An important implication of the recent post on building intuition is that coming to markets looking for setups to trade is probably the wrong approach if you're trying to maximize your gut feel for trading patterns. By explicitly looking for setups, we lose sight of what might already be setting up. We have no feel for the real time patterns, because we are attending to our expectations and needs--not what the markets are actually communicating.
I've found that running through a checklist of observations--much like a physician runs through a standard list of questions during a history and physical--is helpful in arriving at a "market diagnosis." Those questions pertain to intermarket themes, short-term sentiment, how sectors are moving relative to one another, how we are trading relative to established ranges and VWAP, etc.
Out of the observations will often emerge an insight regarding the likely structure of the market day: trending, range, breakout. That, in turn, leads to fresh observations that suport a gut feel for how the market is likely to trade going forward and whether it will make sense to trade or fade market moves.
When we look for trades, we're putting the epistemological cart before the horse. If we look for the right kinds of information, the trades can come to us.
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Thursday, February 18, 2010
Building Market Intuition: How Chance Favors Prepared Minds
The recent post focused on how anxiety and frustration can interfere with the subtle cues that provide an intuitive, gut feel for markets. That has led some trading gurus to insist that emotions are the enemy of good trading. Once we understand the nature of intuition, however, we can see that this is not the case. Our feel for markets *is* a kind of feeling; if we were brain damaged and unable to feel, we would not only lose anxiety; we would lose an intuitive sense for markets and the very helpful feelings that keep us out of dangerous situations.
The problem with accessing intuition is not unique to emotion: any strong set of inputs that cloud our attention to our gut will result in a loss of market feel.
Here are several situations that I have found lead to poor trading because they create a focus on explicit thought rather than a natural feel for markets:
1) Strong Opinions - Once we become anchored to a strong opinion about market direction, we attend to factors that support our view--or we become concerned about factors that aren't lining up with our view. The result is that we're no longer attending to our own feel for markets. Instead we've imposed a view over our gut, trading what we think *should* be happening, instead of what is actually happening.
2) Focus on P/L - When we become unduly concerned over profitability, our attention is directed away from markets and we can no longer register the patterns that evoke our intuitive feel. This can occur both when we're overconfident and trying to juice profitability and when we're worried about losses. Intuition is a function of implicit pattern recognition--and that requires an immersion in markets.
3) Tunnel Vision - Many times, the patterns that evoke our feel for markets are only apparent when we view those markets in unique ways. If we become trapped in a particular market or a particular time frame, we cannot see the patterns that may be occurring across markets or time frames. This often happens to traders who are following the market tick-by-tick: they lose sight of the big picture and never intuit the larger market moves (that eventually run them over).
It is easy to fall into the opposite trap and conclude that *any* explicit thought process is a danger. That, of course, is silly. We cannot achieve an intuitive synthesis of market data unless we're first absorbing and processing the market data. It's the analysis after analysis--observing what is happening across indicators, sectors, markets, and time frames--that leads to the eventual intuitive synthesis and the great trade.
"In the field of observation," Pasteur noted, "chance favors only the prepared mind."
Now we know why.
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The problem with accessing intuition is not unique to emotion: any strong set of inputs that cloud our attention to our gut will result in a loss of market feel.
Here are several situations that I have found lead to poor trading because they create a focus on explicit thought rather than a natural feel for markets:
1) Strong Opinions - Once we become anchored to a strong opinion about market direction, we attend to factors that support our view--or we become concerned about factors that aren't lining up with our view. The result is that we're no longer attending to our own feel for markets. Instead we've imposed a view over our gut, trading what we think *should* be happening, instead of what is actually happening.
2) Focus on P/L - When we become unduly concerned over profitability, our attention is directed away from markets and we can no longer register the patterns that evoke our intuitive feel. This can occur both when we're overconfident and trying to juice profitability and when we're worried about losses. Intuition is a function of implicit pattern recognition--and that requires an immersion in markets.
3) Tunnel Vision - Many times, the patterns that evoke our feel for markets are only apparent when we view those markets in unique ways. If we become trapped in a particular market or a particular time frame, we cannot see the patterns that may be occurring across markets or time frames. This often happens to traders who are following the market tick-by-tick: they lose sight of the big picture and never intuit the larger market moves (that eventually run them over).
It is easy to fall into the opposite trap and conclude that *any* explicit thought process is a danger. That, of course, is silly. We cannot achieve an intuitive synthesis of market data unless we're first absorbing and processing the market data. It's the analysis after analysis--observing what is happening across indicators, sectors, markets, and time frames--that leads to the eventual intuitive synthesis and the great trade.
"In the field of observation," Pasteur noted, "chance favors only the prepared mind."
Now we know why.
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Wednesday, February 17, 2010
Viewpoints at Midweek
* Crucial topic: What to do when you lose confidence as a trader: Part One, Part Two, Part Three
* Nice video on using simulation to become a better trader;
* Worthwhile post on re-entering trades you've been stopped out of;
* Eye-opening article on bypassing Congress and bailing out Fannie Mae, Freddie Mac;
* Will foreign investors step in when Fed stops buying mortgage-backed securities?
* Soros buying gold; so are pension funds;
* Debt plan for Dubai;
* What a European bailout would require;
* Breadth trumps volume--excellent site.
