Dinner and a Talk With Dr. Brett

The Naperville chapter of the Investors Business Daily group is hosting me for a talk this coming Wednesday evening, August 22nd at the 95th St. library (between Book Rd. and Rt 59). The meeting will run from 5 - 9 PM and will include dinner, educational programming re: their CANSLIM methods, and my keynote talk. The group's registration fee for the event is $35; here is the signup page.

After the event I'll be happy to talk with blog readers re: their trading, markets, trading psychology--you name it! Give me a heads up if you're planning to attend, so I know to look for you. And if you're a student and find the registration fee a bit onerous (it's a standard fee set by the group that covers space, dinner, etc.; I don't charge local groups a speaking fee), send me a note and I'll see what I can do to get you in for my portion of the program. Hope to see you there!

Market and Trading Perspectives for Week's End

* What's Held Up - We saw some hunting for yield on Thursday; I notice that PEY--the dividend yield ETF--has held above its prior lows and saw nice buying. Those consumer staples have also held up reasonably well as hedges against recession: PG, KO, JNJ. Shares in Japan, on the other hand, are feeling the effects of a resurgent Yen and have shown recent weakness. GS continues as my proxy for concerns about the financial sector; hard to imagine sustaining a reversal in the broad market while those financial stalwarts are making new lows.

* Links on the Meltdown - TraderMike updates his links, including an excellent perspective on the problem with housing loans. Abnormal Returns chronicles divergent views on the market and the economic consequences of the housing mess. The Big Picture offers an important insight on what happens when institutions unwind their leverage. Daily Options Report reports on what's happened to buy-write strategies as volatility has soared. I like how DK Report has been tracking this decline, and Chris Perruna has done a fine job of staying on top of the bear themes.

* What the Volatility is About and What to Do About It - Great, great perspective from Larry Connors, including a historical look at what happens after spikes in VIX.

* Insightful Site - Thanks to a sharp blog reader who pointed out this informative site on the credit markets. Here's a unique perspective on how recent events have hit the retail bond investor.

* Exercising the Brain - I predict we'll see aging baby boomers turn toward activities such as trading as mental stimulation, not just income production--part of an emerging "use it or lose it" set of priorities.

* Trading Eurex - Here's a link to a free Webinar hosted by Market Delta.

* What's On Traders' Minds? - Here's what's most popular at the Wikinvest site.
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For Traders, It's Not Just The Destination, But The Journey

Suppose I told you that I had studied the market's present situation going back a large number of years. I examined the historical record and found that, two months later, the market was higher 45 of the 50 occasions studied for an average gain of 5%. Would you consider buying that market?

Now suppose I added one piece of information to the analysis: the average adverse excursion for these trades was -12%. In other words, before the market registered its 5% average gain over the two month period, a trader would have had to endure a drawdown that was more than twice as large.

Now would you consider buying that market?

The point here is that, for traders, the journey from point A to point B is just as important as the end point. If risk management guidelines and a trader's own psyche won't countenance a 12% drawdown, then the seemingly great edge is not attractive at all.

Wouldn't it be nice to have an indicator that tells you the ratio of the average expectation to the average adverse excursion for a particular time frame?

It turns out that Henry Carstens has developed precisely such a tool and has posted it to his website, along with the basic logic. When the indicator shows positive expectation, but less expectation than adverse excursion, Henry color-codes the indicator yellow to indicate caution. When we have a positive expectation and more expectation than adverse excursion, we get the green light on his indicator. A red light suggests a negative expectation--no edge or positive returns in the trader's favor.

Interestingly, Henry showed us as having a yellow light for today's trade: positive expectation, but even larger adverse excursion over a five-day period. So far that looks like a good analysis.

Over dinner in Portland just yesterday, Henry shared with me that taking adverse excursion into account had saved his capital during the recent market decline, as he decided to not take trades that otherwise looked good from an expectation perspective (e.g., buying a weak, high volatility market). Calculating adverse excursion thus becomes a risk management aid.

It will be interesting to follow Henry's tool as we attempt to put a bottom in this market. I will also make an effort to add an analysis of average adverse excursions to my historical pattern analyses to see if they help to define edges that traders can actually participate in.

There's a saying among physicians: pills don't work in the bottle. If the side effects are too onerous, the patient won't take the medication and derive any benefit. Similarly, a statistical edge is worthless if it entails so much drawdown that traders won't stick the trade out. Even the best vacation destinations are unappealing if the journey seems unsafe. Perhaps that's why so many traders end up cutting their winners short, sensing adverse excursions to come.

