One topic I will be covering in greater detail in upcoming blog and Twitter posts is market reversals and transitional structures in the intraday markets. A very interesting one occurred a little after 14:00 CT today. As my last intraday tweet noted, the market had been rising on strong NYSE TICK, spurred by the Fed's decision to goose the economy with its quantitative easing.
We pulled back into about 14:05 CT, with price in the ES futures breaking the low we had made around 13:51 CT. From that point we rallied for the next ten minutes or so, with TICK exceeding +1000 on three different occasions. But volume was unusually low during the upmove, volatility to the upside was very restrained, and upside momentum quickly petered out.
What happened was that buying interest, as measured by TICK, could no longer result in higher prices. In volume terms, large market participants were no longer leaning to the buy side. Such inefficiency--the inability of buyers or sellers to sustain a move to the upside or downside--frequently occurs at the tail end of one-sided market moves. Before sellers enter the market in force, we see buyers retreat from the market.
Admittedly, this is not a precise pattern; it's a relationship that marks a shift in the ability of buying or selling pressure to attract volume and move price. With enough exposure to examples of these patterns, you'll be able to develop a nose for these intraday reversals. Here is a post that elaborates the transitional structure concept. If I see a pattern forming intraday on a day when I'm not meeting with traders, I'll note via Twitter (free subscription here); I'll also use blog posts as further illustrations to help you decide when to get out of trades.
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Wednesday, March 18, 2009
Reasoning With Price Levels: A Key Trading Skill
I recently mentioned that I'm using the intraday Twitter tweets to model a certain kind of reasoning process with respect to intraday market movement. One element in this process is what we might call "thinking in price levels". Here is an example from yesterday's market:
In the morning, my Twitter post indicated:
If you go to an intraday chart of the ES futures, you'll see what I was looking at. The market had moved below its overnight range in early trade and then rallied back into that range. In an earlier post, I had noted the reduced relative volume and raised the issue of a range day. A range day, my earlier tweet reviewed, should oscillate around the volume-weighted average price, with VWAP not differing greatly from the market's opening price.
From about 9:45 AM CT to 10:30 AM CT, we moved lower, with volume dwindling on the down move. I noticed some signs of selling drying up as we approached the market's opening price. From my perspective, that was important, because it suggested that not only could we not sustain selling below the market's overnight range. Now we weren't sustaining selling below the market open. Any market that cannot move below its open in morning trade should be a good candidate to hit its near-term upside targets.
When I posted the 10:42 AM CT tweet above, I had already noticed buying coming into the market on the bounce off the opening price. From an execution vantage point, I don't want to try to pick market bottoms. Rather, I wait for initial buying to validate my idea, then take the first pullback for entry. That is why my post emphasized the need to watch NYSE TICK carefully. If, indeed, buying interest was dominating above the market open, the Cumulative TICK from that point forward should stay positive. As long as that is the case, a normal, expectable pullback in TICK provides an entry to the upside, with the previous day's pivot and the morning high as immediate profit targets, followed by the overnight high.
Although this particular example focuses on the market open as an important level, the same reasoning process holds for any key level. If, for example, we hit R1 on strength and then pull back but manage to stay above the previous day's high on the pullback, I'm thinking of buying the pullback for a move certainly back to R1 and, depending on the strength of the buying that unfolds, to R2. If we can't take out the overnight high in early trade and move below the previous day's pivot, then bounce higher but stay below the pivot, I'm thinking about selling the bounce for a move all the way through the overnight range and perhaps to the previous day's low price.
In other words, we're using the ability or inability to hold price levels as an ongoing assessement tool for markets. These levels are not just price targets; they are reference points. (Clear areas of support and resistance in a range also serve as key reference points). If I'm an active trader, I'll think about exiting a long trade at one level, waiting for a pullback to show me that the market can't go to the next lower level, and then entering again in the direction of the day's trend to target the next higher level. (From this vantage point, your trade's failure to hit a target level is also diagnostic and can set up worthwhile trading ideas).
Many traders draw their levels on their screen in advance to aid with this reasoning process. I will be illustrating with future intraday Twitter posts. As always, subscription to the Twitter messaging service is free; you can also view the last five tweets on the blog page under "Twitter Trader". For more on the reasoning process in trading check out this previous post.
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In the morning, my Twitter post indicated:
10:42 AM CT - Seeing if we can hold above open price to test AM & overnite highs. Watching TICK closely.
If you go to an intraday chart of the ES futures, you'll see what I was looking at. The market had moved below its overnight range in early trade and then rallied back into that range. In an earlier post, I had noted the reduced relative volume and raised the issue of a range day. A range day, my earlier tweet reviewed, should oscillate around the volume-weighted average price, with VWAP not differing greatly from the market's opening price.
From about 9:45 AM CT to 10:30 AM CT, we moved lower, with volume dwindling on the down move. I noticed some signs of selling drying up as we approached the market's opening price. From my perspective, that was important, because it suggested that not only could we not sustain selling below the market's overnight range. Now we weren't sustaining selling below the market open. Any market that cannot move below its open in morning trade should be a good candidate to hit its near-term upside targets.
When I posted the 10:42 AM CT tweet above, I had already noticed buying coming into the market on the bounce off the opening price. From an execution vantage point, I don't want to try to pick market bottoms. Rather, I wait for initial buying to validate my idea, then take the first pullback for entry. That is why my post emphasized the need to watch NYSE TICK carefully. If, indeed, buying interest was dominating above the market open, the Cumulative TICK from that point forward should stay positive. As long as that is the case, a normal, expectable pullback in TICK provides an entry to the upside, with the previous day's pivot and the morning high as immediate profit targets, followed by the overnight high.
Although this particular example focuses on the market open as an important level, the same reasoning process holds for any key level. If, for example, we hit R1 on strength and then pull back but manage to stay above the previous day's high on the pullback, I'm thinking of buying the pullback for a move certainly back to R1 and, depending on the strength of the buying that unfolds, to R2. If we can't take out the overnight high in early trade and move below the previous day's pivot, then bounce higher but stay below the pivot, I'm thinking about selling the bounce for a move all the way through the overnight range and perhaps to the previous day's low price.
In other words, we're using the ability or inability to hold price levels as an ongoing assessement tool for markets. These levels are not just price targets; they are reference points. (Clear areas of support and resistance in a range also serve as key reference points). If I'm an active trader, I'll think about exiting a long trade at one level, waiting for a pullback to show me that the market can't go to the next lower level, and then entering again in the direction of the day's trend to target the next higher level. (From this vantage point, your trade's failure to hit a target level is also diagnostic and can set up worthwhile trading ideas).
Many traders draw their levels on their screen in advance to aid with this reasoning process. I will be illustrating with future intraday Twitter posts. As always, subscription to the Twitter messaging service is free; you can also view the last five tweets on the blog page under "Twitter Trader". For more on the reasoning process in trading check out this previous post.
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Tuesday, March 17, 2009
Market Indicators and Tools: What Works?
Thought I'd offer a potpourri of thoughts and ideas as I catch up with email, blog comments, and a full day of meetings with traders:
* Does Market Profile Work? - That was the topic of an email that recently came my way. Apparently, one of the gurus of Market Profile has opined that the tool does not work as well as it once did. The writer asked my opinion on the matter. In a nutshell, I think it's the wrong question. Market Profile, like so many indicators and tools, was never intended as a source of mechanical trading signals. In my view, it's a way of organizing market observations, much as a physician's diagnostic system is a way of organizing data from a patient's history and physical. The question is, not whether it works, but whether it works for you. Is it a useful framework for organizing your observations of markets? A different framework would be Elliott Wave theory or chart-based technical analysis. If a framework helps you make sense of supply and demand and if it helps you see and act upon market patterns, it works for you.
