Here I used a pair of ETFs: the oil ETF USO and the euro ETF FXE to estimate the movement in the price of oil denominated in euros.
Because of the weakness in the euro and the firmness of oil prices, we see that oil has moved up about 50% since the bear lows in March of 2009. With the recent drop in the euro and rise in oil prices, we see that the price of oil in euros has been moving steadily higher thus far in 2010.
With many European economies being energy importers, not producers, such a rise in oil prices can only provide headwinds to economic growth in the eurozone. .
This post will begin a review of the key ideas from my three trading psychology books and the roughly 3700 blog posts on this site. Wherever possible, I will link to posts and resources pertinent to each topic for ready reference.
But first an introduction to trading psychology. The relevance of psychology for trading is based upon two important realities:
1) Trading is a performance activity, much like athletics or performing arts. Psychological variables influence both the acquisition of skills in any performance field and the application of those skills. While there is much more to performance than mindset alone--talents, skills, and interests must align--the wrong mindset can greatly hamper performance;
2) The human mind does not process information efficiently or effectively under conditions of risk and uncertainty. To simply "trade what you see" is a recipe for falling prey to a variety of cognitive and emotional biases. The trader's psychological development is crucial to learning how to properly gauge risk and reward when performance pressures mount.
Trading psychology is not something that is simply appended to trading practice: it is an integral part of functioning as a trader and is acquired in the process of learning how to trade. It is through the trader's developmental process that he or she learns how to manage risk, how to temper overconfidence and fear, and how to sustain positive motivation.
Indeed, a proper training curriculum for a new trader is one which helps the trader and the trading develop over time. A great deal of psychological learning comes from making the classic mistakes that bedevil all new traders: making impulsive decisions, allowing fear to overtake opportunity, overtrading, allowing losing trades to run and capping winners, and the like. If you can make those mistakes--and learn from them--long before you put the lion's share of your capital at risk, you will have an opportunity to grow into the trader you're capable of becoming.
Sometimes the best therapy for your trading is to get into therapy yourself. The markets are an expensive place to be working out your issues about success/failure, competency/adequacy, and need for approval/esteem. Many people take their repetitive patterns from family and romantic relationships and enact them in trading. When that is the case, psychological development needs to precede trading development: resolving those issues is the best way to approach markets with a clear and open mind.
Eventually, you will be able to take your psychological development to the next level of trading: you will recognize when others are making the mistakes you used to make. You will see markets acting on fear and greed and you'll be able to take the other side of those reactive trades. You'll observe when market sentiment is tilted one way and price can no longer sustain its trend. Developing yourself psychologically doesn't mean that you'll be free of emotion; it means that you will become increasingly competent at using your feelings as useful trading information.
More:
The Psychology of Trading is a good introduction to the topic of how life's challenges play themselves out in the trading world.
Enhancing Trader Performance is a good introduction to the learning curves of traders and the process of developing competence and expertise.
The Daily Trading Coach is a good compendium of self-help ideas and techniques for traders looking to coach themselves toward better performance. .
Above, we see a different ETF pair that tracks the relative performance of high yield credit (HYG) vs. investment grade credit (LQD). The idea is that, when investors expect stable and positive economic conditions, they will display their risk appetite by pursuing higher yield. When investors expect unstable and poor economic conditions, they will tend to be risk averse and seek the relative safety of high quality credit over high yielding issues.
As the chart above illustrates, throughout the bull market, we've seen high yield debt outperform investment grade issues. While the pace of that outperformance has waned recently--we have not made fresh 2010 highs since January--we've not seen any underperformance of HYG that would lead us to worry about an increase in perceived default risk. .
Energy is an important market sector, as it reflects not only demand for energy-related companies, but also for energy as a commodity. If traders and investors are expecting global growth, that should show up in terms of greater industrial activity and increased demand for oil and other fuels.
Note the upside breakout among energy stocks (XLE; above) today, reflecting firmness in crude oil prices. Should we get runaway growth in the current low interest rate environment, one would expect that to eventually show up in the prices of raw materials and energy--and the companies in those sectors. .
Here we can see the steady march higher of the S&P 500 Index (SPY; blue line) during the bull market, plotted against the number of stocks across the NYSE, ASE, and NASDAQ that have made 65-day new highs minus new lows. What we see is that dips in the 65-day highs minus lows have occurred at successively higher price points, a hallmark of a bull market. We also see that the 65-day highs minus lows have stayed persistently above zero since the important February bottom.
In evaluating market cycles, we generally want to look for momentum peaks--points at which the largest number of stocks make their new highs--and lows. As Terry Laundry has stressed, there is a proportionality between the time it takes markets to make momentum highs and cycle lows and the time it takes a subsequent bull cycle to make a fresh peak. With the momentum high in early September and the cycle low in early February, that formulation suggests that this bull phase could last into the summer.