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* Nice video on using simulation to become a better trader;
* Worthwhile post on re-entering trades you've been stopped out of;
* Eye-opening article on bypassing Congress and bailing out Fannie Mae, Freddie Mac;
* Will foreign investors step in when Fed stops buying mortgage-backed securities?
* Soros buying gold; so are pension funds;
* Debt plan for Dubai;
* What a European bailout would require;
* Breadth trumps volume--excellent site.
Midday Briefing for February 17th: Tracking Sentiment With NYSE TICK
This morning I heard from a frustrated trader who was trying to sell the S&P 500 Index in response to the weakness he saw in other markets. While this was a worthwhile idea, it was important this morning to sell the market as part of a range trade, not as part of a trending one. In other words, in the range market, you sell strength above the volume-weighted average price (VWAP); in the trend market, you sell every bounce that stays lower than the prior bounce.
It's tough to get a downtrending market if the majority of stocks are trading on upticks, not downticks. We can see this at a glance with the chart above, which shows one-minute NYSE TICK readings, the zero line (purple), and a 20-minute moving average of the high/low/close values for each TICK reading (blue line).
What we see quickly is that the blue, moving average line is spending more time above the zero line than below. Indeed, the moving average of TICK barely goes negative for the morning. That is a sign that there are not a significant number of sell programs being executed in stocks. As long as that's the case, it is dangerous to sell weakness, as weakness will often correspond to the lower end of a trading range.
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Morning Briefing for February 17th: Weighed Down by the Euro
Note how the sharp downside break in the euro this morning (above chart) corresponded to weakness in commodities and eventually stocks. While we saw some follow through buying in stocks early in the morning, it is difficult to sustain strength when macro players around the world are selling risk assets. Seeing those intermarket relationships is extremely helpful in formulating hypotheses about continuations vs. reversals in the stock market.
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What Happens After Strong Stock Market Breakouts?
Yesterday we saw my proprietary measure of Demand exceed Supply by a greater than 10:1 ratio. (Note: I post Demand and Supply scores each morning before the open via Twitter; follow the tweets here).
Recall that Demand is an index of the number of stocks across the major indexes that have closed above the volatility envelopes surrounding their moving averages. Supply is an index of the number of stocks closing below those envelopes.
When we get a large plurality of stocks trading above their envelopes and very few below (as happened yesterday), it generally signifies a broad breakout move to the upside. What has happened historically following such a move?
I went back to the start of my database in late 2002 and found 30 occasions in which Demand exceeded Supply by a ratio of 10:1 or greater. Five days later, the S&P 500 Index (SPY) was down by an average -.67% (15 up, 15 down). By contrast, for the remainder of the sample, SPY was up on a five-day basis by an average of .12% (1008 up, 810 down).
In other words, it is common for upside breakout moves to take a breather over the next week. The exceptions would be unusually strong markets coming off intermediate and long-term lows, as very nicely explained and illustrated today in the excellent SentimenTrader service.
Knowing the market's "script"--how it has tended to behave historically--gives us a nice benchmark by which to assess upcoming market action. It's when markets don't do what they are "supposed" to do that we often can find meaningful opportunity.
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Recall that Demand is an index of the number of stocks across the major indexes that have closed above the volatility envelopes surrounding their moving averages. Supply is an index of the number of stocks closing below those envelopes.
When we get a large plurality of stocks trading above their envelopes and very few below (as happened yesterday), it generally signifies a broad breakout move to the upside. What has happened historically following such a move?
I went back to the start of my database in late 2002 and found 30 occasions in which Demand exceeded Supply by a ratio of 10:1 or greater. Five days later, the S&P 500 Index (SPY) was down by an average -.67% (15 up, 15 down). By contrast, for the remainder of the sample, SPY was up on a five-day basis by an average of .12% (1008 up, 810 down).
In other words, it is common for upside breakout moves to take a breather over the next week. The exceptions would be unusually strong markets coming off intermediate and long-term lows, as very nicely explained and illustrated today in the excellent SentimenTrader service.
Knowing the market's "script"--how it has tended to behave historically--gives us a nice benchmark by which to assess upcoming market action. It's when markets don't do what they are "supposed" to do that we often can find meaningful opportunity.
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Intuition, Luck, and Anxiety in Trading
Two recent posts dovetail, with interesting implications.
Recall the post on what makes people lucky: one research finding was that tense people tend to be unlucky ones. By focusing on threat, they miss potential opportunity.
Now go back to the post on intuition. An important research observation was that dampening explicit thought aided access to a person's gut feel.
These findings are not unrelated. A good part of what we call luck may involve intuitive access to information that unlucky people lack. A while back I was driving into Chicago before rush hour and started to shift into the left, express lane. Something didn't feel right, however, and I moved back into the right hand, local lanes. After a while, I saw that there was an accident in the express lane; traffic was snarled, but the local lanes moved normally.
I felt lucky, but what I believe actually happened is that the ratio of cars in the express lane relative to the local ones felt too high. Intuitively, I sensed that the express lane shouldn't be that busy when local lane traffic was light. In retrospect, I was sensing the beginning of the traffic build-up following the accident.
Now, had I been highly anxious about getting to work on time, I would have felt a press to use the express lane. I would have ignored any intuition--or, more likely, wouldn't have felt the discomfort in the left lane at all--and, voila!--I would have been unlucky. By focusing on my source of anxiety, I no longer could receive the more subtle signals from the gut.