RELEVANT POSTS:

Self-Inflicted Problems of Trading

Risk Management and Trader Biology
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How To Use Twitter Trader

By now, most readers are aware that I post comments on the market via the Twitter application. The latest five comments appear on the blog home page; the full list of comments can be accessed via my Twitter page or by subscribing to my page as an RSS feed.

During times such as recently, when I'm on the road and with limited computer access, my Twitter comments will mainly occur before the start of trading and after the market close. The goal of these posts is to help traders prepare for the coming trading session. When I'm actively following markets and trading myself, I also use Twitter to comment on the market intraday and aid with that day's trade.

Most of my posts will cover one of three areas:

1) Relevant trading ranges, support/resistance levels: points to look for either breakout trades or reversions to the range mean.

2) Indicator levels: assessments of market strength and weakness.

3) Correlated markets: what is happening in markets and sectors relevant to the broad stock market.

These three areas are ones that I draw upon to determine whether my leaning will be to buy dips, sell rallies, or expect range bound trade.

The indicators I follow break down into measures of:

1) Strength - How many stocks are making fresh new highs and lows?

2) Momentum - How many stocks are trading above and below their volatility envelopes (Demand vs Supply) and how many are trading above their intermediate-term moving averages?

3) Sentiment - Are traders predominantly lifting offers, hitting bids, or displaying little short-term bias (NYSE TICK).

4) Leadership - Are key sectors participating in rallies/declines or breaking out of ranges?

In general, when the indicators point to distinctive (and growing) strength or weakness, I expect near-term continuation of that move. When the indicators are losing strength and momentum at new price highs or lows, I expect range bound trade and eventual reversal. These are hypotheses I work with; not fixed, rigid conclusions.

The purpose of the comments is decision support: to provide information for you to generate your own trading ideas. If there is additional information you'd find helpful, by all means comment to the blog or send me an email.

Thanks for your continued interest!

Brett

Five Principles of Growth and Development for Traders

1) The Bodybuilding Principle - You only grow and develop when you work against significant resistance, lifting more than you can comfortably handle. Hard workouts, then rest: a formula followed by all fine athletes.

2) The Process Principle - Work on doing things well and the outcomes take care of themselves. Focus on outcomes and you interfere with doing things well. Process goals spur improvement; outcome goals create pressure.

3) The Feedback Principle - Turning feedback about how you're doing into concrete goals for further work channels your development. Work without goals is like exploring without a map: you spend much time wandering aimlessly.

4) The Strengths Principle - You reach your greatest potential by making the most of your distinctive strengths, not by incrementally improving your weaknesses. What you're good at will fuel your greatest passion and stimulate your highest efforts.

5) Maslow's Principle - You cannot meet your higher level needs for success and fulfillment if your more basic needs go unmet. Achievement at work cannot substitute for love, security, and well-being, but the absence of these can interfere with achievement.

RELEVANT POSTS:

Life's Formula for Success
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A Bit of Perspective

Suppose you're contemplating a sailing trip. The weather forecast suggests only 10% chance of a thunderstorm, so you decide to set sail.

As you get out onto the ocean, you notice a few raindrops. Then you notice the sky darkening. The air pressure begins to fall rapidly.

What do you do: continue your voyage or pull into port?

When traders examine the historical record for what markets have done under particular conditions, they come up with their own weather forecasts for the market. When conditions have been bullish, the forecasts after market declines are apt to be bullish.

But suppose you begin to venture into the market and notice fewer stocks making new highs. Then you observe more selling pressure than buying with respect to the NYSE TICK. You see the advance-decline line making new lows. You see continued signs of risk aversion among institutional traders.

What do you do: continue buying the market or pull back?

A market that fails to live up to its recent historical precedents is providing useful information, just as there's useful information in weather patterns that violate a forecast.

The idea is not to blindly and grimly hold onto a position when you identify a possible historical edge. Rather, you use that information as a yardstick by which you gauge current market action.

When markets fail to rally when they have tended to move higher under similar circumstances, that's not just a failed forecast. That's a useful update to your forecast.

One of Trading's Greatest Emotional Pitfalls

Research in psychology tells us that there are several important facets to subjective well-being (SWB):

1) Joy - Our happiness; the proportion of time we experience positive emotion;

2) Contentment - Our satisfaction with life and sense that life is meaningful and worthwhile;

3) Energy - Our physical and emotional sense of vitality;

4) Affection - The quality of our close personal relationships; the consistent giving and receiving of love.

