?  In this post, we will take a look at market behavior and how market patterns themselves create trading psychology challenges.  The common assumption is that, if we can just maintain a good mindset, we'll be able to identify market patterns and make money.  This post will show that this is a gross simplification.

I examined the last three years of daily data, focusing on the SPY and the percentage of stocks in the Standard and Poors 500 Index trading above their 5 and 20 day moving averages.  (Data from the excellent Barchart site).  I divided the data set into quartiles and specifically examined what happens following periods of very strong (top quartile) and very weak breadth (bottom quartile).

When the percentage of stocks trading above their five-day moving averages was in the top quartile (approximately 74+%), the next five days in SPY averaged a loss of -.14%.  Note that this was during a period in which SPY rose by approximately 30% and the average daily gain was +.20%.  When the percentage of stocks trading above their five-day moving averages was in the bottom quartile (approximately less than 33%), the next five days in SPY averaged a gain of +.57%.  In other words, going with strength after a five-day period lost a trader money regardless of their mindset.  Buying stocks,after five days of weakness--when it's scariest to be jumping into the market--was solidly profitable and more than doubled average returns.

Hmmm...

So now let's examine average returns after 20 days of strength and weakness.  When 20-day returns have been strongest (over 73% of stocks trading above their 20-day moving averages), the next 20 days in SPY have averaged a loss of about -.31%.  This is eye-opening, as the average 20-day gain during this period was +.79%.  Conversely, when 20-day returns have been in their weakest quartile (fewer than 37% of stocks trading above their 20-day moving averages), the next 20 days have averaged a whopping gain of +1.85%.  Going with strength systematically lost traders money; fading weakness achieved superior returns.

In short, traders lose money when they focus on trend and momentum.  They are expecting strong and weak returns to continue into the future.  What actually happens on average, however, is reversal.  Stocks behave in a cyclical way.  When markets *do* display momentum and trend, it is generally because longer-term cycles are dominant.  The up or down phase of a longer-term cycle overwhelms any reversal tendencies in the short run.  (Note how this opens the door to forecasting market movement as a function of the interaction of multiple cycles:  a topic I hope to address soon).

The market tends to frustrate the expectations of traders.  It is human nature to extrapolate the future from the past.  This--regardless of a trader's psychology--will lose money over time.  Drawing and following trendlines, going with breakouts, waiting for "price confirmation" to enter market moves:  all, over time, lose money.  It is not just our psychology that undermines our trading.  It is our assumptions.

Further Reading:

How to Lead a Visionary Life

The Secret to Overcoming Adversity

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How to Lead a Visionary Life

 

The great risk in life is to live reactively, bouncing from activity to activity without plan or purpose.  When we live purposeful lives, life becomes meaningful--and that gives us energy.  Suppose we were to begin our days, weeks, and months by posing questions:

*  What is the one thing I most want to accomplish today in my personal life and in my work life that will make the day successful?

*  What is the one thing I most want to accomplish this week in my personal and work lives that will make the week successful?

*  What is the one thing I most want to accomplish this month in my personal and work lives that will make the month successful?

*  What is the one thing I most want to accomplish this year in my personal and work lives that will make the year successful?

That's it:  Every day, every week, every month, every year is guided by a singular vision.  What one thing will lead you to look back on each day, week, month, and year and feel pride in what you've accomplished?  

Once we have a vision, we cannot live on auto-pilot.  The one thing you most want to accomplish becomes your mission statement--it pushes you and inspires you.  The risk isn't trying and falling short; it's never trying and never finding out what we're capable of.

Further Reading:

Making Your Passion Your Purpose

The Profound Psychological Benefits of a Purposeful Life

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The Secret to Overcoming Adversity

 

Margie and I recently toured Eastern Europe and finished the trip with a tour of the concentration camp at Terezin.  During the 3-1/2 years of the camp's existence, thousands of inmates were killed or died of untreated diseases.  What I found most memorable were the displays of artworks created by the inmates during their internment.  Music, painting, drama, sculpture:  all were of vital importance to the inmates.  Despite inhuman conditions of crowding and frequent abuse and torture, prisoners focused on creating works of beauty.  That many of these works are with us today attests to the success of their quest.     

For me, it was a powerful reminder that, no matter how bad our situations become, we always can rise above them through creative expression and achievement.  When we create--a painting, a book, a scientific theory, even a trading system--we rise above what is and realize a vision of what can be.  Indeed, the more we face loss and setback, the more important it becomes to create and immerse ourselves in meaning and beauty.