I believe that this is a major reason that anxious, stressed traders are invariably poor traders. Much of short-term trading boils down to pattern recognition, and much of pattern recognition boils down to a feel for markets that results from long periods of observation and internalization. When we are feeling tense or frustrated, we easily lose a feel for markets.
And that can make us unlucky.
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Recall the post on what makes people lucky: one research finding was that tense people tend to be unlucky ones. By focusing on threat, they miss potential opportunity.
Now go back to the post on intuition. An important research observation was that dampening explicit thought aided access to a person's gut feel.
These findings are not unrelated. A good part of what we call luck may involve intuitive access to information that unlucky people lack. A while back I was driving into Chicago before rush hour and started to shift into the left, express lane. Something didn't feel right, however, and I moved back into the right hand, local lanes. After a while, I saw that there was an accident in the express lane; traffic was snarled, but the local lanes moved normally.
I felt lucky, but what I believe actually happened is that the ratio of cars in the express lane relative to the local ones felt too high. Intuitively, I sensed that the express lane shouldn't be that busy when local lane traffic was light. In retrospect, I was sensing the beginning of the traffic build-up following the accident.
Now, had I been highly anxious about getting to work on time, I would have felt a press to use the express lane. I would have ignored any intuition--or, more likely, wouldn't have felt the discomfort in the left lane at all--and, voila!--I would have been unlucky. By focusing on my source of anxiety, I no longer could receive the more subtle signals from the gut.
I believe that this is a major reason that anxious, stressed traders are invariably poor traders. Much of short-term trading boils down to pattern recognition, and much of pattern recognition boils down to a feel for markets that results from long periods of observation and internalization. When we are feeling tense or frustrated, we easily lose a feel for markets.
And that can make us unlucky.
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Tuesday, February 16, 2010
The Role of Intuition in Trading Decisions
This afternoon I had an unusually strong intuition that the market would close strong and even mentioned my impression to a couple of trading colleagues. Initially, the market ticked down after I told them of my idea, but my certainty did not waver. Within minutes, we broke to new highs and traded higher on expanded volume.
Such intuitive moments are not common for me, but when they occur, they are invariably on the mark. Most of the time, the intuitions are related to market patterns that I have experienced and reviewed. The feeling that occurs on these occasions is a kind of "Aha!" feeling, where everything I have been observing comes together. Instead of seeing isolated market data, I recognize a pattern.
Perhaps the most interesting aspect of these intuitions is that they never come when I am looking for market ideas. The pattern has to come to me; when I look for patterns, I never find them with the degree of certainty and rightness that I feel at the intuitive moments.
There appears to be a brain-based reason for this. An interesting research study found that research subjects who took a tranquillizing drug performed worse on a recall task than those that did not take the drug. The subjects who took the drug, however, scored higher in the ability to perceive novel pairs--a task that relied on "gut feeling".
The researchers hypothesize that two different brain systems are at work in learning: one is an explicit system based on recall and reasoning; the other, an implicit system based upon the brain's reward system. By dampening the explicit learning system, the tranquillizing drug provided subjects with greater access to their gut.
Of course, it is not necessary to tranquillize oneself to gain access to intuition. It may well be that relaxation, meditation, and focused concentration exercises can accomplish the same thing. My experience suggests that periods of intuition are most common following periods of intensive market observation: the intuitive, creative synthesis only occurs after a period of immersive analysis.
Can traders be trained to maximize intuition? I suspect that might be possible, but only if the usual training in technical and fundamental analysis is followed by the teaching of thought-dampening skills that facilitate synthesis.
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Such intuitive moments are not common for me, but when they occur, they are invariably on the mark. Most of the time, the intuitions are related to market patterns that I have experienced and reviewed. The feeling that occurs on these occasions is a kind of "Aha!" feeling, where everything I have been observing comes together. Instead of seeing isolated market data, I recognize a pattern.
Perhaps the most interesting aspect of these intuitions is that they never come when I am looking for market ideas. The pattern has to come to me; when I look for patterns, I never find them with the degree of certainty and rightness that I feel at the intuitive moments.
There appears to be a brain-based reason for this. An interesting research study found that research subjects who took a tranquillizing drug performed worse on a recall task than those that did not take the drug. The subjects who took the drug, however, scored higher in the ability to perceive novel pairs--a task that relied on "gut feeling".
The researchers hypothesize that two different brain systems are at work in learning: one is an explicit system based on recall and reasoning; the other, an implicit system based upon the brain's reward system. By dampening the explicit learning system, the tranquillizing drug provided subjects with greater access to their gut.
Of course, it is not necessary to tranquillize oneself to gain access to intuition. It may well be that relaxation, meditation, and focused concentration exercises can accomplish the same thing. My experience suggests that periods of intuition are most common following periods of intensive market observation: the intuitive, creative synthesis only occurs after a period of immersive analysis.
Can traders be trained to maximize intuition? I suspect that might be possible, but only if the usual training in technical and fundamental analysis is followed by the teaching of thought-dampening skills that facilitate synthesis.
