So much of what's written on market sites is about trading. So much of what's written about trading is about daytrading. This blog is as guilty as any in that regard, given the author's trading history and background. Active traders are more likely than others to purchase trading-related products, to watch market-related media, and visit trading-relevant websites. It's only natural for those in the industry to go after that audience. But looking beyond active trading, there is an important development that has gained traction in the investment world. It loosely falls under the umbrella of alternative investing. Why focus on investing? The first reason was nicely captured in this article by Morgan Housel on why we're awful at assessing risk. There are real costs associated with fees, overtrading, and undersaving. I've met many active traders looking to make a living from a small capital base. If they trade with a $5.00 retail commission and place one trade in the morning, one at midday, and one in the afternoon each day--hardly wild-eyed daytrading--they will have accumulated about $7500 in brokerage expenses over the course of a year. On a $50,000 trading count that means that the active trader is down a guaranteed 15% over the year--not including other expenses such as equipment, software, data fees, etc. With the house stacked that way, Vegas starts to look attractive. The larger reason for the investment focus is that baby boomers have found that they need to take control of their finances in a zero interest rate world. These self-directed investors are smart enough to know that they need diversification in their portfolios. They don't need to be whiz-bang daytraders--they need to be competent portfolio managers. But how can the average self-directed investor become a portfolio manager and hope to compete with experienced hedge fund and asset management pros? One answer has become alternative mutual funds, which invest in strategies that the pros use. Here's an excellent article passed along by the Simple Alternatives blog; it explains the the difference between hedged mutual funds and hedge funds. It's a very important distinction for individual investors. Imagine informed investors assembling portfolios of hedged mutual funds across a variety of asset classes and strategies. In such a world, investors would look less like traders and more like funds of funds. That future is already coming. Take a look at one of my favorite sites, Abnormal Returns. Every week editor Tadas identifies the links that have received the greatest number of clicks. Here is the list for this past week and the week before. What I find interesting in the lists is that so many of the links are pertinent to individual investing, not trading. Those who need to manage their capital are hungering for information to help them become better at balancing the needs for return of capital and return on capital. When you hear individual investors debating the risk-adjusted returns of their investment alternatives and not the short-term path of the stock market, you'll know that the revolution is upon us.
I just took a look at the most recent report from Quantifiable Edges, including a historical study that examined what happens when (as on Friday) SPY drops on positive NYSE breadth. Interestingly, over the near term, winning periods outnumbered losing ones by about 2:1. If you check out the Quant Edges blog, you'll see similar studies posted. That pattern makes sense because the breadth is showing strength underlying the stock market, even while the large caps--which dominate the indexes--may be seeing selling. Still, any trader looking to make use of that information has to make a key assumption: that the near-term future will mirror the past. In other words, whatever has driven forward price movement in the backtest will persist as drivers during the next market period. I think of historical patterns as precisely that: a script that markets should follow if they are driven by the same factors that influenced past price movement. In addition to how markets *should* trade, however, there is also how markets *are* trading. That is why measures like NYSE TICK and Market Delta are valuable from my perspective: they tell us if buyers or sellers actually are dominating the market. It is when how markets *are* trading lines up with how markets *should* trade that interesting trading ideas emerge. And if markets don't follow their historical scripts? That, too, is information. It tells us that markets are responding more to current, idiosyncratic factors than historical ones. In such a situation, I want to find out what those present drivers are and track their waxing and waning. The historical query from Quant Edges suggests we could see a bounce in the first half of the coming week. We know, however, that there are unsettling events in Russia/Ukraine and China that could trump those odds. Teasing apart those present influences from the historical ones will be a key to successful trading this coming week. Further Reading: Historical Studies and Being Prepared
Harry Truman defined pessimists as those who make difficulties of their opportunities, whereas optimists make opportunities of their difficulties. It turns out that optimism is an important variable in the response to stress. This post points to research suggesting that people who are optimistic have more stable levels of cortisol (stress hormone) than pessimists. Interestingly, optimists with high pressure jobs start their morning with higher cortisol levels. This suggests that stress hormones can produce distress--and they can get us going. High pressure might not imply high stress if we feel optimistic about what we're doing. Here's an excellent article summarizing evidence that optimism is the most important predictor of emotional resilience: the ability to weather adversity. Summarizing the research of Barbara Fredrickson, the author makes the point that, in a positive mind state, you're more primed to notice positive things and act on them. In a negative state, you're more likely to be defensive and narrow your field of vision.