The secret to overcoming adversity is to transform your life into a work of art:  to become so focused on creating what is beautiful and meaningful that everything else becomes secondary.  Our relationships can become masterpieces; our careers can become paths for pursuing a vision of what is possible.  All of us become artists when we approach life creatively and find the beauty in each facet of life.      

As I was leaving the courtyard of Terezin where prisoners were herded into barracks, I noticed a smooth, round, quartz-like stone on the ground.  I took the stone home with me, and it now sits on my desk where I do my writing.  It's an immediate reminder of the horrors that I saw--and also the soaring human spirit that transcended the evil.  

Every life setback--including setbacks in markets--is an opportunity to rise above loss and create the future.  We tap into our Divinity when we become Creators.

Further Reading:

The Role of Creative Insight in Trading Success

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The Wellness Grid: A Framework For Optimizing Your Trading Psychology

 

Note:  Written aboard a ship on the Danube River, traveling to Prague, Czech Republic:

Imagine a 3x3 Wellness Grid:

On the X axis, we have three dimensions of psychological wellness:  

1)  Happiness - How much joy we experience;

2)  Fulfillment - How much satisfaction and pride we experience;

3)  Energy - How much inspiration and excitement we experience;

On the Y axis, we have three dimensions of wellness in life:

1)  Personal Life - What we are doing to develop ourselves as individuals;

2)  Interpersonal Life - What we are doing to maintain, expand, and deepen our relationships;

3)  Work Life - What we are doing to grow and succeed in the work we undertake.

With this Wellness Grid, we have a handy weekly report card that enables us to track over time how well we are maximizing the quality of our lives.  We also have a framework for tracking the synergies in our lives:  the degree to which improving one area of life creates benefits for other areas.  And, of course, we can track how setbacks in one sphere of life might be impacting others.

If we are consciously working on the nine boxes of the Wellness Grid, what we're really working on is intentionality:  the expansion of our free will.  The idea is to live life in a state in which we're fully awake, not functioning on auto-pilot.  We maximize our trading psychology when we maximize our capacities for living intentionally.  The big enemy of mindset is not stress; it's the absence of well-being.  We all need routines to live life efficiently, but when all of life becomes a set of routines, we are no longer fully alive--and we fail to grow.  Ideally, each week, we push ourselves beyond our comfort levels in all nine areas of the Wellness Grid.

Further Reading:

Tacking Your Problems Will Never Optimize Your Life

Gurdjieff, Turtles, and Trading

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Weak Market: What Comes Next?

 

We've seen a stock market that has been rather weak over the last couple of weeks.  Higher interest rates at the long end have particularly impacted rate-sensitive sectors, such as utilities and real estate, and have provided support for the U.S. dollar and dollar-related carry trades.  Speculation has shifted from imminent recession to an environment of "sticky" inflation and rates that are likely to be "higher for longer".  So is the recent pullback in stocks an opportunity to participate in the longer-term uptrend, or is it a warning to preserve capital?

Let's step back a minute.

I observe two problems among market participants.  The first is to construct trades without underlying robust ideas.  Traders who look to charts for "setups" are particularly guilty of this mistake.  The second problem is to generate big picture, top-down narratives based on fundamental data, but not anchor these themes in well-analyzed trades that provide favorable reward relative to risk in a shorter-term time frame.  My experience with successful market participants is that they are both investors and traders.  They generate robust bigger picture ideas through unique, rigorous analyses and they then translate those ideas into good trades by rigorously assessing shorter-term risk-reward.

In the terms of Daniel Kahneman, success in markets requires both deeper, slower thinking and faster, flexible thinking.  In practice, this means having consistent strategies but flexibly adapting the implementation of those frameworks based upon current conditions.

So now let's look at the current market:

I notice that, across the NYSE universe, we have seen over 1500 stocks making fresh monthly lows and fewer than 1000 registering new three-month lows.  That is what we would expect during a correction in a rising market.  When one-month lows *and* three-month lows are high (bear market), next ten-day returns since 2010 have been negative.  When one-month lows have been high and three-month lows have not been significantly elevated, next ten-day returns have been distinctively bullish--significantly above average.

In short, context matters.

When analyzing market returns, it's not enough to examine one time frame.  We want to see how the shorter time frame fits into the market's larger picture.

Let's take a second example.  This past week, looking across the NYSE universe, we have seen very few stocks giving buy signals on two technical trading systems, the Wells Wilder Parabolic SAR and the Bollinger Bands.  These systems assess strength and weakness across shorter (SAR) and medium (Bollinger) time frames.  When the number of stocks providing buy signals on the SAR has been weak but the number of stocks giving buy signals on the Bollinger measure has been relatively strong, next ten-day returns since 2019 have been flat to negative.  When we have had few buy signals on both technical systems simultaneously, next ten-day returns have been solidly bullish.