Past efforts among psychologists have been to help people manage stress. What we're now finding out from the research is that it may be more important to maximize well-being. There are a number of emotional and physical health benefits associated with high levels of well-being. We're also most productive when we have high levels of SWB and are most likely to have optimal attention, concentration, and cognitive performance.

I would argue that it is just as important for performers in cognitive fields (like trading) to maximize their well-being as it is for performers in physical fields (like athletics) to maximize their physical conditioning. Indeed, it may be fruitful to think of SWB as a kind of cognitive and emotional conditioning that is developed in the "gymnasiums" that make up our lives. One yardstick of how we spend time each day (and a yardstick of each of our major activities) is the degree to which it contributes to SWB and thus enhances our emotional fitness.

One of trading's greatest emotional pitfalls is relying upon the making of money for SWB. I know many traders who make their happiness, contentment, and energy contingent on trading success. Indeed, I've known many traders who define themselves by their trading success and use that success to seek attention/affection from others.

We can see from recent market experience that even very successful professional traders and trading organizations can undergo meaningful drawdowns when market regimes change. If our SWB rises and falls with our P/L, we are doubly vulnerable--and that adds quite a burden to future trading.

Yes, trading can--and should be--a source of pride, accomplishment, and challenge. It cannot, however, substitute for a full life. The pitfall of wrapping our well-being up in trading results has resulted in much of the trader burnout I've seen in my years of working with traders. If your well-being hinges on your trading results, what will provide the emotional fuel for your comeback?

RELEVANT POSTS:

A Personality Questionnaire for Traders

Steps Toward Improving Your Well-Being
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Persistent Day Selling and Other Topics for a Monday

Selling in the Day - I noticed that only 13 of the past 30 day sessions in SPY have been up in price. Going back to 2004 (N = 878 trading days), we've seen 121 occasions in which 13 or fewer days out of 30 have been higher. Thirty days later, SPY has been up by an average of 2.27% (100 up, 21 down), much stronger than the average 30-day gain of .79% (476 up, 281 down) for the remainder of the sample. When we go back to 1996 (N = 2836 trading days), we find 685 instances of persistent day selling. SPY has been up by an average of 2.03% 30 days later (463 up, 222 down), again stronger than the average 30-day gain of .73% for the remainder of the sample. Interestingly, in the larger sample (unlike 2004-present), there was no positive edge five days out and plenty of instances of drawdown.

Tracking the Markets - Trader Mike finds us in "no man's land", trapped between moving averages, but observes continued strength in on-balance volume. Adam lends some perspective on fair value and what it means. Phil checks out double bottom patterns in the major indexes and strength in some sectors. Brian reviews the averages and is looking for further mini-panics.

Links Worth Checking Out - Abnormal Returns on what insiders are doing here and the quant bloodbath; Chris, with views on creativity and the fear/volatility mix; Big Picture with a linkfest featuring views on volatility and housing contagion; Larry Nusbaum with weekend reading, including many ways of going short.

Forecasting Unlikely Events - Interesting perspective from A Dash of Insight, relevant to the many emails I'm getting about crash concerns.

Do Some Individual Investors Find Consistent Success? - CXO examines the evidence and finds some interesting conclusions.

A Few Observations to Start the Week

* Fewer New Lows - With each downthrust in the market, fewer stocks have been making new lows, as the chart from my latest Weblog entry indicates. For the week, the Adjusted Cumulative TICK was solidly positive. I also notice that Friday's momentum numbers (Demand/Supply) were stronger than Thursday's. I will be watching for signs of buying interest on Monday to see if diminished selling pressure can bring out the bulls.

* Where Value Lies - Since 7/27, nearly 70% of all ES volume and nearly 70% of all one-minute closing prices occurred between 1487 and 1453.50. That's the broad value area for this market. Given the market weakness at week's end, a good Market Profile trader will now look to see this week how we trade relative to this range, especially if we accept or reject value below the lower band.

* Where Strength Lies - It's been a weak month for stocks, but 9 of the 40 S&P stocks I follow in my basket (evenly divided among eight sectors) are actually up over the past 20 trading sessions. These include UPS, PG, KO, WAG, SLB, MRK, LLY, IBM, and CSCO. Recession resistant issues--Consumer Staples stocks--have been particularly strong. Defense stocks ($DFX) have also held up relatively well.

* Strength in the Mortgage Patch - FNM and FRE--Fanny and Freddy--don't seem to mind the mortgage weakness; their securities are backed by fixed-rate mortgages, not the riskier adjustables that are experiencing foreclosures. They were unusually strong, though volatile, this past week.