* How to Develop as a Trader - Check out JT's comment to my recent post on upsets in the NCAA and in trading. He illustrates how to make use of the material on this blog--or any site for that matter. Instead of looking for answers from a guru (which I'm not!), JT uses material selectively for "study/replay" until he can see the patterns in real time. Trading is a performance sport, no different from football or chess. A site or blog can give you ideas for improving your football or chess performance, but it's on the practice field and chessboard that you'll develop yourself. The goal is to take away from the posts what is useful to you, put aside the rest, assimilate material from multiple sources, and integrate all of it into your own style of trading. It's the active work of culling out the important material (JT's folders) and bringing it into your practice that creates the learning and development.
* Twitter Explosion - When I started Twitter posts last year, I was quite pleased when 300 traders signed up for RSS subscriptions to the "blog within a blog". Now the list is up to 3000. I want to thank traders for their interest and feedback on the "tweets". The expansion of interest in the Twitter posts reflects, I believe, traders' need for real time information and mentoring. The blog's Twitter feature is still a work in progress; I will welcome future feedback regarding what is helpful and what is not when it comes to decision support. (Free subscription here).
* Tweetdeck - In case you missed my tweet about Rob Hanna's recommendation of Tweetdeck as a tool for organizing your Twitter posts, here's his post. A number of bloggers are using Twitter, some quite differently from how I use it. I encourage you to check out tweets from various sources and create your own list of people to "follow". If you see some innovative trading applications of Twitter, do feel free to share via a comment to this post. Thanks!
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* Does Market Profile Work? - That was the topic of an email that recently came my way. Apparently, one of the gurus of Market Profile has opined that the tool does not work as well as it once did. The writer asked my opinion on the matter. In a nutshell, I think it's the wrong question. Market Profile, like so many indicators and tools, was never intended as a source of mechanical trading signals. In my view, it's a way of organizing market observations, much as a physician's diagnostic system is a way of organizing data from a patient's history and physical. The question is, not whether it works, but whether it works for you. Is it a useful framework for organizing your observations of markets? A different framework would be Elliott Wave theory or chart-based technical analysis. If a framework helps you make sense of supply and demand and if it helps you see and act upon market patterns, it works for you.
* How to Develop as a Trader - Check out JT's comment to my recent post on upsets in the NCAA and in trading. He illustrates how to make use of the material on this blog--or any site for that matter. Instead of looking for answers from a guru (which I'm not!), JT uses material selectively for "study/replay" until he can see the patterns in real time. Trading is a performance sport, no different from football or chess. A site or blog can give you ideas for improving your football or chess performance, but it's on the practice field and chessboard that you'll develop yourself. The goal is to take away from the posts what is useful to you, put aside the rest, assimilate material from multiple sources, and integrate all of it into your own style of trading. It's the active work of culling out the important material (JT's folders) and bringing it into your practice that creates the learning and development.
* Twitter Explosion - When I started Twitter posts last year, I was quite pleased when 300 traders signed up for RSS subscriptions to the "blog within a blog". Now the list is up to 3000. I want to thank traders for their interest and feedback on the "tweets". The expansion of interest in the Twitter posts reflects, I believe, traders' need for real time information and mentoring. The blog's Twitter feature is still a work in progress; I will welcome future feedback regarding what is helpful and what is not when it comes to decision support. (Free subscription here).
* Tweetdeck - In case you missed my tweet about Rob Hanna's recommendation of Tweetdeck as a tool for organizing your Twitter posts, here's his post. A number of bloggers are using Twitter, some quite differently from how I use it. I encourage you to check out tweets from various sources and create your own list of people to "follow". If you see some innovative trading applications of Twitter, do feel free to share via a comment to this post. Thanks!
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NCAA and Trading Upsets: Know Your Performance Profile
An excellent article in today's Wall St. Journal describes the science behind upsets in the NCAA tournaments. The article points out:
"Despite all the hunches about sleeper picks, teams often win basketball games at any level for a simple reason--they create more chances to score than their opponents do by forcing more turnovers and grabbing more rebounds. More shots at the basket usually generate more points."
The article later provides examples of teams that perform better or worse depending on the quality of their opponents. These statistical tendencies greatly alter the odds of tournament upsets.
The implications for trading are significant. Much of trading success boils down to consistency: being able to "score" against a variety of opponents (in different market conditions). Many times we see a trader make money, only to find that it's primarily made on the long side when buying the market. Little wonder that the trader experiences a tournament upset when the trend changes.
Similarly, just as basketball fundamentals--rebounding, limiting turnovers--alter the odds of winning, the fundamentals of trading affect profitability. Does the trader wait for weakness before buying or strength before selling, thereby improving the risk:reward profile for the trade? Does the trader limit losses promptly, using information from those losing trades to score with new, winning ideas? Does the trader take a level of risk in the trade commensurate with the trade's potential and uncertainty?
The most important implication of the article, however, is that many upsets are not really upsets, once we drill down to performance statistics. Most traders don't know how they perform in different market conditions; in their long vs. short trades; in their trades in different names or markets; in different times of day. It's difficult to improve yourself as a performer if you don't truly understand your strengths and weaknesses as a performer. Playing to your strengths and minimizing your exposure in weak areas can help ensure that you will be the one pulling off upsets in the markets, not the one who gets smoked in seemingly easy market conditions.
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"Despite all the hunches about sleeper picks, teams often win basketball games at any level for a simple reason--they create more chances to score than their opponents do by forcing more turnovers and grabbing more rebounds. More shots at the basket usually generate more points."
The article later provides examples of teams that perform better or worse depending on the quality of their opponents. These statistical tendencies greatly alter the odds of tournament upsets.
The implications for trading are significant. Much of trading success boils down to consistency: being able to "score" against a variety of opponents (in different market conditions). Many times we see a trader make money, only to find that it's primarily made on the long side when buying the market. Little wonder that the trader experiences a tournament upset when the trend changes.
Similarly, just as basketball fundamentals--rebounding, limiting turnovers--alter the odds of winning, the fundamentals of trading affect profitability. Does the trader wait for weakness before buying or strength before selling, thereby improving the risk:reward profile for the trade? Does the trader limit losses promptly, using information from those losing trades to score with new, winning ideas? Does the trader take a level of risk in the trade commensurate with the trade's potential and uncertainty?
The most important implication of the article, however, is that many upsets are not really upsets, once we drill down to performance statistics. Most traders don't know how they perform in different market conditions; in their long vs. short trades; in their trades in different names or markets; in different times of day. It's difficult to improve yourself as a performer if you don't truly understand your strengths and weaknesses as a performer. Playing to your strengths and minimizing your exposure in weak areas can help ensure that you will be the one pulling off upsets in the markets, not the one who gets smoked in seemingly easy market conditions.
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Monday, March 16, 2009
Tracking the Quality of Stock Market Movement
Today was a great example of a low-quality stock market rally. We opened to the upside, advancing stocks led decliners, and NYSE TICK was strong through the morning, with a positive slope to the Cumulative TICK line.
Two elements, however, made the rise low quality:
1) It was a mixed market - As my Twitter post early in the morning noted, sector participation in the rise was far from uniform. NASDAQ and small cap stocks were underperforming the S&P 500 Index. Industrial stocks were strong in the morning; consumer discretionary shares could not best their opening levels. In a good trend, sectors move in unison. Mixed markets suggest that there is correction occurring as well as strength.