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Midday Briefing for February 16th: Watching VWAPs
At this juncture in the day, 30 of the 40 stocks that I follow in my basket (five stocks from each of the eight S&P sectors that I track regularly) are trading above their volume-weighted average prices. We're also seeing positive Cumulative TICK on the day and a positive Cumulative Delta. In a trending market, we should sustain a sizable plurality of stocks above or below VWAP and positively sloped Cumulative TICK and Delta. Very often, a narrowing of the difference between the prices of stocks and their VWAPs will point the way toward a general market move back toward its VWAP--particularly if we're seeing similar erosion in TICK and Delta readings.
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Morning Briefing for February 16th: Upside Break
10:52 AM CT - I've added the top chart to show how we've broken above the overnight highs on solid buying volume, propelled by the intermarket action (weak USD, strong commodities). We need to stay above those overnight highs and see continued net volume at offer vs. bid to sustain the market rally.
Note the upside breakout in pre-opening trade in the ES futures (above). Since that time, we pulled back, but bounced back above VWAP despite tepid EU support for Greece. We see a stronger euro and Aussie dollar; we also see oil and gold higher. That tells us that intermarket themes are supporting higher stock prices--and it puts us short-term bullish as long as we hold above the 1080 area of recent support. Bigger picture resistance is in the low 1100 region.
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Stop-Loss Points in Trading: Do We Need Stops When We Trade?
Henry Carstens has recently written about ways to manage risk other than through stop loss points. I've noticed with traders recently that stops not only tend to be price-based, but tend to be placed at price points that are relatively obvious. For example, someone who is short stocks will place a stop just above a recent high or vice versa. Stops just above or below recent price ranges are also common.
The problem with such stops is that they are natural targets for algorithmic programs that exploit asymmetries in buying and selling orders and tendencies. The trader with obvious stops falls victim to false breakout moves, exiting trades just before they reverse and go the intended way.
An important gauge of the value of your stops is to track markets *after* you have been stopped out. Do you stop loss points save you money on balance? Do they protect you from risk, or do they shake you out of opportunity? Most traders have never closely looked at the true value of their stops; they just take for granted that stops are needed and place them intuitively (and obviously).
Over the years, I've found that placing price-based stops further away from my entry at points where my underlying trade idea is clearly wrong helps keep me from getting shaken out of good trades. Those price-based stops act as "catastrophic" stops for me. More effective, as a rule, for my own trading have been indicator-based stops and time-based stops.
An example of an indicator-based stop would be a sudden surge in NYSE TICK to new highs or lows against my position or a surge in buying or selling volume against my position. As soon as I see the surge, I exit and reassess. More often than not, such a surge indicates that the short-term tide has moved against me and that it is not helpful to fight that.
Time-based stops are based on my observation that my best trades are executed well and tend to go my way relatively quickly, with little heat taken. If I have to sit and sit and sit in the trade, the odds that it will go my way eventually are diminished: the dynamics that placed me in the trade simply are not operative. Similarly, if the market moves against me very shortly after my entry, I generally find it's best to try to scratch the trade and reassess.
It *is* important to have stop-loss points for trades. As I've noted previously, everyone does have a stop-loss point: it is either explicit, based on market action, or it is unstated and based on pain. The latter can wipe out days' worth of good trading.
But while it's important to have stops, it's not necessarily the case that all stops need to be price-based. You should stop a trade when you see that the underlying idea is wrong, not simply when you've lost a certain amount of money.
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The problem with such stops is that they are natural targets for algorithmic programs that exploit asymmetries in buying and selling orders and tendencies. The trader with obvious stops falls victim to false breakout moves, exiting trades just before they reverse and go the intended way.
An important gauge of the value of your stops is to track markets *after* you have been stopped out. Do you stop loss points save you money on balance? Do they protect you from risk, or do they shake you out of opportunity? Most traders have never closely looked at the true value of their stops; they just take for granted that stops are needed and place them intuitively (and obviously).
Over the years, I've found that placing price-based stops further away from my entry at points where my underlying trade idea is clearly wrong helps keep me from getting shaken out of good trades. Those price-based stops act as "catastrophic" stops for me. More effective, as a rule, for my own trading have been indicator-based stops and time-based stops.
An example of an indicator-based stop would be a sudden surge in NYSE TICK to new highs or lows against my position or a surge in buying or selling volume against my position. As soon as I see the surge, I exit and reassess. More often than not, such a surge indicates that the short-term tide has moved against me and that it is not helpful to fight that.
Time-based stops are based on my observation that my best trades are executed well and tend to go my way relatively quickly, with little heat taken. If I have to sit and sit and sit in the trade, the odds that it will go my way eventually are diminished: the dynamics that placed me in the trade simply are not operative. Similarly, if the market moves against me very shortly after my entry, I generally find it's best to try to scratch the trade and reassess.
It *is* important to have stop-loss points for trades. As I've noted previously, everyone does have a stop-loss point: it is either explicit, based on market action, or it is unstated and based on pain. The latter can wipe out days' worth of good trading.
But while it's important to have stops, it's not necessarily the case that all stops need to be price-based. You should stop a trade when you see that the underlying idea is wrong, not simply when you've lost a certain amount of money.
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Monday, February 15, 2010
Learning to be Lucky
Many thanks to an eagle-eyed reader for calling my attention to this excellent article on what differentiates lucky and unlucky people. It turns out that people unwittingly make their own luck. Unlucky people tend to be tense and miss unexpected opportunities because they are focusing on the sources of their anxiety.