Do You Trade Strength or Fade It?

In my recent post, I illustrated that waiting for confirmed strength and weakness and then going with those trends in the S&P 500 Index was a great way to lose money. If you examine the relevant links at the end of that post, you'll see that this logic holds true over multiple time frames.

Still, a writer makes an excellent point. Dr. Humphrey Lloyd, whose work I happened to feature in my latest Trader Performance post, emailed to make the point that he has been very successful catching early strength in markets and going with it.

That makes sense to me, particularly coming off an oversold condition. In essence, you're counting on a reversal of weakness, but using incipient strength as your entry. The reverse logic also makes sense with respect to fading overbought markets.

What Dr. Lloyd does in his book is track an indicator that places the current market relative to two moving averages. You can then identify which stage or zone a market is in by seeing whether it is above both averages, below both, or trading between the two. Buying early strength or selling early weakness would have you trading something akin to a moving average crossover, filtered with overbought/oversold indications.

My own work addresses this issue differently. I separate the measurement of strength (as assessed by the number of stocks making fresh new highs or lows over a lookback period) and momentum (as assessed by the number of stocks trading above or below their volatility envelopes surrounding moving averages) from price change. When we have rising or falling markets with strength/momentum that is increasing/falling, I look for short-term continuation. When we have rising or falling markets with strength/momentum not confirming price weakness, I look for reversal.

Still, I think the basic point raised by Dr. Lloyd is valuable: one might go with a strengthening market, even as one fades markets that have already been strong.

The problem, however, is that traders tend to look at past price change alone and become more confident in markets as prices rise. We can see this in the positive correlation between put/call ratios and past price change and in the positive correlations between sentiment surveys and past price changes.

In my next post, I'll look at market strength and weakness in the current market and report on a study that addresses the trade vs. fade issue.

RELEVANT POST:

The Most Common Trading Problem
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Help Dr. Brett Write His Next Book!

Dear Readers,

It's about that time when I devote time to writing another book. This one will be my fifth--I have two psychology texts and two trading ones--and it will be my most unique.

My first two trading books were trader-centric, focusing on the psychology and performance of the trader, respectively. This one will emphasize the psychology of the markets themselves, highlighting trading strategies that are grounded in trader/investor sentiment and behavior patterns.

I say the book will be unique, because it will be an electronic product as well as a print text. That means that it will incorporate annotated color graphics, links to online resources, audio presentations, and trading videos in a single package.

Most e-books are simply electronic versions of print texts with a few HTML links tossed in. In the future, books will be multimedia publications that integrate text, graphics, audio, and video in a single package. The text will explain a concept, the graphics will illustrate it, and the audio/video will explain and show how to utilize it.

That means that readers will learn more effectively, seeing, hearing, and reading information, processing the material through multiple sensory/learning modalities.

Static text is great for conveying factual information, not so good for illustrating and demonstrating skills. The books of the future will be anything but static.

My next book will also be unique in that I will make an effort to incorporate the ideas of many different writers from the trading literature. One of the surest signs that trading is a non-scientific field is that it lacks a literature that is cumulative. Books rarely make a conscious effort to survey existing knowledge in the field and add to the corpus. Instead, writers tread old ground and fail to advance the solid understandings from the past.

So, to the best of my ability, I will review a range of trading literature. My aim is to give credit to those who have lent their shoulders and provided me with a broader view than I could ever have achieved on my own.

Finally, I'm hoping that the book will be unique in that its content will be influenced by its future readers. I'm asking interested traders to either comment on this blog or email me (at the address at the bottom of the "About Me" section of the blog home page) and suggest topics they would like to see covered in a book that addresses trading strategies that draw upon the psychology of markets themselves.

What would most help you in *your* trading? Pass along your questions and topics of interest, and I'll do my best to incorporate them in the new book.

Or maybe you have strategies you'd like to share with others: ones that have worked for you and draw upon an understanding of trader psychology. I'm also open to incorporating those in the book and citing you as the source.

As an electronic text, some of the book will reside on the Web. That means the book can always be updated, always be elaborated. No need for second and third editions: as markets change, ideas will be added to the book and chapters will be revised. The book, if done right, will evolve with our own understandings. And it will never go out of print.

For those who engage in the commerce of ideas, these are exciting times indeed. The technology is there to create books like those in the Harry Potter movies: you open the cover and the material literally comes to life.

I invite you to be my co-author and suggest topics for the book to address and ideas to share.