Seeing the whole market field is not just a matter of looking at more charts and indicators; it's also a function of the cognitive set with which we process the information. The answer to successful performance is not to simply don rose-colored lenses. Optimism does not mean ignoring challenges--that is denial. Rather, an optimist finds opportunity in challenge. We can't always feel good about outcomes, but we can find meaning and value in the process of learning and developing from those outcomes. Further Reading: Optimism and Motivation
There will always be people in life who envy you, who resent your success, who are threatened by your accomplishments, who do what they can to sabotage your efforts. Those include people in a workplace who place politics and "optics" over productivity and innovation. Those also include naysayers who don't dare admit the possibility of achievement because that would undermine their excuses, their failure to make a difference. You know who your friends are when you reach a breakthrough success. Your friends are ready to celebrate with you: they share your joy. Those who cannot celebrate with you? Perhaps they're struggling with their own demons. Perhaps they are burned out and exhausted. That doesn't necessarily make them horrible people. They just can't be your friends. It's natural to feel anger and resentment toward those who stand in your way and seek to undermine your success. I've seen people consumed by hate, plotting revenge and wishing nothing but harm on those who have hurt them. Sadly, they fall prey to the very negativity they resent in others. But you can use liars, naysayers, and mediocrities to make you stronger. Here's a simple exercise: When you find yourself in a negative mindset, talking to yourself in frustrated, angry, and discouraged ways, close your eyes, take a few deep breaths, and visualize the person who has been most destructive toward you--the person you most resent. Vividly imagine his or her face and imagine that he or she is saying to you the very negative things that you're saying to yourself. Feel what it's like to have that other person berating you, putting you down, telling you that you can't succeed, that you're a loser, that you're no good. Suddenly you feel angry. You don't want to hear that kind of message from anyone--and certainly not from the person you most resent! With your eyes still closed and that image still vivid, imagine telling that other person off, standing up for yourself, and putting things in a much more constructive light. Now you're angry at the negativity, not at yourself. You're refusing to talk to yourself the way an enemy would speak to you. Holding anger and resentment can indeed be a poison. Channeling it toward the patterns we want to change distances us from those patterns and frees us from them. We won't want to own a pattern that we associate with someone destructive. Very often, the first step in a change process is becoming so disgusted and angry with our old ways of doing things that we're propelled into new ways. Those who have wronged you can make you stronger. In vowing to never be like them, you set a positive course for yourself and free yourself from bitterness--secure in the knowledge that living well is the best revenge.
Obstacles are like weights in a gym: when lifted, they make us stronger.
Great quarterbacks, it is said, see the whole field. It may look as though receivers are covered and no passing opportunities are present if you're looking down the center of the field, but off toward the sidelines--or maybe even just off to your side--could be a good opportunity to complete a pass.
If all you were looking at yesterday afternoon was the S&P 500 Index (SPY, bottom chart above), what you saw was weakness through the day.
Had you been looking at the smaller cap Russell 2000 shares (IWM, middle chart above) or the emerging markets ETF (EEM, top chart above), you would have seen shares holding nicely above their morning lows.
There was significant selling pressure in the afternoon, with multiple NYSE TICK readings below -800, and yet by the end of the day we had 643 stocks making fresh monthly lows, compared with 685 the day before. Failing to trade below their prior day's lows were small cap shares (IJR); midcap shares (MDY); homebuilding shares (XHB); consumer discretionary stocks (XLY); raw materials shares (XLB); energy shares (XLE); EuroStoxx shares (FEZ); and utilities stocks (XLU).
If we see renewed broad weakness early Monday, we'll know that's fresh selling pressure-- and that would be information. If we see firmness in stock prices early Monday, a number of tunnel-visioned quarterbacks might just have to cover their shorts.
I recently posted a measure of intermediate-term market strength as well as moving average crossovers. Above is a short-term measure of breadth specific to S&P 500 stocks that I have found helpful. As with the intermediate measure, the raw data are from the Index Indicators site--shoutout to Mo Shaarani for a very useful site. I archive the data and construct the indicator and chart it within Excel.