Interestingly, that is consistent with today's market analysis by SentimenTrader, who investigated historical periods of persistent upside momentum and found that those rarely turn tail quickly. That view also meshes with the analysis of Market Tells, which finds intermediate-term bullish action tends to follow strength in their version of the S&P Oscillator.
All that is not to say that we won't have our share of short-term market pullbacks between now and then. It does suggest, however, that automatically assuming that an overbought market will reverse in the near term can be hazardous to your wealth. As long as more stocks are making 20- and 65-day highs than lows and the advance-decline line is making fresh bull highs, those pullbacks will tend to provide opportunity for investors to buy into a strengthening economy that continues to enjoy low interest rates and little inflation.
I am absolutely humbled by the large number of heartfelt responses to my recent blog postannouncing that I will be winding down the blog. I've experienced many gratifying moments in my career, but few can compare with today. To be able to be a part of so many people's personal and professional development is a real honor.
In response to a question that many readers raised, yes, I will do everything I can to keep the blog up and archive "best of" posts. If, as expected, I do join a trading firm on a full-time basis, it is likely that my contract will prevent me from doing new writing. There is just too much room for conflict of interest if the firm is sharing its positions with me and then I'm writing about markets for the trading public.
Similarly, if I'm developing coaching innovations for the firm, they don't necessarily want me sharing those with others, including competitors.
So, for a while, I will take a break from writing. For many of the same reasons, I will need to take a break from trading.
I look back on the opportunities that have come from the blog--the books and book sales, the coaching opportunities, the valuable contacts and colleagues--and the return on the investment of my time has been immense. It's been phenomenally rewarding personally and emotionally, but it's also contributed to many hundreds of thousands of dollars of income. All without subscriptions. All without advertising.
And that's the thought I want to leave you with: If you put yourself out there, share your best ideas, reach out to people, and give more than anyone ever could expect you to give, you'll attract the right kinds of people--and the right kinds of opportunity. If you have passion and you have talent, make yourself visible: the best people will find their way to you and everyone will benefit.
I've been blessed with many colleagues and friends through the TraderFeed blog; it has been a most gratifying experience sharing ideas about psychology and markets over the years. With nearly 3700 posts on topics ranging from short-term trading techniques to behavioral finance and self-help methods for problems affecting traders, the blog has become the largest compendium of trading psychology-related material on the Web.
Unfortunately, or perhaps fortunately, my continued writing of the blog will need to wind down in coming weeks due to a major career change. My future coaching involvement with traders will preclude me from writing: much of what I'll be doing will need to be proprietary. When the i's are dotted and the t's crossed, I'll announce that change in coaching involvement more specifically.
The reason for the career change is pretty simple: If I as a coach am not pushing myself to grow and develop, then my efforts to help others evolve are fraudulent. I cannot offer others more than I can achieve myself. To take myself to the next level as a psychologist, I need to pursue challenges that will bring the best out in me.
Remember this: Your growth always lies on the other side of your discomfort. Whether it's in the weight room or in career decisions, you'll never develop yourself by staying in your comfort zone. People don't become old when they reach a certain birthday; they become old when they decide to live life without crossing that line of discomfort.
So, as the blog wraps up, what topics would you like for me to tackle? I'll happily take suggestions as comments to this post. I may not be able to get to all topics in the days ahead, but I'll make a sincere effort. As always, thanks for your understanding and support.
While we've seen selling in the large cap S&P 500 Index today, small caps are holding near their bull highs and we actually have a few more stocks rising on the day than declining. Sector performance is mixed, with weakness among financial and health care stocks and relative strength among the industrial and consumer discretionary shares. .
Commodities (DBC, above) have traded higher through the bull market, but have lagged stocks since January thus far. I am watching commodities closely, as a breakout to new highs could have implications for raw materials and energy stocks, inflation concerns, and the broad economy. .
8:58 AM CT - Note the relative strength among bank and homebuilder shares, but only a little more than 500 advancing stocks than decliners so far. Health care and materials shares relatively weak; watching closely to see if this is simply sector reallocation or if the rally in banks can lift the broad market.
We're trading toward the top of a broad multiday range; handicapping whether we can attract fresh buying at the highs vs. fall back into the range will set up the best trades for today. I'll be watching the intraday advance-decline line and new 20-day highs/lows carefully during the day for clues as to the likelihood of sustaining a breakout: with a little over 1300 new 20-day highs on Tuesday, we're seeing some thinning of participation on this most recent leg up in stocks. Note also that we're falling short of recent highs overseas, in EEM and EFA. .