As always, I greatly appreciate your interest and support. The many fine people I've met through the blog have been one of the true joys and rewards of my life.

Brett

How to Lose at Trading the Stock Market

"I need to see the market making new highs to confirm an uptrend," a trader recently told me with a knowing air. "I'm not going to sell until we get confirmation of a downtrend."

I haven't heard from that trader since the market began its high volatility decline. I shudder to think what would have happened had he consistently bought highs and sold lows.

The reality, however, is that the stock market has never rewarded the obvious. A belt-and-suspenders approach to trading has never produced superior returns. Give me a short-to-intermediate term moving average and I'll show you the returns that will refute our trader's strategy.

Today's little exercise draws upon data from Barchart.com, which has a nice "performance" feature that tracks the P/L of various stocks using various technical indicators for entries and exits. Here we'll be looking at the S&P 500 Index (SPY) and the Commodity Channel Index (CCI), an oscillator that captures market strength and weakness.

We'll follow our trader's strategy by buying SPY when the 40-day CCI hits +100 (shows strength) and exiting the position when it crosses below +100. Similarly, we'll sell SPY when the CCI hits -100 and exit the position when it crosses back above -100.

This strategy may produce a fair number of whipsaws, but should capture the big trends.

Over the past two years of trading, this strategy has produced 49 trades, with an average holding time of 8 days. We've had 11 winning trades (including one that is presently open) and 38 losers, about a 22% win rate. The total number of SPY points lost over the two years was a bit over 23 (or 230 S&P futures points), which roughly translates to a 16% loss of capital if we assume no leverage and equal position sizing for each trade.

In other words, during a distinct market uptrend, trading a strategy that buys strength and sells weakness has lost significant money.

But let's look further under the hood to understand *why* such a strategy fails.

If we break out the trades, we find 35 long trades and only 14 shorts. This reflects the upside bias in the market: we haven't often dipped below -100 on an intermediate-term oscillator.

Of the 35 long trades, we would have had 9 winners and 26 losers. Cumulatively, those would have lost us 6.45 SPY points. The winning trades would have brought in 14.40 points, or 1.60 SPY points per trade. The losing trades would have cost us 20.85 points, or .80 point per trade.

When we examine the short trades, we would have had only 2 winners and 12 losers. The winning trades would have made us 1.37 SPY points or about .69 point per trade. The losers would have cost us 18.22 points, or about 1.52 SPY points per trade.

In a limited way, the strategy worked; it did catch some large moves on the long side. As a result, the average size of the winning long trade was twice as large as the average size of the loser. Even so, however, the long trades would have cost us money. Why? Because losing trades outnumbered winners by about 3:1. Stated otherwise, even in a bull market, strong moves only followed through with further strength 25% of the time.

It's when we look at the short side that we see the trading system completely break down. The win rate on trades was about 15%. On top of that, the average size of losing trades was more than double the average size of the winners! Selling weakness over the last two years has been a complete and utter disaster.

Now for some disclaimers: Yes, there are other ways to trade the CCI; my purpose is not to dis this particular indicator. And, yes, results would be different if you added a variety of stops and money management elements to the mix. And, of course, results would have been different had we examined the strategy at other points in market history or if we had pre-selected a wonderfully trending market over these past two years.

My point is this: If we use SPY as a proxy for the stock market (as the most actively traded index ETF) and adopt a strategy of "buy confirmed strength, sell confirmed weakness", we would have lost money at an alarming pace. Even if we had employed it as a long-only strategy, it would have lost us money in a solid bull market! Trading the short side in this environment led to severe losses.

In fact, I would go so far as to say that the "buy strength, sell weakness" strategy is so bad that it's promising. Simply reversing (fading) the strategy in SPY and adding a time stop (to avoid the few long uptrends) would have made a trader a chunk of change.

Of course, nothing is 100%. The "sell weakness" part of the strategy had us going short SPY on 8/9/07 and, as of Friday's close, the trade was profitable. The system sold at 145.39; it remains an open trade. The previous short trade was on 7/26/07 and covered on 8/8/07 for a loss of 1.81 SPY points (about 18 ES futures points). That was a bearish period, but still the strategy managed to lose a decent sum. You have to marvel at the consistency of the market's ability to punish the obvious.

RELATED POSTS:

Why Short-Term Traders Lose Money

How to Lose Money Buying in an Uptrend

Reversal Effects and Fading the Herd

The Market is Rigged Against Human Nature
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Short-Term Waterfall Declines in the Stock Market: What Happens Next?