This short-term breadth measure consists of a daily average of the percentage of SPX shares trading above their 3-day moving averages, their 5-day moving averages, their 10-day moving averages, and their 20-day moving averages. So when the index approaches 100, the vast majority of shares are in uptrends over all of those short-term timeframes; when it approaches 0, the vast majority of shares are in short-term downtrends. Interestingly, when the breadth index closes below 30, since 2013 the next five-day gain in SPY has been 1.25%, almost four times the average gain for the remainder of occasions (.33%). It's a great example of how markets that look and feel the worst--and that trigger the most stops for long positions--end up having the best near-term returns. Imagine short-term cycles superimposed on a long-term upward trend: that is the market we've enjoyed for the last couple of years or so. In such a market, it makes a lot of sense to be a trend follower--but to enter long positions in a countertrend mode. Further Reading: Breadth as a Market Tool
Here's a measure that has done a nice job for me of tracking intermediate-term market strength and weakness. You can see that we topped ahead of price, which is common, and have rolled over. We have not, however, reached oversold levels, despite yesterday's stiff decline. Those oversold occasions have marked very good buying opportunities in the past several years. The intermediate strength measure looks at the number of S&P 500 stocks making fresh 5, 20, and 100-day new highs and lows and takes a moving average of that composite. The data come from the Index Indicators site. Like the crossovers, I've tracked these measures for years. Daily posting of numbers and testing of relationships provides a learning experience that, for me, is far deeper than anything I can get from staring at screens. Further Reading: Implicit Learning and Trading Performance
So imagine you are following all common stocks trading across the major U.S. exchanges and you track how many each day are crossing above their 20-day moving averages and how many are crossing below their 20-day averages. If you take the net number of crossovers each day and track on a rolling five-day basis, you'd get a chart that looks like the above. You'll notice that thrusts in crossovers to the upside have tended to lead price peaks in the market. Troughs in the number of crossovers have corresponded with a number of short-term bottoms. After yesterday's rout, you can see we're in the range of many of those troughs. Indeed, since 2012, when (as yesterday) the net five-day number of crossovers has fallen below -1000, the next five days in SPY have averaged a gain of over 1.4%--about four times the average five-day price change over that period. There are plenty of current geopolitical factors that could erupt and turn the recent decline into a deeper dive, so one cannot blindly assume that the future will mirror the past. It's when tape action begins to confirm historical tendencies that you have a potential good short-term trade and NRK goes shopping. Further Reading: How Trading Systems Can Inform Discretionary Trading
FXI, the China ETF, has been underperforming U.S. stocks for a number of years and has moved lower recently in the wake of a domestic loan default and fears of a chain reaction. Emerging market bonds (EMB) have also moved down in recent days, but are still well off lows of the last several months. Note also the weakness in copper, which has been tied to the China trade in interesting ways. With banks cutting lending to sectors with high levels of shadow banking debt, this familiar story has gained a bit of urgency in recent days.
Here's a chart of rolling correlations among the major sectors of the S&P 500 stock universe vs. the S&P Index (SPY) itself. Whether we are in a more correlated or less correlated environment impacts the relative value of trading the index itself vs. stock picking within the index. Most recently we've been in a lower correlation mode. Indeed, as we see from the FinViz site, over the last three months, returns from the major sectors have varied from a high of 10.1% (healthcare) to a low of -17.4% (conglomerates). As a rule, the sectors tend to become more correlated during moves down and initial rises from lows and then less correlated during periods of short-term topping. It is during those topping processes that we see sector rotation and weaker sectors falling off while stronger ones hold their highs. My longer-term correlation metric has increased from .65 during 2005-2006 to .80 for 2012-present. That has been part of the stockpicking challenge in the large cap universe and (along with volatility and its collapse) is one of the reasons many short-term traders in the stock market have gravitated to smaller cap shares that move more idiosyncratically. It's yet another illustration of how market environments can shift over time and impact opportunity sets for traders. Further Reading: Adapting to Change
There is no more important coaching relationship than the relationship you have with yourself. How do you talk to yourself when you start your day? When you are in losing trades or drawdowns? When you are traversing your learning curve? Our self-talk creates our most immediate psychological environment. Do you talk to yourself the way you would speak with a loved one or a dear friend? Do you motivate yourself? Inspire yourself? Challenge yourself? Support yourself? You wouldn't want to work for an employer that wasn't constructive, motivating, inspiring, challenging, and supportive. Why would you settle for that as your internal workplace? Successful traders, I find, may or may not make use of formal coaching, but they are generally good self-coaches. They know when to give themselves a kick in the pants and when to be their own best friend. I've long defined my work as a psychologist as comforting the afflicted and afflicting the comfortable. That's also not a bad formulation for effective self-talk: staying constructive when things go wrong and challenging ourselves when things go right. Effective self-talk is much more than empty positive thinking: it's staying constructive no matter how challenging life and markets become. Further Reading: We Become What We Think
Here are readings and sites you can sink your teeth into:
Shoutout to Financial Juice, which has a running scroll of financial news and world developments. The site includes a calendar of upcoming global economic releases and latest pivot numbers from Pivot Farm, as well as links to webinars. Consistently the best and greatest number of links to financial media come from Abnormal Returns, including this recent curation that shows how high yield bond spreads have retraced their crisis move higher.