* We are in a cyclical bull market within a secular bear market. The secular bear market began in 2000 and, like secular bear markets before this one (1929-1949; 1966-1982), this one could last for 15 years or so. Even after secular bear markets have put in price lows (1932, 1974), we've typically seen years of weakness and bottoming action until stocks become an unloved asset class. The March, 2009 may have been a price low for stocks, but we've got a way to go before stocks are a shunned investment.
* All that being said, we *are* in a cyclical bull market and only recently have we begun to see the kind of bullish sentiment extremes that might accompany a topping process. This bull market has lasted a little more than a year. Most bull markets last longer than that. I'm not convinced we'll roll over until there are stronger hints of a move away from low interest rates. The inability of traders and investors to recognize the difference between cyclical market moves and secular ones has created much pain for bulls and bears alike.
* I find it hard to believe that the Fed will have the political cover to raise interest rates until we see hard signs of inflation. That means that commodities might have to rally hard before we see the bull market in stocks roll over. If we're not overheating, I'm can't imagine the Fed raising rates in a high unemployment environment. So we stick with monetary ease until we overheat.
* A rise in long Treasury rates (decline in bond prices) will be a good tell for inflationary expectations and anticipation of overheating. As long as rates stay tame, it's hard for me to imagine stocks going to hell.
* I'm open to the possibility that all the above might be wrong and that the next driver of stock prices will be monetary tightening and a hard landing among emerging market economies. If the emerging nations stop serving as the engine of global economic growth, that's when we could see a second economic slowdown. I'm not convinced that the China miracle won't end up looking like the Japan miracle.
* I don't know how we emerge from burdensome debt other than to transition from being a consumption-driven economy to being an export-driven one. Over the long haul, growth-by-export will support a weak U.S. dollar, though any near term economic slowdown led by emerging markets would likely see a flight to the dollar.
* It is hard for me to imagine a transition away from a consumer-driven economy without deflationary pressures coming from household deleveraging, weakness in commercial real estate, and pressure on local/state governments and local/regional financial institutions. The panicky flight to high yield debt (junk bonds, muni debt) could end badly if we get a second bout of deflation.
* If I have to bet on the future, I'll bet on countries with favorable demographics, favorable balance sheets, favorable rates of taxation, and freer markets. Free markets are messy and far from perfect, but they are ultimately self-correcting; centralized ones are not. .
We are trading in a broad multiday range in the ES futures (above), defined by yesterday's lows around 1180 and the bull highs around 1210 from 4/15. Sector performance is mixed: consumer discretionary and energy shares are at their bull highs, whereas health care stocks, consumer staples, materials, and financial issues lag. We're also seeing 10-year rates, gold, and oil well off their bull peaks. In all, this is looking like a period of distribution, sector rotation, and consolidation following a strong and persistent bull run. .
Recent posts have looked at EEM vs. SPY and XLY vs. XLP as sentiment gauges for the broad stock market. Above we see yet another ETF pair, IWM vs. SPY, as a gauge of speculative sentiment among traders and investors.
The underlying logic is much the same as EEM vs. SPY: traders will be drawn to the smaller, more entrepreneurial, growth-oriented companies when they anticipate economic expansion and will gravitate toward the larger, safer issues when they expect economic weakness.
As we can see above, the small and midcap stocks that are part of IWM have been outperforming the large cap SPY issues, recently moving to relative strength highs. That strength can also be seen in the advance/decline line specific to NYSE common stocks: the broad list of smaller cap issues has been moving the line to bull highs lately.
It is interesting to juxtapose the bullish speculative sentiment of IWM vs. SPY with the more tempered outlook given by EEM vs. SPY. Within the universe of U.S. stocks, we see risk-taking sentiment among traders; that same sentiment is not extending itself globally. Indeed, if we look at large cap stocks across Europe, the Far East, and Australasia (EFA), we can see that those overseas bourses as a whole have not sustained bull highs thus far in 2010.
As long as there is broad participation in upward movement in the U.S., I don't expect any major market correction. Should we begin to see small caps underperform their larger cap counterparts and overseas markets--especially in emerging economies--underperforming the U.S., I would become far more defensive. .
I recently took at look at ETF pairs--consumer discretionary and consumer staples issues--as sentiment gauges for the broad stock market. Above we see another ETF pair: emerging market stocks (EEM) vs. U.S. large caps (SPY) as another gauge of speculative sentiment in the stock market.
EEM represents trader and investor interest in the fastest growing economies in the world. While these display high potential appreciation, they are also quite vulnerable to downturns in global economic strength. SPY represents a universe of shares with lower growth potential, but also higher stability.