Well, I was all excited and went to show Mali the post about her, but she'd hear none of it. "The market was down big overnight yesterday," she exclaimed. "Then it was down big during the day session. Now it's down big going into today's open. Tell the people what happens in the market when this has occurred in the past!"

Mali's a very practical cat.

Anyway, I went back to 1996 (N = 2891 trading days) and found only four occasions in which we had a prior overnight session down by 1% or more followed by a day session down by 1% or more and a current overnight session down by 1% or more. Interestingly, these short-term waterfall declines tended to occur at key junctures near intermediate lows in bear markets: 9/21/01 (after the 9/11 incident); 10/28/97; 4/17/2000; and 10/1/98. Three of the four occasions rose very sharply during the subsequent day session (over 3%) after dipping very little after the open. The one occasion that was down during the day session (by a little over 1%), recovered to a gain the following day.

I relaxed the criteria to look for occasions in which the prior overnight session, prior day session, and most recent overnight session were each down .50% or more (N = 16). When we look two days out (to the close of the *following* day's trade), the market was up 12 times, down 4 for an average gain of 2.20%--much stronger than the average gain of .01% for the market overall during the remainder of the sample.

Once again, it was when the downside was contained during the day session following the short-term waterfall that near-term returns were particularly outstanding. It appears that these waterfalls have the potential for triggering considerable short covering when they dry up.

Life Lessons From My Cat

Our loved ones provide some of life's best lessons. I've written about wife Margie and what makes a trader's marriage work. I've also written about daughter Devon and what she taught me about finding one's niche in life. Then there's son Macrae, who showed me the communications that are possible across cultures.

So now it's Mali's turn.

Mali is our calico cat.

Mali was neglected at birth by a Syracuse, NY shop owner and kept in a cage in a storefront. She received little attention or care. When she developed feline herpes, it went untreated and spread to her eyes. She was blinded as a result.

I heard about Mali from an angel of a woman in Syracuse who went out of her way to rescue animals in need. She saw Mali in the store and insisted that the owner surrender the cat. The little calico was taken to a vet and there she stayed in a larger cage, awaiting adoption.

But there were no takers for a blind cat. Truth to tell, Mali was not a great candidate for adoption. Her fur was not kept especially clean and her eyes had frequent discharges. There was concern that, because of these discharges, she could infect other cats with the herpes virus.

So when we were called about Mali--we had already rescued two cats from this woman--our leaning was to take a pass. We didn't want Gina and Ginger to possibly contract the virus.

But, I decided on my own--without telling anyone in the family--to visit Mali.

She was very small, and she had kitty litter in her fur. Her eyes were visibly damaged, and she sniffed loudly to check out her environment. When I held her, she purred louder than any cat I'd ever heard.

Here was a cat that wanted love.

We adopted Mali and she's done very well. The other cats have stayed healthy, and we added quite a friend to the household. Every night Mali tucks herself under the covers between Margie and me and sleeps with us. Her purring at night reminds me of that day I first visited her.

Mali's taught us several important lessons:

1) Make the Most of What You Have - Mali had very little stimulation early in her life. She was an active, curious kitten locked in a small cage. A big part of the reason she didn't keep herself clean was that she learned to use her kitty litter as a toy. She would scoop it in her paws and toss it around. Not exactly the most sanitary activity, but it was the only game available to her. She kept herself stimulated until a family came around for her. How many of us would have the presence of mind to avoid self-pity and create stimulation out of an otherwise barren environment? Mali demonstrated that it *is* possible to make the most of even the most limited situations.

2) Love Comes From Love - What convinced me to adopt Mali was not only her loud purr, but her sudden cleaning of herself when I held her. In her cage, she rarely washed herself. Once I held her, however, she began her ritual cleaning, furiously licking her paws and washing her face and sides. To this day, she grooms herself very well, but she most vigorously cleans herself when she's in bed with us. It is difficult to value yourself when you're neglected. But exposed to love, we feel loved, and that makes us love ourselves. Mali took care of herself once someone wanted to take care of her. How similar people are: We feel most special when we're special to others.

3) It's How You Compensate for Weaknesses That Counts - Mali is almost totally blind; she can only distinguish bright light from dark. Nevertheless, she has compensated with an excellent sense of smell and an uncanny sense of direction. When we brought Mali home, it only took her a few days to learn her way around our house. When we moved to a larger home, it similarly took her just a few days to figure out the layout. She navigates around furniture, sniffing, feeling with her whiskers and paws, and listening for sounds. Given little stimulation at an early age, she now craves stimulation and loves to have new people come to the home. As a result, she's an unusually friendly cat and receives loads of attention. By compensating for her weaknesses and limitations of upbringing, Mali has cultivated strengths.