Conversely, it appears that lucky people approach situations with a degree of optimism. The author explains, "My research revealed that lucky people generate good fortune via four basic principles. They are skilled at creating and noticing chance opportunities, make lucky decisions by listening to their intuition, create self-fulfilling prophecies via positive expectations, and adopt a resilient attitude that transforms bad luck into good."
Here's a simple personal example that I never thought of in terms of luck, but certainly fits the author's research:
In the past, I used to dislike large social gatherings. The cocktail chit-chat struck me as superficial and I invariably had a bad time and met few worthwhile people. At some point, I decided to approach these events differently. I said to myself, "In such a large group, just from statistical chance alone, there should be one or two really interesting people. My job is to find them."
Suddenly, the socializing became a game, and I became unusually good at spotting interesting people in a crowd. That made the gatherings not only fun, but rewarding.
Much later, someone commented to me that I was fortunate to have such a large, positive social network. In retrospect, my luck was a direct result of my approach to a situation. By preparing myself to find good things, I was able to stumble across them. When I was convinced that nothing good could come from the situation, I created an unlucky, self-fulfilling prophecy.
Now think about how traders approach markets and substitute markets for gatherings in my above example. Perhaps a great deal of market success boils down to a learned skill of luck: we are most likely to find opportunity when we expect to encounter it.
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Conversely, it appears that lucky people approach situations with a degree of optimism. The author explains, "My research revealed that lucky people generate good fortune via four basic principles. They are skilled at creating and noticing chance opportunities, make lucky decisions by listening to their intuition, create self-fulfilling prophecies via positive expectations, and adopt a resilient attitude that transforms bad luck into good."
Here's a simple personal example that I never thought of in terms of luck, but certainly fits the author's research:
In the past, I used to dislike large social gatherings. The cocktail chit-chat struck me as superficial and I invariably had a bad time and met few worthwhile people. At some point, I decided to approach these events differently. I said to myself, "In such a large group, just from statistical chance alone, there should be one or two really interesting people. My job is to find them."
Suddenly, the socializing became a game, and I became unusually good at spotting interesting people in a crowd. That made the gatherings not only fun, but rewarding.
Much later, someone commented to me that I was fortunate to have such a large, positive social network. In retrospect, my luck was a direct result of my approach to a situation. By preparing myself to find good things, I was able to stumble across them. When I was convinced that nothing good could come from the situation, I created an unlucky, self-fulfilling prophecy.
Now think about how traders approach markets and substitute markets for gatherings in my above example. Perhaps a great deal of market success boils down to a learned skill of luck: we are most likely to find opportunity when we expect to encounter it.
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Drills to Improve Your Intraday Trading
I recently posted on why I like the replay mode of Market Delta to support simulated trading. There is much more to structuring a learning program, however, than practicing trading. A well-developed training curriculum will break a performance down into component parts, practice those parts with drills (and immediate feedback), and only later assemble those parts into simulated (and eventually real-time) performance.
Here's a drill that I use to practice execution:
You have to enter a trade in the next five minutes and exit the trade within the subsequent five minutes. The key is to find a good enough point of entry that you will take minimum heat on the simulated trade and make a profit. The drill also is good practice at working orders in the book and changing those orders as market conditions dictate. A nice measure of the trader's success with the drill is the amount of heat taken in the trade.
Here is a variation of the same drill to practice position management:
You have to enter a trade in the next hour and exit the trade within 60 minutes of the entry. You have 1000 shares maximum to trade. You have to choose to scale into the trade or scale out and then implement that plan. The drill combines execution ability with the ability to maximize opportunity and minimize risk depending on market conditions. A good measure of the trader's success with the drill is how the scaling in/out compares in P/L with a simple "all in" entry and exit.
Here is a drill to read markets in real time:
When the alarm goes off, you have to enter a position at the market. Depending on your reading of current market conditions, you can choose to buy or to sell for a holding period of up to 30 minutes. You have to identify the market trend, where you'll stop out of the trade (and why), and where you would take profits (and why); then you have to implement that plan. The drill pushes you to quickly size up markets and act on your perception.
Notice that each of these drills involves learning by doing. They also allow for immediate feedback, so that you can see what you did right or wrong and learn from it. Indeed, with replay capability, you can truly review the trade and see how you might improve your performance. Then you can use what you learned for the next set of drills.
There is so much more to learning trading than simply gathering information about chart patterns, statistical probabilities, indicator readings, and fundamentals. Performance is about the honing of skills, and that takes the kind of structured practice that is rare indeed among programs that offer education, mentorship, and training.
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Here's a drill that I use to practice execution:
You have to enter a trade in the next five minutes and exit the trade within the subsequent five minutes. The key is to find a good enough point of entry that you will take minimum heat on the simulated trade and make a profit. The drill also is good practice at working orders in the book and changing those orders as market conditions dictate. A nice measure of the trader's success with the drill is the amount of heat taken in the trade.
Here is a variation of the same drill to practice position management:
You have to enter a trade in the next hour and exit the trade within 60 minutes of the entry. You have 1000 shares maximum to trade. You have to choose to scale into the trade or scale out and then implement that plan. The drill combines execution ability with the ability to maximize opportunity and minimize risk depending on market conditions. A good measure of the trader's success with the drill is how the scaling in/out compares in P/L with a simple "all in" entry and exit.