2) The market was inefficient - An efficient market is one that achieves a high degree of price movement for a given unit of buying interest (such as NYSE TICK or advance/decline). An inefficient market is one that struggles to move higher, even as there is net buying pressure. How do we know a market is struggling? If the market needs considerable time simply to break out of its overnight range or to touch R1, then its rise is less efficient than that of a market that hits R1 very early in trade.
Mixed, inefficient markets are low quality markets, and low quality markets are ones that are ripe for reversal. That is why, in my Twitter post at 12:57 CT, I quickly noted the possibility of reversion back into the morning trading range.
A rise is not a rise is not a rise. There is more to markets than the price movements of capitalization-weighted averages. By seeing how various components of markets are moving and by gauging the trajectory of market moves, we can make meaningful inferences as to whether rises are likely to persist or reverse.
As I can (this week is on the road working with traders), I will update Twitter with intraday observations to help illustrate these patterns (free subscription here).
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Two elements, however, made the rise low quality:
1) It was a mixed market - As my Twitter post early in the morning noted, sector participation in the rise was far from uniform. NASDAQ and small cap stocks were underperforming the S&P 500 Index. Industrial stocks were strong in the morning; consumer discretionary shares could not best their opening levels. In a good trend, sectors move in unison. Mixed markets suggest that there is correction occurring as well as strength.
2) The market was inefficient - An efficient market is one that achieves a high degree of price movement for a given unit of buying interest (such as NYSE TICK or advance/decline). An inefficient market is one that struggles to move higher, even as there is net buying pressure. How do we know a market is struggling? If the market needs considerable time simply to break out of its overnight range or to touch R1, then its rise is less efficient than that of a market that hits R1 very early in trade.
Mixed, inefficient markets are low quality markets, and low quality markets are ones that are ripe for reversal. That is why, in my Twitter post at 12:57 CT, I quickly noted the possibility of reversion back into the morning trading range.
A rise is not a rise is not a rise. There is more to markets than the price movements of capitalization-weighted averages. By seeing how various components of markets are moving and by gauging the trajectory of market moves, we can make meaningful inferences as to whether rises are likely to persist or reverse.
As I can (this week is on the road working with traders), I will update Twitter with intraday observations to help illustrate these patterns (free subscription here).
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Indicator Update for March 16th
Last week's review of indicators concluded that, "Until we see evidence of a rising Cumulative TICK line and Demand exceeding Supply, it is premature to assume that oversold indicator readings will lead to a sustained market rally." We did, indeed, see strength in the NYSE TICK (second chart from bottom) as the week moved along, and Demand soared ahead of Supply. The eight S&P 500 sectors that I track moved from deeply oversold positions to a more neutral status, as formerly weak sectors saw significant buying.
While we saw advancing stocks trouncing decliners for most of the week (bottom chart), we're still in a downtrend in the advance-decline line for the NYSE common stocks, as nicely illustrated by Decision Point. Similarly, 20-day highs hold only a relatively slim edge of lows (second chart from top), and the Cumulative NYSE TICK remains well off its recent highs. In short, as impressive as the rally was, there is nothing yet that makes it different from other sharp bounces we've had in the past several months.
So what would we need to see to conclude that this is more than a violent short-covering rally? That's where the Cumulative Demand/Supply Index (top chart) enters the picture. If you click on that chart, you'll see that we've soared to an overbought point that has been typical of recent market peaks.
In a sustained bull move, pullbacks in the Cumulative DSI toward zero tend to be shallow in price terms and are followed by subsequent rises in Demand and spikes in the Cumulative DSI indicator, with price making new highs. In a bear market, peaks in the Cumulative DSI invite strong selling, a significant excess of Supply over Demand, and near-term topping out.
In other words, we'll have a good handle on the sustainability of this rally when we see if we can sustain days in which significant upside momentum (Demand) stays ahead of significant downside momentum (Supply). For now, two observations are germane: we're in a short-term bull move until the indicators show us otherwise, and--to this point--peaks in the Cumulative DSI are occurring at successively lower price highs. As long as the indicators remain strong, it's premature to fade market strength; as long as we see lower price highs and lower price lows during successive peaks and valleys in the indicators, it's premature to conclude that the bear market is over.
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Sunday, March 15, 2009
Demand and Supply: Measures of Stock Market Momentum
Probably the most unique and unusual indicator I track is a proprietary measure called Demand and Supply. These measures are not available in the public domain to my knowledge; I do, however, track them each morning before the market open in my Twitter posts (free subscription here).
We can think of Demand and Supply as momentum measures: Demand taps significant upside momentum, Supply captures significant downside momentum.
Significant momentum is defined by a stock's closing above or below its Bollinger Band; i.e., above or below the volatility envelope surrounding its short-term moving average. The larger the number, the greater the number of NYSE, NASDAQ, and ASE stocks that are trading with significant momentum.
This is useful in identifying market turns (as strong momentum turns to weak momentum before reversing), and it's useful in identifying markets with considerable thrust that are likely to follow through in the short run.
In the chart above, you can see how Supply (yellow line) peaked well ahead of price and how it petered out prior to the market rally. We can also see Demand (pink line) soar early in the rally, suggesting considerable upthrust.
I'll be posting more regarding applications of this unusual indicator. For instance, when both Demand and Supply are low, we tend to have a range market. Pullbacks in Demand and bounces in Supply represent good swing entry points in trending markets. A cumulative line of the difference between Demand and Supply is the best overbought/oversold indicator in my arsenal. (Note: it is updated each Monday as part of my indicator review; tomorrow's Cumulative Demand/Supply Indicator posting is particularly interesting). When a period of strong Demand is followed by a spike in Supply (as in the second week of February) or vice versa, we typically see a trend change.
The core idea behind Demand and Supply is that momentum tends to top and bottom ahead of price. Again, I will be posting much more on this topic later in the week.
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Sector Update for March 15th
Last week's sector review found that weakness was evenly spread among sectors, with all showing bearish Technical Strength. With the rally of the past week, however, that situation has changed significantly. Here is how the sectors are looking as of Friday's close. Recall that Technical Strength (a quantification of short-term trending) varies from -500 (strong downtrend) to +500 (strong uptrend), with values between -100 and +100 suggesting no significant trend:
We see that all of the sectors have turned around significantly from their lows last week, but none of the sectors are even close to an overbought status. Indeed, the recent rally--strong as it has been--has only been sufficient to move the sectors to neutral status in Technical Strength. Note the especially large turnarounds in the Consumer Discretionary and Financial sectors, as sentiment has shifted from relative risk aversion to risk seeking.
This also suggests that a good part of the recent rally has been short-covering among those beaten down sectors. We will need active, continued buying to move the sectors from neutral to solid uptrending status.
When we look at the percentage of issues in each sector that closed on Friday above their 20-day moving average (in parentheses, as reported by Decision Point), we see that most of the sectors show more than 50% of their components trading above that benchmark. Again, note the considerable bullish swing among Consumer Discretionary and Financial shares; Industrials lag the pack. As long as we see Technical Strength, Demand/Supply, and the percentage of stocks above their 20-day average rising, it is premature to fade market strength.
Readers interested in tracking sector strength and weakness on a daily basis should note the tally of bullish, bearish, and neutral stocks in my S&P 500 basket that is evenly divided among the eight sectors above. I also track the percentage of SPX stocks overall that close above their moving averages. Those measures, and especially the very sensitive Demand/Supply index, caught the turnaround in the market quite nicely this past week. Both measures are posted each morning prior to the market open via Twitter; subscription (RSS) is free of charge, or you can pick up the last five "tweets" on the blog page under "Twitter Trader".