Again, context matters.

Across a number of these kinds of analyses, we see favorable average near term returns after selloffs in rising markets.  That's the perspective from the slower, deeper analyses.  Now, going forward, if we see selling pressure that cannot result in lower prices, we can speculate that bears are trapped, will need to cover, and we could bet on higher prices going forward.  Conversely, if we see that buying pressure is limited and/or cannot drive price meaningfully higher, we can entertain the idea that this time, indeed, may be different and follow that up with further analyses and possibly very different bets.

The most successful traders I work with look at new and different things and they look at things in new and different ways.  Over time, unique returns cannot come from consensus thinking.  

Further Reading:

The Momentum Curve

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Your Flaw Is Your Strength

 

While writing my next book, I came across a thought-provoking essay from a well-known Jewish Rabbi, Zalman Schachter-Shalomi.  His topic was the opal stone that we see in jewelry.

The opal gem consists of small silica spheres and gaps between the spheres, which in one context could be considered flaws.  However, the very gaps that occur on the opal's surface are what create the opal's beauty when light is shined.  The light rays are diffracted by the spheres and gaps, which break the light into a fiery array of component colors.  The Rabbi's point is that we are like opals:  what are our flaws when viewed one way become our greatest sources of beauty in a different light.  

Our flaws, in the right light, are our strengths.

For example, in one light, our ambition and achievement orientation are flaws, leading us to become so wrapped up in our work that we neglect our health and relationships.  Those flaws lead us to trade from the ego, overreact to gains and losses, and chop ourselves up when big moves aren't realized.

In a different light, our ambition and achievement orientation lead us to define and seek goals and ideals and realize our vision for being the best possible version of ourselves. 

There are so many ways in which our flaws and strengths mirror one another.  Think about how our sensitivity in relationships can lead to caring, but also hurt and disagreements.  Think about how our desire for self-development can result in personal growth--and in an insensitivity to others.  Think about how our commitment to not losing money can stand in the way of making significant money.

We are like opals, and our challenge is to find the light that enables us to shine.

Here's a simple exercise to help with that challenge:  Each week, identify the one most fulfilling, meaningful event that occurred to you during the past seven days.  Then identify the one most frustrating, negative event over that same period.  Then reflect on how the two are related and what made the positive experience so special and what made the negative experience so disappointing.  What is the light in which you are simply a stone with spheres and gaps, and what is the light in which you shine?  Over time, keeping this simple journal, you'll discover the contexts in which you display your fire.   

The goal is not to eliminate your flaws, but to turn those into sources of beauty.

Further Reading:

Greatness in Life and Trading

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Why Do I Get Chopped Up In My Trading?

 

The most recent post took a look at why we can perform well in markets, only to suddenly make poor decisions and blow up.  Now we'll examine a second common complaint of traders, especially in recent markets:  how we can develop good ideas for trades but then get chopped up in actually trading those ideas.  Most often this occurs when we are counting on momentum or trend--shorter or longer-term extensions of directional moves--only to experience reversals.  

Getting chopped up can cause considerable psychological frustration, but I'm not sure it's a purely psychological problem.  Let's look at the last 10 years of data from the stock market to illustrate the point:

For the first investigation, I broke down the daily closing cash VIX level into quartiles and examined the forward returns in the SPX.  When VIX has been in the lowest half of its distribution over the past ten years (below 16.66), the next five days in SPX have averaged a gain of only +.06%.  When VIX has been in the highest half of its distribution, the next five days in SPX have averaged a gain of +.36%.  The results widen out over time, so that the next twenty-day return in SPX for the two VIX conditions have been +.32% vs. +1.39%.  We know that VIX tends to fall in a rising market and rise in a falling market.  Indeed, there is a very significant correlation between VIX and most recent 50, 100, and 200-day returns.  What the data are telling us is that we are most likely to get a meaningful five-day bounce in a weak, volatile market.

For the second investigation, I examined the daily 5-day RSI for every stock in the SPX and the overall average level of those 5-day RSIs.  I then broke those daily average RSIs into quartiles over the past ten years.  Sure enough, when the RSIs have been in their weakest quartile, the next five days in SPX averaged +.49% vs. +.11% for the remainder of the sample.  When the market sells off over a five-day period, the next five day returns are superior to all other market occasions.  