Suppose two traders applied for a position at your firm. One has a history of very consistent success with a winning strategy. The other has gone through ups and downs across many markets but maintained profitability over time. Which would you be inclined to select, if that is all you knew about the candidates?
It turns out that research from Angela Duckworth and team finds that "grit"--perseverance in the face of setbacks--is a significant predictor of future success. Indeed, a study of spelling bee winners found that those who sustain the greatest deliberate practice and display the greatest grit are most likely to succeed. The trader who has known nothing but success has little to fall back upon when markets change and fat tails create large losses. The trader who has been through winning and losing has cultivated resilience and is most likely to be emotionally prepared for losing--and prepared in his or her risk-taking.
A great formula for success: embrace setbacks and continually learn from them. Here's a talk on why passion and perseverance outweigh IQ as a determinant of success. Want to measure your grit? Here's a short test designed by Professor Duckworth. Further Reading: Persistence and Resilience in Trading
Simonton points out an interesting facet of creative genius: about 50% of creative ideas come from the 10% of contributors in a field who are most productive. One would think that creative geniuses bat out one creative masterpiece after another. That, Simonton's research finds, is not the case. The hit rate for the greatest geniuses--the ratio of works deemed creative masterpieces versus not masterpieces--is no higher for the geniuses than for their lesser competitors.
Those we come to know as great don't get that way by hitting home runs every time they come to the plate, so to speak. Rather, they go up to the plate more often: they produce many more works and a relatively constant proportion of those works end up becoming historical contributions. In other words, the signature characteristic of creative geniuses is prodigious productivity: they produce many more works than their peers and so are more likely to produce "mutations" that pass the test of natural selection.
What makes eminent contributors to their fields so unusually productive? Simonton observes that they are absorbed in their work and put in unusual numbers of hours doing what fascinates them. To paraphrase Seykota in the Market Wizards interview, they don't just have talent: the talent has them. This absorption in their work is a big part of what gives them the deliberate practice hours to achieve expertise.
The traders who I've seen maintain career success are also those who are absorbed by their talent. Their unusual productivity shows up in the constant flow of new ideas they generate and their continuous efforts at improvement and adaptation. One of the best tests of a trader is what they do when markets are closed. The best are absorbed in markets, whether markets are trading or not: theirs is a passion for mastery, not just a need to trade.
Kudos to Forbes for their New Year's list of inspiring quotes regarding greatness. As the Lee quote suggests, greatness is contagious: it is so much easier to find the best within us when we are surrounded by others who aren't afraid to think greatly. That principle applies to our psychological environment, as well. Greatness starts with doing something greatly every single day. How can we be the best we can be in life if we're not realizing our best day to day? Further Reading: The Power of Solution Focus
Here is a chart of the average true range for the stock market on a rolling 100-day basis going back to 1997. What you can see is that volatility has been all over the place. Anyone in 2012 who counted on markets moving similarly to the prior several years has been severely disappointed. Indeed, the current 100-day average true range is .88%, just a little over half the median level seen since 1997. For directional traders, that means that moves on any time frame are extending far less than they have historically. So let's say that a trader waits for price confirmation (i.e., for prices to move in the desired direction) prior to entering a position. Because moves extend less in a low-volatility environment, this means that going long on strength or going short on weakness (or adding to long positions on strength or adding to shorts on weakness) will give trades a particularly short half-life of profitability. By the time the trader has gained confidence in the move, it's ready to reverse. How frustrating is that? Since 2009, we've gained a little over 100 points in SPY. It's been quite a bull run, as the index has more than doubled. If we separate next-day returns based upon prior five-day returns, then we can see that only a little more than 13 points of the total move followed the strongest half of five-day periods. The remaining 88 points--nearly 90% of the total bull move--occurred following the weakest half of five-day periods. In a low volatility regime, the short-term trend is not necessarily your friend. It was great being a momentum trader in the late 1990s and many short-term traders I worked with did well during the volatility spike around 2008. It's been harder for those traders from 2013 forward.
How do you figure out what works in a more mean-reverting regime? Studying your successful trades can provide a valuable clue. It may be the case that you don't need to remake yourself. Rather, the challenge might be to simply stop doing the things that no longer work. Reverse engineering your best trades and isolating what makes them work can provide the best coaching of all. Further Reading: Stock Market Trends are Not Your Friends
This guest post is from Naomi Ruth Katz, who has experienced more markets than I could possibly study. It's an honor to share her wisdom; she is normally quite private.