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MATERIALS: +100 (66%)
INDUSTRIAL: +80 (33%)
CONSUMER DISCRETIONARY: +100 (76%)
CONSUMER STAPLES: +80 (60%)
ENERGY: +20 (58%)
HEALTH CARE: +80 (48%)
FINANCIAL: +140 (73%)
TECHNOLOGY: +140 (78%)
INDUSTRIAL: +80 (33%)
CONSUMER DISCRETIONARY: +100 (76%)
CONSUMER STAPLES: +80 (60%)
ENERGY: +20 (58%)
HEALTH CARE: +80 (48%)
FINANCIAL: +140 (73%)
TECHNOLOGY: +140 (78%)
We see that all of the sectors have turned around significantly from their lows last week, but none of the sectors are even close to an overbought status. Indeed, the recent rally--strong as it has been--has only been sufficient to move the sectors to neutral status in Technical Strength. Note the especially large turnarounds in the Consumer Discretionary and Financial sectors, as sentiment has shifted from relative risk aversion to risk seeking.
This also suggests that a good part of the recent rally has been short-covering among those beaten down sectors. We will need active, continued buying to move the sectors from neutral to solid uptrending status.
When we look at the percentage of issues in each sector that closed on Friday above their 20-day moving average (in parentheses, as reported by Decision Point), we see that most of the sectors show more than 50% of their components trading above that benchmark. Again, note the considerable bullish swing among Consumer Discretionary and Financial shares; Industrials lag the pack. As long as we see Technical Strength, Demand/Supply, and the percentage of stocks above their 20-day average rising, it is premature to fade market strength.
Readers interested in tracking sector strength and weakness on a daily basis should note the tally of bullish, bearish, and neutral stocks in my S&P 500 basket that is evenly divided among the eight sectors above. I also track the percentage of SPX stocks overall that close above their moving averages. Those measures, and especially the very sensitive Demand/Supply index, caught the turnaround in the market quite nicely this past week. Both measures are posted each morning prior to the market open via Twitter; subscription (RSS) is free of charge, or you can pick up the last five "tweets" on the blog page under "Twitter Trader".
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Predicting Trending and Non-Trending Markets: A Direction for Research
My recent post suggested that the intraday NYSE advance-decline line ($ADD) offers a useful perspective on whether the day is shaping up as a mixed, range day or a one-sided trending day. Because an awareness of the emerging day structure is key to trading tactics--whether you'll trade or fade strength or weakness--few research questions are as important to the active trader. Nonetheless, I've seen no solid research on this topic in the writings I've encountered.
Let's frame the research challenge more broadly: If we consider indicators A, B, C...etc. at points of time X, Y, Z...etc. during the morning hours, which indicators most accurately predict trending and non-trending markets earliest during the market day?
Say, for example, that indicator C at time X is the best gauge of whether or not we'll have a trending market, significantly correlating with price movement from time X to the market close. It would then make sense for a daytrader to sit out the period from the market open to time X, waiting for the noise to sort itself out before an educated estimate could be made relative to the issue of day structure.
Armed with this information, a trader could then establish tactics for the trading day and use his/her feel for markets to aid in the execution of those tactics.
Here's a simple example: If we go back to late September, 2008 (which is as far as my intraday data set for the indicator goes), we find that the opening value of the advance-decline indicator ($ADD) correlates with the final, closing value by about .30. That means that 9% of the variance in the closing value of $ADD is accounted for by its opening value.
If, however, we look at the value of $ADD after the first 15 minutes of trade, that correlation with the closing advance-decline value jumps to .63. That means that 39% of the variance in the closing value of $ADD is accounted for--a significant jump. Indeed, if the first 15 minutes in $ADD are positive, the average closing value of $ADD is +675. If the first 15 minutes are negative, the average closing value of $ADD is -1063.
These findings are suggestive and illustrative only. Crucial questions remain: How do the indicators correlate with an actual price-based measure of trending/non-trending? Will a combination of indicators prove more predictive (or predict more early) than a single indicator? Are the indicator values related to trending/non-trending in a linear or non-linear manner?
Good posts offer fresh answers to tough trading questions. The best posts, however, offer fresh questions and directions for trading. Personally, I think this is the best post I've written in quite a while.
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Let's frame the research challenge more broadly: If we consider indicators A, B, C...etc. at points of time X, Y, Z...etc. during the morning hours, which indicators most accurately predict trending and non-trending markets earliest during the market day?
Say, for example, that indicator C at time X is the best gauge of whether or not we'll have a trending market, significantly correlating with price movement from time X to the market close. It would then make sense for a daytrader to sit out the period from the market open to time X, waiting for the noise to sort itself out before an educated estimate could be made relative to the issue of day structure.
Armed with this information, a trader could then establish tactics for the trading day and use his/her feel for markets to aid in the execution of those tactics.
Here's a simple example: If we go back to late September, 2008 (which is as far as my intraday data set for the indicator goes), we find that the opening value of the advance-decline indicator ($ADD) correlates with the final, closing value by about .30. That means that 9% of the variance in the closing value of $ADD is accounted for by its opening value.
If, however, we look at the value of $ADD after the first 15 minutes of trade, that correlation with the closing advance-decline value jumps to .63. That means that 39% of the variance in the closing value of $ADD is accounted for--a significant jump. Indeed, if the first 15 minutes in $ADD are positive, the average closing value of $ADD is +675. If the first 15 minutes are negative, the average closing value of $ADD is -1063.
These findings are suggestive and illustrative only. Crucial questions remain: How do the indicators correlate with an actual price-based measure of trending/non-trending? Will a combination of indicators prove more predictive (or predict more early) than a single indicator? Are the indicator values related to trending/non-trending in a linear or non-linear manner?
Good posts offer fresh answers to tough trading questions. The best posts, however, offer fresh questions and directions for trading. Personally, I think this is the best post I've written in quite a while.
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Saturday, March 14, 2009
Bernard Madoff, Trust in Markets, and More
* Investor Trust - I recently did a short segment for First Business TV and was asked if Bernard Madoff's confession and jailing would help restore investor confidence. My reply was that confidence has not only been broken with respect to regulation and enforcement, but with the entire notion of buy-and-hold. Professional money managers are fleeing to lower risk strategies, less leverage, and more liquid markets. That is not a trend that will turn on a dime.
* Setups - I've been posting quite a bit on recognizing the structure of market days. Getting that call right on whether we're trending or range bound is half the day trading battle. After that, it's a matter of mastering execution on three basic setups. I'll be focusing on that in future posts.
* Mentorship - In case you missed my Twitter link, here's the post on the mentorship program that Charles Kirk is offering. Great opportunity, IMO.
* Sentiment Data - My recent post took a look at Data Explorers and their unique measure of stock and sector sentiment. Here's a paper that investigates the results of a trading strategy that utilizes those data.
* Big Themes - This is a very worthwhile article touching upon earnings weakness, problems in Japan, and competitive devaluation from Switzerland.
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* Setups - I've been posting quite a bit on recognizing the structure of market days. Getting that call right on whether we're trending or range bound is half the day trading battle. After that, it's a matter of mastering execution on three basic setups. I'll be focusing on that in future posts.
* Mentorship - In case you missed my Twitter link, here's the post on the mentorship program that Charles Kirk is offering. Great opportunity, IMO.
* Sentiment Data - My recent post took a look at Data Explorers and their unique measure of stock and sector sentiment. Here's a paper that investigates the results of a trading strategy that utilizes those data.