Here is a drill to read markets in real time:
When the alarm goes off, you have to enter a position at the market. Depending on your reading of current market conditions, you can choose to buy or to sell for a holding period of up to 30 minutes. You have to identify the market trend, where you'll stop out of the trade (and why), and where you would take profits (and why); then you have to implement that plan. The drill pushes you to quickly size up markets and act on your perception.
Notice that each of these drills involves learning by doing. They also allow for immediate feedback, so that you can see what you did right or wrong and learn from it. Indeed, with replay capability, you can truly review the trade and see how you might improve your performance. Then you can use what you learned for the next set of drills.
There is so much more to learning trading than simply gathering information about chart patterns, statistical probabilities, indicator readings, and fundamentals. Performance is about the honing of skills, and that takes the kind of structured practice that is rare indeed among programs that offer education, mentorship, and training.
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Starting the Week: International Perspectives and More
* These are the kinds of trades I rehearse in simulation mode; more on this topic shortly;
* Coaching yourself to let profits run;
* EU finance ministers to meet today regarding aid to Greece;
* China as uber black swan;
* How the market behaves after President's Day and other good readings;
* ETF investors avoiding the U.S. and many more fine links;
* Excellent ETF review for the week shows some breaching their 200 DMA;
* Housing aid to wind down; what next?
* StockScouter's top rated stocks;
* Questioning getting wedded to bear views;
* Unemployment leading to emigration in Ireland;
* Yuan to rise to fight inflation in China?
* How we are misjudging China;
* Continued concerns over the role of investment banks in hiding Greek debt;
* Housing bubble in Canada?
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* Coaching yourself to let profits run;
* EU finance ministers to meet today regarding aid to Greece;
* China as uber black swan;
* How the market behaves after President's Day and other good readings;
* ETF investors avoiding the U.S. and many more fine links;
* Excellent ETF review for the week shows some breaching their 200 DMA;
* Housing aid to wind down; what next?
* StockScouter's top rated stocks;
* Questioning getting wedded to bear views;
* Unemployment leading to emigration in Ireland;
* Yuan to rise to fight inflation in China?
* How we are misjudging China;
* Continued concerns over the role of investment banks in hiding Greek debt;
* Housing bubble in Canada?
Sunday, February 14, 2010
Simulation Trading With Market Delta: A Powerful Learning Tool
My recent post outlined the importance of simulation in learning a performance discipline such as trading. If you click on the chart above, you will see how I was replaying Friday's trading using the "playback" feature in Market Delta.
What makes this feature useful is that the chart is set up exactly as it is when I'm trading. In other words, on one screen I can see price, volume, how volume is distributed at the market offer vs. bid (bottom histogram), how volume is distributed by price through the day (side histogram), and the cumulative Delta (cumulative volume at offer minus volume at bid) for the day (bottom row in the columns underneath the bottom histogram). I can also see where the trade is occurring relative to the day's volume-weighted average price (VWAP; red line).
As I replay the market day, I look within each one-minute bar to see where size is entering the market--at the offer price or at the bid. I gain a feel for how the large traders are leaning.
That is a lot of information on one screen, and it replays exactly how the trade occurred each day.
That enables me to review market action. It also allows me to review my own performance and see where I could have executed trades better, where there was opportunity I missed, etc. If I'm trading poorly, I can use the replay mode to practice trading and get back into the groove before returning to live trade and putting money on the line.
Think of doing that day after day, seeing pattern after pattern replayed.
Simulation rocks.
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Indicator Update for February 14th
Last week's indicator review suggested that we had put in a momentum low in the stock market, with possible tests of the lows to follow. We indeed see follow-through weakness in stocks this past week, but prices held above 1050 in the S&P 500 Index futures before we closed the week higher.
Note from the 20-day new highs minus lows (top chart) that the great majority of issues have pulled off their recent lows, with new highs running close to the level of new lows. I use a cumulative running total of new highs minus lows as an intermediate-term trend indicator. We need to see an expansion of new highs relative to lows to return us to an uptrend. A bounce with feeble new high/low strength would place us in a pattern of making lower price highs following a break of the December, 2009 lows. For that reason, I am reluctant to chase price strength that cannot push new highs meaningfully above lows.
At the same time, I will be watching closely for any break below that 1050 area to see if new 20-day lows are expanding. A test of that area with broad non-confirmations from sectors and new highs/lows would be consistent with a bottoming process and the pattern of momentum lows followed by subsequent tests.
Note that, despite the recent bounce, the eight S&P sectors that I follow weekly (middle chart) remain largely in short-term downtrends according to my proprietary Technical Strength measure. Consumer-related sectors strengthened week-over-week, as did Energy stocks. Financial and Industrial shares remain relatively weak. Once again, I need to see sectors display positive Technical Strength before trusting market bounces and committing to the long side.
Finally, if you take a look at the advance-decline line specific to NYSE common stocks--a very useful perspective from Decision Point--we find that we have, indeed, done technical damage to the stock market during the recent decline. Moreover, the recent bounce has not added significant advance-decline strength to the market. I am watching the October/November lows in this indicator very closely; a break of those would suggest a continuation of an intermediate-term downtrend.