When Brett asked me to write for his blog, I wondered, "What's this blog? It sounds like something that comes out of your nose." But Brett explained that blogs are a way of publishing without writing things on paper. In my day, when you wanted to write, you took out a pen and paper and put the letter in an envelope and mailed it. Now they have blogs. Go and figure. So what can I tell you about trading? The best trade I made was giving up my first husband. What a putz! For years I thought about ways of getting rid of him like that Hitchcock episode where the woman kills her husband with a frozen leg of lamb and serves it to the detectives. But you have to let those things go. You learn from your losses and you move on. Like I tell my son, the one with the tuchespunim: why always so farbissen?
But trading markets is different than getting rid of a cheating piece of dreck. You should keep it simple, otherwise you'll give yourself an ulcer. When you go to the store, do you shop for the most expensive things? Of course not. You look for a bargain. It's that way with stocks. You don't buy them when everyone wants them and the price is high. You wait for everyone to hate them, because that's when they go in the bargain bin. I love the bargain bin, like the one at the dollar store. I get things for 50 cents at the Flatbush outlet all the time, including a nice shampoo that doesn't make my hair frizz. Listen to me, you'll never make money trading with a goyishe kop. Never pay the retail price for anything. And make sure you return your library books on time, or they make you pay a fine.
One other thing, live a little. There are too many people like Brett getting up at 4 in the morning just to hock a chaynik about changing markets. Forget markets, worry about changing your oil. You can drive yourself farmisht with all these statistics. Hold onto your money, find good bargains, and take a vacation every so often. Only it shouldn't always be in the same place.
I just drew this chart on the fly. Imagine we're describing different kinds of people. The Y-axis captures whether the person predominantly talks about the world around them, ideas, and inspirations vs. talks about themselves. That Y-axis also captures a positivity dimension: many people who talk about ideas are supercharged by those ideas. Many who are self-focused come from a position of need, even/especially when they are in self-promotion mode. The X-axis captures whether the person mostly wants things from you and is in a taking mode vs. a sharing/giving mode where there is back and forth and true reciprocity. I've color-coded the quadrants. I find that the upper right, green quadrant is one that renews my energy. The lower left takes quite a bit of energy. A big part of success and happiness is surrounding yourself with the people and things that give you energy and minimizing the things that deplete energy. This is especially true in one's romantic life. One reason I like the idea of creating your own trading groups is that you have the opportunity to generate an oxygenated work environment. It's amazing how much growth and learning can occur when you're around growing, learning people. It's much easier operating with the right internal, psychological environment if you're in the right interpersonal environment. Further Reading: The Essence of Greatness
Many traders talk about having an "edge" in markets. Few actually measure and identify the sources of that edge. Let's say that roads never changed: there were never detours, road closings, new roads, etc. In such a situation, one would never need a GPS to get to work. One's memory and experience would be the source of edge: the driver could follow the same course and always arrive at the destination successfully. Now let's say roads changed routinely: the roads that were best to get to work one week might not be open or available the following week. In such a rapidly changing environment, one would lean heavily on an updated GPS. Without the guidance of the machine, it would be hit or miss as to whether one's past course would lead to the destination successfully in the future. Now imagine a driving educator who tells you that all you need to get to work is a chart of the roads, called a map. You're very excited, because this will tell you how to get to work each day. But the map never changes when roads open and close, so the best the map can do is aid your detours. But even the detours suggested by the map might be closed... Fortunately, there's a driving coach who tells you that your problem is that you lacked the discipline to follow your map and shows you several exercises to be a better map follower. The coach even shows you higher resolution maps to guide your commute. But the maps never change and the roads do. Much of my work these days consists of building better GPS systems for markets: systems that tell you when markets are changing, how they are changing, what drives the changed markets.. The GPS doesn't replace the driver; it informs the driver. The more roads change, the more important the GPS becomes. Meanwhile, drivers keep working on their map reading...keep running into detours...keep seeking out those coaches when frustration boils over... Further Reading: How to Identify an Edge in Markets
We've all had the experience of perceiving little opportunity in markets. Is there actually little opportunity, or are we in the wrong mindset to perceive opportunity that is there? It's an important question. Successful traders study themselves, the way Ted Williams studied his hitting as a function of where the pitch fell within or around the strike zone. That study told Ted which pitches to swing at and which to let go. As a trader, how well do you know your strike zone? It's only after understanding your sweet spots that you can properly differentiate between markets that have little opportunity for you and occasions when you are in the wrong frame of mind to perceive and act on legitimate opportunity. It turns out that exercise has a beneficial impact on creativity. Creativity also benefits from sleep and from positive mood. How you manage your personal life ends up being quite important to your ability to generate promising ideas. But all the creativity in the world won't help if you're swinging at pitches outside your strike zone. Further Reading: Trading Lessons From Ted Williams
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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