* Big Themes - This is a very worthwhile article touching upon earnings weakness, problems in Japan, and competitive devaluation from Switzerland.
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The NYSE Advance-Decline Line: Identifying Trending and Range Environments
I've emphasized in recent posts that the single most important market call an active trader makes during the early portion of the day is whether we are in a range bound or trending environment. This one call sets trading tactics going forward. If we're range bound, we will want to identify the "fulcrum"--the midpoint--of that range and fade moves away from that estimate of value. Friday was a good example of that kind of trade. As readers are aware, I utilize volume-weighted average price (VWAP) as an evolving estimate of fulcrum/value.
Conversely, in a trending environment, we've typically broken out of an established range and are moving directionally. We want to identify the first counter-trend movement in such a directional move (pullbacks in NYSE TICK are useful for this purpose) and then enter in the direction of the trend.
So, in a range environment, you tend to fade strength and weakness; in a trend environment, you tend to go with market direction. Because traders lack the tools and skills to identify the environment as it unfolds--or because they get into mindframe that denies them access to the information from their tools and skills--they fade trends and chase direction during ranges. If you just identify the market environment properly, your execution can be less than stellar and the market will be somewhat forgiving. If you misidentify the environment, there is swift retribution.
(That is one reason that losing trades can also be good learning experiences. A losing trade may provide you with information that you are wrong in your expectations of the day's unfolding structure. That is a great topic for review when you're losing money during the day).
In my intraday Twitter comments, you'll sometimes see me suggest very early in the trading day that we might be in a range environment. For example, here was an early comment on Friday morning:
In a trending environment, sectors should be moving in unison. When we see some sectors quite strong and others struggling to break even or even down, that tells us that we're either not trending as a market or that the trend is not robust.
A very effective tool for identifying trend environments vs. range ones is the intraday NYSE advance-decline line. I track the difference between advancing and declining stocks on an intraday basis; this goes under the symbol $ADD on the e-Signal platform.
Interestingly, the opening value for $ADD correlates with the value at the end of the first half hour of trade by .56, going back to October, 2008. The median opening value for $ADD has been -1, with a standard deviation of 81. So when we see $ADD open at +150 or greater or at -150 or less, that's a bit of a heads up that we might be in a trending environment.
By the end of the first half hour of trade, again going back to October, 2008, we find that the median value for $ADD has been -346, with a whopping standard deviation of 1378. That tells us that, within the first 30 minutes of trading, much of the issue of whether or not we're in a trending environment has been sorted out. (My next post will explore this issue more specifically). If we're seeing $ADD between -1000 and +1000 by the end of the first half hour of trade, we're much less likely to be in a trending environment than if we have readings of +1500 or more or -1500 or less.
Will a break above or below a range lead to a directional, trending move? It's likely that the participation of the NYSE advance-decline line will provide some clues. If, for instance, a break above a market's opening range (say, its range for the first 15 minutes of trade) occurs with $ADD well below +1000 and with mixed sector strength, we might be much less likely to go with that move than if the breakout vaults $ADD above +1500 with strong sector participation and leadership.
When I'm not tied up working with the firms I work with, I'll make early AM Twitter comments about $ADD for traders' decision support. Over 2800 traders are signed up for the Twitter feed (subscription is free, no registration required), and an equal number appear to be pulling the "tweets" off the blog page, where the most recent five always appear. The goal is to help you think about markets in a more structured and disciplined fashion. This is where trading skill and psychology come together: when we're grounded in skill, we're most likely to sustain a proper performance mindset.
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Conversely, in a trending environment, we've typically broken out of an established range and are moving directionally. We want to identify the first counter-trend movement in such a directional move (pullbacks in NYSE TICK are useful for this purpose) and then enter in the direction of the trend.
So, in a range environment, you tend to fade strength and weakness; in a trend environment, you tend to go with market direction. Because traders lack the tools and skills to identify the environment as it unfolds--or because they get into mindframe that denies them access to the information from their tools and skills--they fade trends and chase direction during ranges. If you just identify the market environment properly, your execution can be less than stellar and the market will be somewhat forgiving. If you misidentify the environment, there is swift retribution.
(That is one reason that losing trades can also be good learning experiences. A losing trade may provide you with information that you are wrong in your expectations of the day's unfolding structure. That is a great topic for review when you're losing money during the day).
In my intraday Twitter comments, you'll sometimes see me suggest very early in the trading day that we might be in a range environment. For example, here was an early comment on Friday morning:
8:45 AM CT - Mixed performance among sectors continues; AD line stalling out; if that continues, entertaining reversion move to pivot.
In a trending environment, sectors should be moving in unison. When we see some sectors quite strong and others struggling to break even or even down, that tells us that we're either not trending as a market or that the trend is not robust.
A very effective tool for identifying trend environments vs. range ones is the intraday NYSE advance-decline line. I track the difference between advancing and declining stocks on an intraday basis; this goes under the symbol $ADD on the e-Signal platform.
Interestingly, the opening value for $ADD correlates with the value at the end of the first half hour of trade by .56, going back to October, 2008. The median opening value for $ADD has been -1, with a standard deviation of 81. So when we see $ADD open at +150 or greater or at -150 or less, that's a bit of a heads up that we might be in a trending environment.
By the end of the first half hour of trade, again going back to October, 2008, we find that the median value for $ADD has been -346, with a whopping standard deviation of 1378. That tells us that, within the first 30 minutes of trading, much of the issue of whether or not we're in a trending environment has been sorted out. (My next post will explore this issue more specifically). If we're seeing $ADD between -1000 and +1000 by the end of the first half hour of trade, we're much less likely to be in a trending environment than if we have readings of +1500 or more or -1500 or less.
Will a break above or below a range lead to a directional, trending move? It's likely that the participation of the NYSE advance-decline line will provide some clues. If, for instance, a break above a market's opening range (say, its range for the first 15 minutes of trade) occurs with $ADD well below +1000 and with mixed sector strength, we might be much less likely to go with that move than if the breakout vaults $ADD above +1500 with strong sector participation and leadership.
When I'm not tied up working with the firms I work with, I'll make early AM Twitter comments about $ADD for traders' decision support. Over 2800 traders are signed up for the Twitter feed (subscription is free, no registration required), and an equal number appear to be pulling the "tweets" off the blog page, where the most recent five always appear. The goal is to help you think about markets in a more structured and disciplined fashion. This is where trading skill and psychology come together: when we're grounded in skill, we're most likely to sustain a proper performance mindset.
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Friday, March 13, 2009
Data Explorers: Generating A Unique Measure of Stock Market Sentiment
Let's say that you were prescient last week and anticipated a market rally or perhaps saw one in the making this week. What stocks and sectors would you want to buy? One way to select candidates for superior gains would be to buy the stocks that were most heavily shorted. Those, after all, would be most subject to short squeezes and short covering rallies.
But how can we obtain short sales data on a timeframe shorter than the monthly data reported by the exchanges? A unique solution is offered by the Data Explorers site, which collects short sales data daily from Custodians and Prime Brokers to help them benchmark their costs. Once Data Explorers has aggregated these data for all stocks, they can create timely reports on how actively shorted a particular stock or sector might be. That creates a potentially useful sentiment measure.
I created the chart above in Excel with last week's data from Data Explorers (not wanting to compromise their current data). You can see that, of the sectors this blog follows weekly, the two that had the largest percentage of shares borrowed for shorting were Consumer Discretionary and Financial. Those, indeed, have shown relative strength during the recent market rally.