In all, we've seen a bounce off apparent momentum lows, but no resumption of bullish market action. The recent market behavior is consistent with a bottoming process and an intermediate-term correction in an ongoing bull market. I am watching the indicators closely, however, for signs that the correction could deepen in the wake of troubling news from Europe, Dubai, and China and continued saber-rattling in the Middle East.
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Training Traders: The Role of Simulation in Supercharging Learning
A recent research report suggests that computer simulations can be as effective as direct observation in education. Simulations have long been used in medical education to help students learn the skills of physicians. Simulations are also standard in training airline pilots and in preparing for war scenarios. By trying out moves against a computer, developing chess players can work on various aspects of their game.
When I directed a training program for new traders at a prop firm, we found that simulated trading using live market data was especially helpful in preparing traders for shifting market conditions, dealing with uncertainty and risk, and making rapid decisions. Interestingly, we also found that when simulations were graded and reviewed by an instructor, they also incorporated some of the performance pressure faced during actual trading. If a trader knows that he has to sustain profitability in simulation mode before trading live, the simulation begins to simulate the emotional elements of trading.
Simulation, however, entails several advantages over live trading for training purposes:
1) Simulation allows traders to make mistakes and try out tactics without losing money early in their developmental processes;
2) Simulation allows for more focused learning, as traders can replay aspects of the day to rehearse trading under specific conditions;
3) Simulation provides standardization in learning, as trading days can be archived and traders can practice trading specific kinds of market conditions from the archives;
4) Simulation enables traders to get more learning into a day's period than would be possible during live trading, as many days' worth of experience can be concentrated into a single training day.
5) Simulation offers an objective test of traders' skills. If a trader cannot be successful in simulation mode with live market data, surely he will not succeed under the more strenuous conditions of having real money on the line.
A number of trading platforms and programs offer a "replay" mode that can serve as simulation-based learning for traders. By replaying challenging periods in the market, traders can observe mistakes that they made and correct them before the next day begins. That supercharges learning.
In my book Enhancing Trader Performance, I devote considerable space to the topic of simulation. My conclusion: "Research and experience suggest that the single most important investment you can make in your trading development is the acquisition of software that will allow you to develop your own training program and drill the skills that are central to your trading niche" (p. 100).
The great weakness of most "training" programs for traders is that they provide information, rather than develop skills. Information is necessary but not sufficient for the cultivation of expertise. Learning about chess or about surgery will not, in itself, create a chess champion or an elite surgeon. We can learn a great deal of information about football, but remain unable to master the game.
There is a very straightforward formula for success across performance fields: find the performance area that best matches your interests and talents; engage in structured practice under safe conditions to master the skills that are components of success; engage in realistic practice to assemble those components into actual simulated performances; and then tackle real-world performance situations with ongoing feedback and efforts at improvement.
Traders don't fail because they lack the right setups or because they weren't born with the right trading personality. Traders fail because they do not survive their learning curves: they put their capital at risk long before they have developed necessary skills and expertise. Simulation-based learning is a way to accelerate that curve and reduce the costs associated with the inevitable mistakes made by learners.
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When I directed a training program for new traders at a prop firm, we found that simulated trading using live market data was especially helpful in preparing traders for shifting market conditions, dealing with uncertainty and risk, and making rapid decisions. Interestingly, we also found that when simulations were graded and reviewed by an instructor, they also incorporated some of the performance pressure faced during actual trading. If a trader knows that he has to sustain profitability in simulation mode before trading live, the simulation begins to simulate the emotional elements of trading.
Simulation, however, entails several advantages over live trading for training purposes:
1) Simulation allows traders to make mistakes and try out tactics without losing money early in their developmental processes;
2) Simulation allows for more focused learning, as traders can replay aspects of the day to rehearse trading under specific conditions;
3) Simulation provides standardization in learning, as trading days can be archived and traders can practice trading specific kinds of market conditions from the archives;
4) Simulation enables traders to get more learning into a day's period than would be possible during live trading, as many days' worth of experience can be concentrated into a single training day.
5) Simulation offers an objective test of traders' skills. If a trader cannot be successful in simulation mode with live market data, surely he will not succeed under the more strenuous conditions of having real money on the line.
A number of trading platforms and programs offer a "replay" mode that can serve as simulation-based learning for traders. By replaying challenging periods in the market, traders can observe mistakes that they made and correct them before the next day begins. That supercharges learning.
In my book Enhancing Trader Performance, I devote considerable space to the topic of simulation. My conclusion: "Research and experience suggest that the single most important investment you can make in your trading development is the acquisition of software that will allow you to develop your own training program and drill the skills that are central to your trading niche" (p. 100).
The great weakness of most "training" programs for traders is that they provide information, rather than develop skills. Information is necessary but not sufficient for the cultivation of expertise. Learning about chess or about surgery will not, in itself, create a chess champion or an elite surgeon. We can learn a great deal of information about football, but remain unable to master the game.
There is a very straightforward formula for success across performance fields: find the performance area that best matches your interests and talents; engage in structured practice under safe conditions to master the skills that are components of success; engage in realistic practice to assemble those components into actual simulated performances; and then tackle real-world performance situations with ongoing feedback and efforts at improvement.
Traders don't fail because they lack the right setups or because they weren't born with the right trading personality. Traders fail because they do not survive their learning curves: they put their capital at risk long before they have developed necessary skills and expertise. Simulation-based learning is a way to accelerate that curve and reduce the costs associated with the inevitable mistakes made by learners.