Mali has been a true inspiration. She's a survivor--and a reminder that happy endings are always possible.

But every so often, she still tosses her kitty litter!

RELATED POSTS:

What Trading Teaches Us About Life

Life Lessons From a Personal Crisis
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Ideas and Links for a Volatile Thursday

* A Market of Reversals - We had downside range breakouts on 8/3 and 8/6 that were sharply reversed, then an upside breakout on 8/8 that we reversed hard today. Meanwhile, recount all the (volatile) market movement during the last ten trading session and consider that every one of those trading days but one traded between 1467 and 1470 in the ES futures at some point during the regular trading session. The trend has simply not been the trader's friend during this period. Meanwhile, Adam nicely illustrates the explosion of volatility in the market indices themselves.

* Interesting Observation - Trader Mike finds bullish on-balance volume (OBV) patterns for the major stock indices.

* Global Credit Squeeze - Excellent graphic from WSJ passed along by Todd Chalem shows how the credit crunch has taken on global dimensions. Abnormal Returns documents some of the resulting damage.

* Historical Perspective on Market Declines - Roger Nusbaum and Seeking Alpha take out the almanac and find plenty of precedent for normal, large market declines.

* World Wide Economic Calendar - Here's a nice resource from Daily FX: A listing of economic reports due out each day around the world.

* Is It Trading, Or Is It Gambling? - A thoughtful essay from InvestorGuide looks at the differences--and similarities--between the two. My take? Self-control is an important differentiating element.

* Playing Defense in a Weak Market - The defense stock sector ($DFX) has held up well overall during this decline, despite today's drop. James Altucher and StockPickr offer some bull plays that won't be affected by mortgage concerns.
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Why Trading Ranges Are Important

Markets establish value; that is their purpose. When we trade within a defined trading range, there is relative consensus about value. A break out of that range represents a potential repricing of an asset, and thus the beginning of a possible trend. When that break out returns to the prior range, it tells us that market auction participants are not perceiving the repricing as justified. This typically takes us back to at least the midpoint of the prior range and often has us probing value at the opposite end.

Key to trading is seeing these range/value dynamics at multiple time frames. Here is an hourly chart of the ES futures (including overnight trade) that shows how we broke above a multi-day range on Wednesday, only to return to that range in preopening trade today. (Click on chart for greater detail). We have sliced through important support around 1483; that becomes the important range level above us, with the 8/7 lows (also roughly the range midpoint) as next major support.

Some of the best trades we're seeing in the current market involve handicapping the movement of the market out of--and back into--these ranges, as traders are both entering and exiting the market in panicky ways. Tracking the ebb and flow of volume around these movements--including the distribution of this volume around the market bid and offer--has been one important source of this handicapping. I'll be illustrating in upcoming posts.

Using the Intraday Twitter Comments

I've received a number of positive responses regarding the intraday Twitter comments on the blog. These have been my attempt to add observations to the market as trade is occurring. The last five comments appear on the blog home page and can be updated simply by refreshing the page. The complete list of comments appear on my Twitter page; interested traders can subscribe to my Twitter feed and receive updates automatically.

Gradually I've been formalizing the comments, and this will continue this coming week as my coaching work with traders (and writing commitments) expand and keep me from the screen. What this will mean in practice is that there will be Twitter comments after the trade that summarize major indicators and what they mean, and there will be Twitter comments before the trade that summarize overnight developments and implications. The goal of these post-market and pre-market comments will be to help traders prepare for the coming trading session. Look for a blog post on the topic of "preparing for the day's trading" to come shortly. That will explain in detail how to utilize the Twitter content.

I will then update Twitter on an intraday basis (preferably midday) as best I can given my increasing work (and phone work) with traders, travel/writing schedule, etc. The goal will be to provide decision support for traders--an intraday blog within a blog. I welcome comments on the comments, as I attempt to make this feature as useful as possible. Thanks for your interest.

Brett

It So Rarely Pays to Act on Panic

During the recent market volatility, we've had a number of sudden, sharp runs both to the upside and downside. One of the things I've marveled at is how infrequently those who jumped aboard those sharp runs actually made money--whether they were bulls *or* bears. On a larger scale, we can see that those selling into the persistent bearishness noted earlier have also not fared well, as we've now retraced more than half the market's declines.