These data are of obvious value to hedge funds that trade equities, but also to stock index traders (aggregate all the sectors and you have daily reports on market shorting--an excellent sentiment tool) and even daytraders looking for stocks in play. I like sentiment measures that are based on the actual behavior of traders and investors in the marketplace; the Data Explorer measures are unique in that they tap the sentiment of institutional traders that can move the markets.
Interested traders and portfolio managers might check out the Short Stories blog, which highlights promising findings from the Data Explorer database.
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Trading With an Independent and Open Mind
Well, once again a shout out to the source of all Despair for a worthwhile market lesson. It's true that minds, like parachutes, only function when they're open. I find that trading is most successful when I'm entertaining multiple hypotheses and scenarios at any one time. For instance, as we near the top of the prior day's range, I'm mentally rehearsing what I would do if I see expanded buying on increased volume, but I'm also preparing for what I would do if I see the buying interest drying up.
One of the hardest lessons for traders to learn is to not fight markets. Once you become attached to a particular idea or scenario, your ego wants to be right. Instead of focusing on making money, you're caught up in proving yourself to be correct. That makes it impossible to quickly exit a wrong position and flip it into a winning one.
By entertaining multiple scenarios at any one time, we don't allow ourselves to become too attached to any one. Our thinking takes on an "if-then" planning that is focused on process, rather than P/L. This keeps us grounded in the reality that there is always a measure of uncertainty in markets; we always need to be prepared for markets to disconfirm our preferred scenarios.
But what if, as the poster above suggests, we lose our minds altogether? We become filled with frustration, overconfidence, or fear, and now we don't really have a planned scenario at all. Many times, out of loss of confidence, we'll stop thinking about markets altogether and lean entirely on the analyses of others. We forget about our parachutes and try to borrow the chute of a selected guru. Well intentioned as some readers of this blog are, they sometimes ask me for answers in lieu of taking the steps to find their own. Even if my ideas are sound, substituting those for one's own independent judgment cannot breed self-confidence. No one's parachute can take the place of one's own.
In my last post, I made a mistake out of haste and referred to a "bear trap" when I meant a "bull trap". A couple of readers quickly pointed out my error. I decided, however, to keep the mistake intact as a reminder of fallibility--my own most of all. Learn from others, but ultimately make the learning your own. You'll sail to earth successfully only with your own chute, fully open.
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Thursday, March 12, 2009
A Shift to the Bull or Bear Trap for the Unwary?
If you click the chart of the S&P 500 Index (SPY) above, you'll see that, since September, forays above the 20-day moving VWAP line have been short-lived. With today's continued rally, we're now peeking above that level.
A hallmark of a downtrending market is that sharp short-covering rallies serve as opportunities for further selling by the bears. It is how large institutional traders respond to market strength that determines whether this is a rally in a bear or the start of a bottoming process.
I will be following the Cumulative TICK, new highs/lows, and sector strength to gain some clarity on this issue. To this juncture, rallies above the 20-day VWAP have been bear traps. Will the November support now act as resistance and keep us in bear mode? Or can we sustain prices above that level? As long as retracements are shallow--like we saw yesterday and this morning--we have to respect the rally and the clear strength in the Demand/Supply numbers. I'll be updating those numbers tomorrow morning before the open via Twitter.
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Trading Mentors: Learning by Seeing, Doing, Teaching
A good trading mentor, like a good teacher of physicians, will both model skills and observe the skills of students, providing timely feedback as part of a review process. This supervision, based on the "see one, do one, teach one" model of training, emphasizes learning by doing, not by classroom teaching. Much of that learning entails pattern recognition: seeing so many cases that you begin to appreciate similarities and differences.
One of the first sets of skills aspiring physicians learn is diagnosis. You can't effectively treat an illness until you clearly identify it first. Similarly, you can't effectively trade a market unless you acquire an understanding of the market you're trading.
In the doctoring world, physicians run various tests on patients, from blood workups to checks on vital signs to imaging studies. These tests are their "indicators" of a patient's condition. From the results of these tests, physicians learn to rule out certain problems and entertain the possibility of other ones.
The informed trader is not so different. Indicators emphasized in this blog, such as relative volume and NYSE TICK, help a trader rule out certain possibilities (an upward trending market) and rule in other ones (a range market). From this "diagnosis" of the market, the trader can make inferences regarding the likelihood of hitting certain price levels, such as the prior day's average price (pivot) or the current day's volume-weighted average price.
If a physician takes a sick patient's blood pressure and finds that it's normal, the physician doesn't complain that the "indicator"--blood pressure--"doesn't work". Rather, that information is used to infer that perhaps the illness is not heart-related. Ruling out possibilities is just as important to diagnosis as ruling ones in. If a market is moving higher, but NYSE TICK is mixed, I don't conclude that TICK is unreliable. I know from past market studies that low TICK rises are especially vulnerable to reversal, and I start to question the likelihood that the current rise will be a sustainable upward trend.
Notice one of my early Twitter tweets from yesterday:
Just several minutes into the trading day, I'm seeing signs of mixed strength in the market, so I'm entertaining the hypothesis of a range day. At this early juncture, my hypothesis is just like a physician's tentative diagnosis that a patient might have an ear infection based on the pattern of presenting symptoms. That tentative diagnosis leads to further tests (such as examining the ear for signs of inflammation), just as a tentative hypothesis about the structure of the market day leads me to further examine certain indicators (sector behavior for mixed vs uniform strength; relative volume increasing or decreasing) for signs of trending or reversal.
The challenge for the trader is not so much one of making market predictions as refining trading hypotheses as market data unfold. The effective trading mentor models this reasoning process, but eventually needs to let junior traders try out their own reasoning, with prompt review of solid and flawed reasoning. That is why sound mentoring has to occur during the trading process, just as effective training of physicians has to occur at the bedside or in the clinic.
The intraday Twitter posts (free subscription) are my way of modeling my thinking about markets as trading unfolds. Imagine, however, an interactive messaging environment, in which students can work as teams to diagnose markets and propose winning trades--just as medical students rotate through different specialties as teams and learn from one another. The challenge for mentoring is to turn one-way mechanisms of delivering information into effective, interactive platforms for mutual seeing, doing, and teaching.
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One of the first sets of skills aspiring physicians learn is diagnosis. You can't effectively treat an illness until you clearly identify it first. Similarly, you can't effectively trade a market unless you acquire an understanding of the market you're trading.
In the doctoring world, physicians run various tests on patients, from blood workups to checks on vital signs to imaging studies. These tests are their "indicators" of a patient's condition. From the results of these tests, physicians learn to rule out certain problems and entertain the possibility of other ones.
The informed trader is not so different. Indicators emphasized in this blog, such as relative volume and NYSE TICK, help a trader rule out certain possibilities (an upward trending market) and rule in other ones (a range market). From this "diagnosis" of the market, the trader can make inferences regarding the likelihood of hitting certain price levels, such as the prior day's average price (pivot) or the current day's volume-weighted average price.
If a physician takes a sick patient's blood pressure and finds that it's normal, the physician doesn't complain that the "indicator"--blood pressure--"doesn't work". Rather, that information is used to infer that perhaps the illness is not heart-related. Ruling out possibilities is just as important to diagnosis as ruling ones in. If a market is moving higher, but NYSE TICK is mixed, I don't conclude that TICK is unreliable. I know from past market studies that low TICK rises are especially vulnerable to reversal, and I start to question the likelihood that the current rise will be a sustainable upward trend.
Notice one of my early Twitter tweets from yesterday:
8:34 AM CT - Overnite low represents initial downside target; watching for signs of range day, so seeing how we trade rel to open & vwap.