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Saturday, February 13, 2010
Weekend Insights
* The elements of a trading plan;
* Lack of economic growth in Europe;
* Global concerns on the radar;
* Is the situation in Greece getting worse?
* Difficult options confronted by Greece;
* Banning cash transactions, raising taxes in Greece;
* A positive view of tightening in China;
* Companies raising cash, not hiring;
* What rents tell us about the housing market;
* Three ETFs showing relative strength.
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* Lack of economic growth in Europe;
* Global concerns on the radar;
* Is the situation in Greece getting worse?
* Difficult options confronted by Greece;
* Banning cash transactions, raising taxes in Greece;
* A positive view of tightening in China;
* Companies raising cash, not hiring;
* What rents tell us about the housing market;
* Three ETFs showing relative strength.
A Look at Investor Sentiment in the Bond Market
Here we see a chart of the relative strength of high yield bonds (JNK) to investment grade bonds (LQD). Note how this relationship went haywire during the Lehman crisis in late 2008 and then bottomed out late that year and early in 2009.
The declining relative strength of JNK to LQD showed that there was risk-averse sentiment affecting the bond market: investors preferred safer yields to higher ones. Since that time, risk appetite has returned to the bond market, though not to the degree that we had before the 2008 collapse.
Notice how risk aversion has been affecting the market most recently, particularly in the wake of debt concerns in Europe. To this point, that risk aversion is a pullback in a rising market and not necessarily suggesting an overall shift in investor sentiment. Should we break the lows from the second half of 2009, however, that would suggest a more fundamental breakdown of risk appetite: one that I would expect to affect multiple markets.
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Three Steps in Overcoming Psychological Trauma
Previous Posts in This Series:
Trading, Trauma, and the Brain
A Psychological Trauma Self-Evaluation
Psychological Trauma and Trading Risk
Trading, Trauma, and the Brain
A Psychological Trauma Self-Evaluation
Psychological Trauma and Trading Risk
The above posts will help you understand psychological traumatic reactions, what causes them, and whether they are impacting your trading.
Now the question is what to do about those reactions.
The disruptions of decision-making that occur as a result of trauma are akin to flashbacks: they occur when current, stressful episodes trigger thoughts, feelings, memories, and coping responses from past traumatic episodes.
A simple example from my book: If I am a passenger in a car and a driver takes a turn too sharply, I find myself tensing up. There is no reason for tension: the turn is not dangerous and there are no cars or pedestrians in the way of the turn. Still I feel anxiety because it was a driver's turn onto a highway that put me in a significant car accident. Our car flipped over and I was propelled from the front passenger seat out of the car's rear window. That accident happened over two decades ago and I still experience occasional aftereffects.
Closer to trading home, I experienced far and away my greatest trading losses in the second half of 1982. I had made good money shorting the market to that point and missed the inflection point in August that signaled the start of the great bull market. The ferocity of the market rally melted a year's worth of profits within days and dashed my hopes of making trading a significant part of my income as a young psychologist. I traded only sparingly over the following decade, following markets relatively closely, but never trading my prior size. Only after completely remaking my trading--focusing on the day timeframe and learning about market timing and risk management--did I reenter markets in a meaningful way. Still, a very sudden and sharp move against my positions gives me an emotional jolt: a reminder of those events long ago.
Several concrete steps enabled me to move forward in the face of these events:
1) Stepping Away - It was quite a while before I allowed myself to be a passenger in a car. After 1982, I stopped trading for a number of months. Those decisions were key in rebuilding a sense of safety and normalcy. Stepping away allowed me to come back to the situations with a fresher perspective.
2) Wading in Slowly - Once I did return to the passenger seat, I started slowly. First I sat in the driveway in the seat without the car moving. I used imagery and relaxation methods to take passenger rides in my mind. Only after I was comfortable at that level did I tackle being a passenger in a moving vehicle with drivers I totally trusted. Similarly, when I returned to markets, it was first on paper, then with small size/risk that built over time. Wading in slowly enabled me to build experiences of safety and re-establish a sense of control.
3) Taking Away Positives - This is perhaps the most important step of all. I became determined to not allow the traumatic events to change me or restrict me. I became a much safer driver as a result of my accident; I also became a more sensitive and helpful passenger when it was time to teach Devon and Macrae how to drive. Had I not lost my money in 1982, I would not have developed the style of trading that has served me well over the years. Nor would I have found the interest to apply my psychology interest to the trading arena.
I recently posted about my 26th anniversary to my wife, Margie. The untold story is that I met Margie only after a considerable period away from serious relationships following a multi-year, very destructive relationship. I stepped away, I waded back into dating slowly, and I took away a positive: I became determined to do relationships differently. Being in a bad relationship taught me what I needed to find in a good one. Being in bad trades taught me what I needed to do to develop good ones.
The greatest traumas can become the greatest learning experiences. But not right away. First you heal: you rebuild a sense of normalcy and security. Then you set about doing things differently--often very differently. In retrospect, I would not have my trading career, my coaching career, or my marriage had I not hit the wall in markets and in love. You can't undo the past, but you can rework it to make sure it doesn't become your future.
More:
Lesson #68 from The Daily Trading Coach outlines exposure methods that are useful psychological techniques during the "wading in" stage of overcoming traumatic events and reactions.
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