When traders and investors anticipate strong global economic growth, they will tend to favor more speculative, growth-oriented regions of the world. That will show up as EEM outperforming SPY. When traders are more risk averse and anticipating global slowdown, they will tend to seek the relative safety of large cap stocks in the world's largest economy. That will show up as SPY outperforming EEM.
What we've seen lately (above) is that, despite very rapid economic growth in Asia and South America, EEM has stopped outperforming SPY. Early in the bull market, we saw EEM dramatically outperform SPY. Since the fourth quarter of 2009, however, that outperformance has stopped.
This leads me to believe that traders and investors are anticipating a monetary tightening cycle among emerging market central banks, restraining growth potential. To the degree that economies in the U.S. and Europe are looking to exports to emerging market economies to fuel their own growth, we could see some headwinds going forward. I will be watching this theme closely, as it could lead to a more challenging environment for all stock markets as the year progresses. .
Although major indexes have traded below Friday's lows thus far today, we're seeing bank stocks ($BKX, above) holding above those lows. We're also seeing relative strength from the most risk-averse stock sectors: health care and consumer staples shares. Meanwhile, oil and gold have been trading lower, Treasury yields are below Friday's levels, and USD is up vs. euro and Aussie dollar. All in all, we're seeing continued risk-sensitivity in the wake of concerns re: allegations of fraud at major banks. .
* As we can see, financial stocks (XLF) broke out to bull market highs in March, only to pull back sharply on very expanded volume on Friday. The catalyst, of course, was the GS news and subsequent selling of bank stocks. Much discussion has focused on whether this will lead us to a sustained correction after a remarkably consistent run up. Less commented upon is the fact that SPY volume more than doubled on Friday from its recent average levels and the daily price range did the same. The GS news has pulled in more institutional participants who, to that point, had found no reason to sell a market that showed rising earnings in a low interest rate, accomodative monetary environment. It's as much a potential shift in volatility regimes as in directional trade;
* Overheard from one savvy trader: "What are the good financial stocks that are getting punished along with the banks?" Sometimes asking the right questions is half the battle. Figuring out how to express the answer to the question is a big part of the other half;
* From a recent email I sent to a sharp trader buddy: "Algos cannot change whether stocks go from point A to point B, but they do influence the path. The more path dependent the trader, the more vulnerable he is."
* I was looking at real estate in the northeast this weekend. No question that activity has picked up. Particularly vulnerable, however, was the luxury condo market: plenty of developments sitting only partially filled, with price declines failing to bring people in. And that's one of the better real estate environments. Miami has over 14,000 housing units for sale, over 8000 of which are condos. To cover costs, condo owners/developers have to rent their units out and that gives little incentive for buyers to step up and risk owning property in failing developments. And how about tenants who bought early and now face a glutted market should they need to sell? Just too much tail risk for buyers, and that has to impact the trajectory of the housing recovery at the high end.
* "A pessimist sees the difficulty in every opportunity. An optimist sees the opportunity in every difficulty." - Sir Winston Churchill .
After Friday's decline, the CBOE equity put/call ratio moved toward levels that have been normal for the bull market, but hardly showed bearishness. Indeed, we can see the extreme bullish sentiment that accompanied the market's recent run up.
Meanwhile, the AAII poll of trader sentiment shows bears at 30%, the lowest reading since the first quarter of 2008. According to the Investor's Intelligence survey, 51% of participants are bullish, 19% bearish. Readings of less than 20% have tended to occur at intermediate-term market tops; the last such reading occurred early in January. .
* Pull out your largest trades--and your most active trading days-- in the past three months and assess the P/L just for those. That will tell you quite a bit about how you are dealing with risk and reward;
* Pull out your top ten winning and bottom ten losing trades over the past three months and compare their P/L. That will tell you quite a bit about your trading discipline;
* If you are much more unhappy when you lose than happy when you win, a 50% win ratio will feel like losing over time, even if you're making money;
* If you are always looking for the next trade, you will ultimately overtrade;
* If you are confident in your ability to make money, you will not fear missing market moves;
* If you are a consistent trend follower or a consistent countertrend trader, you will not consistently make money;
* Dissect your best trades and you will find out who you are as a trader;
* You won't always make money, but you should always expect to trade well;
* You can't control markets, but you can always control when you bet and how much you bet;
* If an athlete spent as much time working on his game as you do on your trading, would the athlete make a living as a professional?
* Great traders work on themselves after a winning streak;
* Confidence when losing, humility when winning: a formula for long-term success in markets.
Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), Trading Psychology 2.0 (Wiley, 2015), The Art and Science of Brief Psychotherapies (APPI, 2018) and Radical Renewal (2019) with an interest in using historical patterns in markets to find a trading edge. Currently writing a book on performance psychology and spirituality. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014.
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