Just several minutes into the trading day, I'm seeing signs of mixed strength in the market, so I'm entertaining the hypothesis of a range day. At this early juncture, my hypothesis is just like a physician's tentative diagnosis that a patient might have an ear infection based on the pattern of presenting symptoms. That tentative diagnosis leads to further tests (such as examining the ear for signs of inflammation), just as a tentative hypothesis about the structure of the market day leads me to further examine certain indicators (sector behavior for mixed vs uniform strength; relative volume increasing or decreasing) for signs of trending or reversal.
The challenge for the trader is not so much one of making market predictions as refining trading hypotheses as market data unfold. The effective trading mentor models this reasoning process, but eventually needs to let junior traders try out their own reasoning, with prompt review of solid and flawed reasoning. That is why sound mentoring has to occur during the trading process, just as effective training of physicians has to occur at the bedside or in the clinic.
The intraday Twitter posts (free subscription) are my way of modeling my thinking about markets as trading unfolds. Imagine, however, an interactive messaging environment, in which students can work as teams to diagnose markets and propose winning trades--just as medical students rotate through different specialties as teams and learn from one another. The challenge for mentoring is to turn one-way mechanisms of delivering information into effective, interactive platforms for mutual seeing, doing, and teaching.
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Wednesday, March 11, 2009
Site Seeing: SentimenTrader on What Makes This Market Different
I recently posted on the topic of blindly following historical patterns in the market. It's been a difficult time for traders and portfolio managers who have assumed that the current market decline is like recent ones. Oversold markets, instead of bouncing, have led to further oversold conditions and lower prices. Jason Goepfert, posting on this topic on his SentimenTrader site, points out, "The most striking aspect of the decline since the fall of 2007 is the utter lack of any lasting rally. We've had a number of fits and starts, but nothing that took for very long. That's what has frustrated traders and investors alike more than just about anything."
Jason backs his view with an interesting chart reproduced above. It goes back to the late 1920s and shows the length of time between 80-day rally periods in the S&P 500 Index. The current period of 288 days is matched only by the weak markets of late 1932, early 1975, and mid-1978. None of those times corresponded to short-term market bottoms, but all turned out to be close to long-term investment opportunities. Clearly, it's been hazardous to model recent markets on data going back to the 1990s or even the 1980s.
I've found Jason's historical analyses to be helpful in gauging the market's long and short-term pictures. He is generously offering to extend his usual 14 day free trial period to 30 days for TraderFeed readers. If you go to his free trial page and enter "traderfeed30" in the Detail field, you'll get the extended look. His service includes historical studies and email updates, as well as market commentary. He's also posting some of his short-term ideas to Twitter; worth checking out!
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Coaching Your Trading: Twitter, Decision Support, and Trading Reviews
In a recent post, I proposed the after action review as a useful tool for coaching traders. If we were to conduct a review of yesterday's trading, one important focus would be how traders traded the early morning portion of the session.
Let's take a look at a few of the Twitter posts from that AM:
6:26 AM CT- Note 3 day range in ES; SPY targets: pivot = 68.49; R1 = 70.55; R2 = 71.24; R3 = 71.93; S1 = 66.42; S2 = 65.73; S3 = 65.04.
8:42 AM CT - Watching TICK, financials to see if we sustain move above yesterday high in ES for R1 target or if we revert to pivot.
8:53 AM CT - We hit R1, as TICK has stayed quite positive on any pullbacks. Need *significant* selling (neg TICK) to effect a reversal.
8:42 AM CT - Watching TICK, financials to see if we sustain move above yesterday high in ES for R1 target or if we revert to pivot.
8:53 AM CT - We hit R1, as TICK has stayed quite positive on any pullbacks. Need *significant* selling (neg TICK) to effect a reversal.
The first "tweet" emphasized the context of morning's trade: we were in a three-day range. Right away, you want to entertain two hypotheses if we see early buying: any market strength will die out and we'll revert to the mean of the range; or buying will attract further interest and we'll sustain a breakout from the range.
This is where the targets are very helpful. A reversion into the range, gives us a price target at the market pivot. An upside break out of that range targets the R1, R2, and R3 price levels. What we need to do in the market's opening minutes is handicap the odds of one of those moves if we open near the top of the range.
By the second Twitter post above, we've already broken above the range. The post tells us that financial stocks are leading the charge (that has been a leading sector in recent sessions) and that NYSE TICK is key to sustaining the breakout. After all, if the breakout is genuine, we should see many more stocks transacting on upticks than downticks.
By 8:53 AM, we've already hit R1, as TICK has stayed quite positive. The Twitter post observes that we need to see *significant* selling to reverse this powerful breakout move. Recall from previous research on the blog that TICK readings are not significant unless they exceed +800 or fall below -800. To that point, we didn't even get a single -500 reading.
Let's now add a few other items to the mix that can help you identify upside breakout days. The green line is a 20-period VWAP line; observe that volume-weighted average price is rising and the ES futures are soaring in early trade above their line. That is a sign of a trending move: price stays above VWAP and VWAP is rising.
Second, observe that the market opened with several big green bars: price was moving (high volatility) and price was moving higher. This is the essence of the Power Measure that I described in the previous post. When directionality and volatility are in sync, we have a trending move.
Finally, note the expanded volume on the rise. Indeed, the volume in the first three five minute periods of the ES futures was about 200,000 contracts, close to the average volume (243,447) for the typical opening *30* minute period. (Relative volume norms are posted in my weekly indicator reviews).
Now, here's the important psychological part. Many traders who don't trade the initial breakout move will fret that they missed the move and will convince themselves that they don't want to "chase the market". So they sit there with a certain part of their anatomy in their hands and watch the market continue higher.
Two problems with that kind of thinking: First, it is backward looking. Instead of focusing on a move that you *didn't* trade, you want to be looking for where the next trade would be coming from. That is what those price targets from the first Twitter post above are for: if you miss the break above the previous day's high, then you wait for a pullback in TICK and play for a move to R1. If you miss the move to R1, you wait for a pullback in TICK and go for R2. As long as volume, volatility, and TICK are on your side, you want to trade with the trend.
Which gets us to the second problem with the "I don't want to chase" risk aversion: it fails to identify what is happening in the marketplace. In a range market, you surely don't want to trade momentum and buy strength or sell weakness. But if you have transitioned to a trending market, you want to ride strength or weakness. The trader who doesn't want to chase is locked in the previous, range bound mindset. The whole purpose of looking at indicators such as volume, volatility, TICK, ranges, and targets is to update your thinking so that you can revise your trading tactics.
I believe this illustrates some of the coaching potential of the Twitter application: real time market observations aid decision support. On days in which I'm not on the road working with traders and portfolio managers, I will use Twitter to help you (and me) frame trading ideas and hypotheses. (Subscription to Twitter feed is free via RSS). Then, after the morning or day's trading, you can conduct an after action review to see what you caught and what you missed. Such a process, day after day, is what can accelerate a learning curve and turn market hindsight into foresight.
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Tuesday, March 10, 2009
Calculating the Power Measure
My previous post illustrated an indicator that I've called the Power Measure. It is a running correlation of price change and volatility. Several readers have expressed interest in calculating such a measure, so I thought I'd offer a basic explanation. I will assume a moderate familiarity with Excel.
Let's use five-minute open-high-low-close data. Column A in Excel will be Date; Column B is Time; and Columns C, D, E, and F are Open, High, Low, and Close for the ES futures. In my example, I downloaded the data from e-Signal into Excel and arranged the columns as above.