And to think it was just yesterday that we were wondering if Ben would be taking a helicopter over Wall St.! Meanwhile, the 10-year yield is up to 4.879 as I write, the Yen has broken to multiday lows, and the NYSE TICK distribution has been in monster positive territory. Indeed, traders seem positively giddy about owning stocks. And look at those "A" shares in China: they barely caught their breath during the market weakness before launching to new highs--even as inflation rumbles.

All's well with the financial world indeed. Which may be cause for concern.

Chess, Tai Chi, and Trading: Inner Views of Learning and Performance

My recent post on "Becoming Your Own Trading Coach" referenced Josh Waitzkin's excellent book The Art of Learning. In his book, Waitzkin describes principles of learning and performance that helped him excel in two disciplines: chess and Tai Chi Chuan. These principles are highly relevant to the cultivation of expertise in trading, though they're rarely acknowledged.

To illustrate three of these principles and their application to trading, let's take a simple day trade from Tuesday's market in the ER2 (Russell 2000) futures. We can see that the Russells moved to a new high on expanded volume around 11:30 AM. It was at that point that a nice short-term trade set up--but only for those who had achieved a degree of inner mastery.

Let's break it down, principle by principle:

1) Investment in Loss: Waitzkin describes putting "your ego on hold" and growing through challenges that leave you beaten up. He also captures the essence of Push Hands Tai Chi, in which elite performers "dissolve away from attacks", absorbing and dispelling their energy rather than resisting it. When the market jumps on high volume and makes a new high, our emotions are engaged: we become fearful of missing a good move; we become overeager to jump aboard the move; we become mired in regret for having missed the move. But the expert trader absorbs the event and widens his perception. The market may have thrown him for a loop, but his is the stance of the observer, not the frustrated or defeated participant. He looks for the information in the event: that's the investment. Standing apart from his own market, he can see that the other stock index futures--the ES and NQ--have not made new highs on this move. What looks like a breakout--and the start of a new trend--looks, from a wider perspective, more like a fakeout. Physiological arousal speeds us up; it narrows our perception. The expert performer, looking for the investment, widens his view. Like a good quarterback under the pressure of a blitz, he focuses, sees the whole field, and completes the play.

2) Slowing Down Time - Time moves extra quickly when we're in the physiological arousal of flight or fight. The market seems to be racing when it's moving to new highs without us on board (or against our position). But the expert performer knows how to slow down time. Waitzkin describes observing minute tells in his adversaries--shifts in their eyeblinks or breathing--that enable him to time his movements. Such fine observation is only possible when the mind operates in slow motion--and when we've trained the mind to slow itself under duress. When the experienced trader sees buyers chase the new highs, he becomes very slow and focused for the next minute or two. He watches each trade coming into the market: are large traders jumping aboard the move or standing aside? Are they entering as buyers (lifting offers), or as sellers (hitting bids)? The slowed-down trader can *feel* that the market has stalled after its upward thrust. It's just like a martial arts opponent who has lunged at you, and now is off-balance. That's the cue to enter the market in the opposite direction, knowing that all those buyers who chased the highs will have to unload their positions at lower prices.

3) Numbers to Leave Numbers - Waitzkin explains that the beginning chess player learns by explicitly studying the value of each of the pieces and using this information to help guide play. Eventually, with repeated experience and the internalization of study, the developing chess master no longer thinks in terms of numbers. The value of the pieces in relation to one another is something that is felt, not calculated. But you can only leave numbers by first immersing yourself in numbers. The beginning trader diligently calculates all the relevant information: volume, price movements in various markets, etc. But the expert trader *feels* that the market is stalling and losing steam. His knowing is visceral, like the Push Hands player who senses an opponent that has lost his center of gravity. At that point, you are the market; it is within you. But you never get to that point of implicit knowing without those arduous investments in loss: what Waitzkin calls "using adversity" to further development.

A move in the market. The movement of our emotions. Consciousness widens or narrows. Time slows down or speeds up. We either lose our investment or invest in our losses. These are the invisible, but vital, facets of performance for the short-term trader. I think you'll find that Waitzkin's book is a fine introduction to learning and expertise, a rich road map of the performer's inner world.

RELEVANT RESOURCES:

Trading and Information Processing
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Yen and Stocks: Mirror Images

Above you can see charts from today's action in the Yen and ES futures (click on charts for greater detail). When the Yen could not catch a bid at the 13:35 PM bar (marked with check mark), we started firming in ES. Failure of Yen to make a new high when ES made its marginal new low was a great tell and an instructive illustration of why it helps to keep an eye on correlated markets.