For the third investigation, I examined the percentage of stocks in the SPX closing each day above their five-day moving averages over the past ten years.  When that percentage has been in its highest quartile, next five-day returns have averaged only .06%.  When the percentage has been in its lowest quartile, net five day returns have averaged a respectable +.51%. 

Historically, strong markets have led to more modest forward returns and weak markets have led to superior returns.  This occurs over multiple time frames.  Indeed, by creating a momentum curve across various time periods, we can develop reasonable forecasts for future market moves.

We get chopped up when we expect momentum and trends to extend.  Our expectations set us up for frustration.  This becomes a particular problem if we wait for "price confirmation" to enter a rising or falling market.  By the time that confirmation occurs, the anticipated forward returns are diminished.  One way of overcoming this problem is to investigate the presence of cycles in the market data and use short-term cycles to trade trending markets.  I have consistently found that how we trade a market idea is just as important to profitability as the idea itself.  If we can find short-term cycles within the market moves we're trading, we can become much better at finding superior risk/reward, both on entries and on take-profit levels.

Not all problems that impact our psychology are psychological in origin.  Our tendency to think in straight lines and ignore cycles breeds considerable frustration.

Trading well is the best formula for a winning psychology.

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Why Do I Blow Up My Trading?

 

The recent blog post presented ways in which we can listen to our intuitive inner voice as traders.  Sometimes, we not only fail to listen to our inner voice, but actively do what we know to be harmful to our trading and our success.  We trade well week after week and suddenly oversize a position, refuse to act on a stop, add to the losing position, and then blow up.  Or, on the other hand, we become so concerned about losses that we quickly exit winning positions before they reach their targets, leaving significant money on the table and blowing up our chances for real success.  

Why does this happen?  What can we do to keep ourselves aligned with sound practices and processes? 

A reader recently reached out, explaining that he once in a while experiences losses that wipe out a large share of his monthly profits.  It is frustrating to trade well most of the time, only to lose discipline and seemingly sabotage all we've accomplished.  As the graphic above suggests, the root of self-sabotage is self-abandonment.  We temporarily lose sight of what we're meant to do and instead act on impulse.  In the terms of the Radical Renewal online book, we abandon the soul of what we do and allow our trading to become ego-driven.  

I have never been convinced that the root of such self-sabotage is a deep-seated, inner desire to hurt oneself.  It is usually not an absence of self-esteem that causes us to become reactive.  Rather, we experience "triggers" that set off automatic and often harmful actions.  The problem is a temporary loss of free will.  Under a certain set of emotional and physical conditions, we behave in pre-programmed ways and become reactive rather than active.  Quite literally, it is a loss of self-awareness that allows us to behave in ways that harm our best interests.

Consider the many situations in which we *never* go on tilt and behave reactively and self-destructively.  We're not careful in crossing busy streets 99% of the time, only to occasionally walk directly in front of traffic.  We don't operate machinery (lawn mowers, ovens) safely most of the time, only to occasionally cut or burn ourselves severely.  Why don't we go on tilt in those situations?  Reason one is that our egos are not involved, and reason two is that we are supremely aware of the dangers at hand.  If I don't *need* to cross the road quickly and I'm mindful of the busy traffic, I am perfectly able to wait for a break in the flow of cars to cross safely.  If I'm clearly aware of danger, I will act with caution.  Always.

This is where it's helpful to engage in a "check up from the neck up" prior to any risk taking.  If a surgeon is scheduled for a procedure, but is in an agitated state because of a personal circumstance, that surgeon will delay the operation.  "Above all else do no harm" is the operative principle.  If a pilot is about to take off for a flight, they reach out to the co-pilot and--together--go through the pre-flight checklist to make sure the plane is truly air-worthy.  If something is wrong mechanically, the flight will be delayed.  Above all else, do no harm.

The opposite of self-abandonment is self-awareness.  If we approach each session of trading--each trade!--the way a surgeon approaches an operation or the way in which a pilot preps for a flight, then we are in the state we're normally in when we're crossing a busy street.  The awareness of risk and danger enables us to do no harm.  It isn't discipline or "process" orientation that enables us to not go on tilt when we're handling a carving knife in the kitchen.  It's the immediate, acute awareness of danger.  The key is self-awareness:  knowing when we're in the wrong mindset for risk-taking.  Like the surgeon, like the pilot, we must take danger so seriously that we're willing to postpone our performance until we're assured that we will "do no harm".  If we've performed our own checkup from the neck up, we're not going to trade on impulse.  

Further Readings:

Understanding Trading Tilt

How to Overcome Tilt

Video on Tilt Trading

Advice on Tilt to SMB Traders

Radical Renewal and the Spirituality of Trading

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