For Column G, we'll compute Price Change for the five-minute bar. I calculate that as a percentage change. The formula in Excel (cell G3) would look like:
For Column H, we'll compute the Range for the five-minute bar, which will be our proxy for price volatility. The formula in Excel (cell H3) would look like:
Now we copy G3 and H3 and fill in all the G and H cells to the end of the data sample (which, in my post, was one trading day). That will give us Price Change and Range for each five-minute period during the day.
Now, in Column I, we calculate the 20-bar correlation between the values of Columns G and H; that correlation is our Power Measure. So the formula for cell I22 would look like:
Once again, we copy that cell (I22) and fill in all the I cells to the end of the data sample. We now have a moving 20-period correlation of five-minute data. It's like a moving average, except that it's a moving correlation. My chart simply plotted this moving correlation alongside ES price to illustrate how the indicator moved through the day.
I hope this explanation is helpful. For those with an interest, my new book goes into greater detail into the use of Excel to calculate market indicators and research historical patterns; that is the topic of Chapter 10.
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Let's use five-minute open-high-low-close data. Column A in Excel will be Date; Column B is Time; and Columns C, D, E, and F are Open, High, Low, and Close for the ES futures. In my example, I downloaded the data from e-Signal into Excel and arranged the columns as above.
For Column G, we'll compute Price Change for the five-minute bar. I calculate that as a percentage change. The formula in Excel (cell G3) would look like:
=((f3-f2)/f2)*100
For Column H, we'll compute the Range for the five-minute bar, which will be our proxy for price volatility. The formula in Excel (cell H3) would look like:
=((d3-e3)/e3)*100
Now we copy G3 and H3 and fill in all the G and H cells to the end of the data sample (which, in my post, was one trading day). That will give us Price Change and Range for each five-minute period during the day.
Now, in Column I, we calculate the 20-bar correlation between the values of Columns G and H; that correlation is our Power Measure. So the formula for cell I22 would look like:
=correl(G3:G22,H3:H22)
Once again, we copy that cell (I22) and fill in all the I cells to the end of the data sample. We now have a moving 20-period correlation of five-minute data. It's like a moving average, except that it's a moving correlation. My chart simply plotted this moving correlation alongside ES price to illustrate how the indicator moved through the day.
I hope this explanation is helpful. For those with an interest, my new book goes into greater detail into the use of Excel to calculate market indicators and research historical patterns; that is the topic of Chapter 10.
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The Power Measure: Trading With Direction and Volatility on Your Side
Think of the market as having two moving parts: one is direction, which is always up, down, or sideways in varying degree. The other is volatility, which is always volatile, quiet, or in between again in varying degree. The key to making significant money is to enter directional trades when volatility is also moving your way. In other words, if volatility is expanding as directionality is increasing, you have the makings of a significant trending move.
Above we see a variation of my Power Measure, which tracks the correlation between the directional movement of each bar and the absolute size of that bar. When tracking intraday shifts in direction and trend, I use a moving 20-bar correlation of five-minute data. The underlying logic of correlating price and range, however, is useful across time frames.
Notice how the correlation has stayed positive for much of the day, particularly since the market open at 8:30 AM CT. Indeed, the expansion of the Power Measure as we were breaking above multi-day support was helpful in identifying the nascent trending move. In gross terms, what the Power Measure is indicating is whether the market's "big bars" are predominantly occurring in one direction. When that is the case, it generally means that there is meaningful volume (i.e., institutional participation) and momentum behind the move--and that's worth respecting.
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Trading With a Diversified Emotional Portfolio
A little while back, I gave readers a sneak peak of a chapter from my forthcoming book, The Daily Trading Coach. Yesterday, I received an advance copy of the book in the mail, and I see a few copies have snuck their way onto Amazon for sale, so it's just a matter of time before the book ships. Thanks to readers for their interest in the book; as of my writing this, the book is ranked 1,127 among all Amazon texts. No doubt, the challenging market conditions that we're seeing are spurring an interest in self-help for traders. The goal of the book is to help traders learn to coach themselves with 101 concrete lessons and techniques.
One topic that I address in the second chapter is what we might call "emotional diversification": the degree to which the happiness and contentment in your life are coming from multiple sources. When we are emotionally diversified, no one area of setback in life can turn our stress into overwhelming distress. That is absolutely crucial in a field such as trading, where occasional setbacks are the norm even for the most profitable professionals.
Some questions to consider come from page 51 of the new book:
"How psychologically diversified are you? How much stress and distress are you experiencing in your social life, your family life, and in your general emotional state? How much satisfaction are you experiencing in each of these areas? What sustains you when trading goes poorly? What problems from your personal life creep into your trading day? How is your physical fitness? Your quality of sleep and concentration? Your energy level? It's worth evaluating the nontrading aspects of life as well as your market results with monthly reviews. If the other parts of your life are generating distress, it's only a matter of time before that compromises your focus, decision-making, and performance."
A little while back, I used the Twitter feature of the blog to link to a questionnaire that enables you to perform a brief emotional self-assessment. That generated quite a bit of interest, as readers seem to be interested in performing at their peaks. (You can take the short test here; here's where you can interpret the results; and here's where you can learn more about what the test is measuring). The idea of the monthly self-assessment mentioned above is to make sure that you are sustaining a physical and emotional state that will maximize your learning and performance. Happy, satisfied traders with a full complement of energy and a diversified portfolio of sources of well-being are least likely to trade impulsively out of frustration or desperation, and they are most likely to be in a mindset where they can aggressively take advantage of their opportunities.
Becoming your own trading coach starts with becoming your own observer: stepping back and examining whether or not you're doing the right things. And that starts, not with trading, but with doing the right things in all the other parts of life. No one climbs the learning curve of expertise firing on only a few cylinders. Success in markets is an expression of--not a substitute for--success in life.
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One topic that I address in the second chapter is what we might call "emotional diversification": the degree to which the happiness and contentment in your life are coming from multiple sources. When we are emotionally diversified, no one area of setback in life can turn our stress into overwhelming distress. That is absolutely crucial in a field such as trading, where occasional setbacks are the norm even for the most profitable professionals.
Some questions to consider come from page 51 of the new book:
"How psychologically diversified are you? How much stress and distress are you experiencing in your social life, your family life, and in your general emotional state? How much satisfaction are you experiencing in each of these areas? What sustains you when trading goes poorly? What problems from your personal life creep into your trading day? How is your physical fitness? Your quality of sleep and concentration? Your energy level? It's worth evaluating the nontrading aspects of life as well as your market results with monthly reviews. If the other parts of your life are generating distress, it's only a matter of time before that compromises your focus, decision-making, and performance."
A little while back, I used the Twitter feature of the blog to link to a questionnaire that enables you to perform a brief emotional self-assessment. That generated quite a bit of interest, as readers seem to be interested in performing at their peaks. (You can take the short test here; here's where you can interpret the results; and here's where you can learn more about what the test is measuring). The idea of the monthly self-assessment mentioned above is to make sure that you are sustaining a physical and emotional state that will maximize your learning and performance. Happy, satisfied traders with a full complement of energy and a diversified portfolio of sources of well-being are least likely to trade impulsively out of frustration or desperation, and they are most likely to be in a mindset where they can aggressively take advantage of their opportunities.
Becoming your own trading coach starts with becoming your own observer: stepping back and examining whether or not you're doing the right things. And that starts, not with trading, but with doing the right things in all the other parts of life. No one climbs the learning curve of expertise firing on only a few cylinders. Success in markets is an expression of--not a substitute for--success in life.
.
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