The recent post highlighted weakness that had shown up in the broad stock market. Above we see three perspectives on that weakness. The top chart tracks a cumulative total of the proportion of NYSE stocks trading above vs. below their daily volume-weighted average prices. The idea behind this measure is that, in a strong/weak market, we should see the great preponderance of shares trading above/below their daily moving averages. When stocks made their recent highs, we saw fewer shares participating in strength vis a vis their VWAPs.
The middle chart follows buying pressure vs. selling pressure, where zero represents a balance between the two. Buying pressure is a function of moment-to-moment upticks among NYSE stocks; selling pressure reflects downticks. In a strong/weak market, we should see the majority of stocks upticking/downticking. Note how the balance between buying and selling pressure has been steadily waning in recent days. The bottom chart tracks the proportion of NYSE stocks closing above/below their upper/lower Bollinger Bands. Note here also how recent sessions have provided us with a negative Bollinger balance.
What I look for are common themes among multiple indicators. The big question I'm addressing is whether the stock market is: a) rising and getting stronger; b) rising and getting weaker; c) in a balanced range; d) falling and getting weaker; or e) falling and getting stronger. As market cycles evolve, we shift from a) to b) to c) to d) to e). It is the preponderance of evidence, not any single market measure or chart pattern, that provides a meaningful answer to where we're at in a market cycle. Right now I'm gauging market strength vs. weakness for the current market versus where we stood at the end of December 1st. So far, we're seeing more new highs and fewer new lows than at the start of the month, but also more stocks closing below their lower bands. Raw materials and energy shares are down over 3% on the week; healthcare and financial shares are up over 1%. It is not clear to me that what we're seeing so far is a broad based decline, as opposed to a correction in a broader topping process. Trending markets generally cut across sectors. When sectors are doing very different things, that smacks more of rotation than outright trend--and that keeps me nimble.
A shoutout to Adam Grimes for a thought-provoking post on the development of the trader as an example of the hero's journey. Adam's point is that, as we move from lesser to greater competence and expertise, we are inevitably tested. It is our ability to weather these tests and learn from them that determines whether we truly become--as Joseph Campbell describes--heroes of our own stories. Campbell's quote above adds one key observation to Adam's post: we only become heroes by finding and pursuing causes larger than ourselves. We all know boasters and self promoters who puff themselves up as gurus. The hero does just the opposite, subordinating self in the service of a greater ideal. The entrepreneur is driven by a vision; the soldier soldiers on when inspired by a righteous cause. We survive the challenges of heroism, not because we've mastered one or another psychological techniques, but because we tap into energy sources that call upon the best within us.
I've found it to be a warning sign when traders are predominantly focused on aims smaller than themselves. They're trying to get through the next trade, the next day. They're trying to earn that next paycheck. At some point, it becomes all about coping and getting by. Rarely, very rarely, do I hear traders speak of accomplishing great things, tackling worthy challenges, and expanding in exciting directions. More often, I hear, not the hero's quest, but the worries of the worn-down warrior.
To be sure, trading brings its worries and the best of us become worn down at times. What elevates us is tapping into our strengths, while pursuing noble goals: our competitive drive, our intellectual curiosity, our vision of building a trading or investment business, our mentorship of others, our contributions to the world based upon our success.
Psychologically, profits are necessary in trading, but not sufficient. It is what we achieve to earn profits and how we make use of those profits that define our hero's course. We hear of fear and greed, lack of discipline, cognitive biases, and the perils of poor emotional self-control. All can undermine us. But perhaps, like the tree rotting away from the inside, we only fall prey to those once our vision decays. A tree with a strong core survives the strongest winds.
One of my favorite Ayn Rand quotes is, "Anyone who fights for the future, lives in it today." A good self-evaluation is this: Are you living in today? Are you caught up in yesterday? Or are you fighting for tomorrow and living in it today?
* Here's an indicator I've devoted a good amount of time to this weekend. The idea is to track a basket of stocks, where each of the names is actively traded by large institutions. I look at the behavior of the stocks multiple times per minute throughout the trading day and identify occasions in which most or all of the components trade higher or lower at precisely the same moment. These occasions represent the impact of program buying and selling in the market. The chart above compiles the data on a one-minute basis and examines the ongoing proportion of buy programs to sell programs. I believe this provides a unique window on institutional sentiment and participation. You can see how sell programs dominated as we went into the October lows, followed by a significant preponderance of buy programs. Most recently, we've seen a tailing off of buy programs and some expansion of selling. This is consistent with the recent weakness I noted from my other measures. * Thanks to a savvy trader at SMB for a heads up on this article concerning the value of repetition and resilience. By the way, that savvy trader recently put out a video on trading secondary offerings. I love learning new stuff!
* Kudos to Abnormal Returns for linking to the Morgan Housel post on rules for investors to live by--especially the observation that short-term thinking is a major source of investing problems. Investors cannot expect stratospheric Sharpe ratios, which means that drawdowns will be proportional to sought returns. Strategies to cut off losses by restricting holding periods also cut off positive returns, a factor that has contributed to recent modest fund performance.
I find it helpful to step back every so often and reflect on the lessons that life and markets teach us. Here are a few that have stood out recently: 1) Nothing is quite so unfulfilling as engaging in battles of wits with the half prepared - There will always be those who don't like you, who are threatened by you, who don't share your values, etc. Some of them don't offer constructive feedback, but do spew ad hominem insults and accusations. You know that menu choice in Twitter labeled "block"? It helps to have one of those in your head. Engaging naysayers only amplifies negativity. Never let anyone distract you from the beauty of the world and what is possible in life.
2) If you're not routinely alienating and attracting people, you're not sufficiently visible - Speak your mind, voice your beliefs, act on your convictions. Life will present you with a bell-shaped curve of many who are indifferent and a relatively few who can't stand you and those few who are deeply attracted to you. The tails of the negative distribution make for funny stories to tell at the next craft beer outing; the positive tail consists of those who will become your closest friends and colleagues. Life is all about being visible enough to generate a large positive tail of soul mates. 3) We repeat the same mistakes until we learn the right life lessons - Freud called it the "repetition compulsion". We repeat patterns until we figure out a way to write a new ending to our life's script. But the only way to change our patterns is to first become aware of them. Few people have dozens of problems. Most have one or two issues that repeat themselves in dozens of contexts. To the extent we unwittingly enact patterns, we live life unconsciously, without free will. We can't trade the patterns of markets if we're busy acting out our own. 4) The greatest changes make us more of who we already are - We are who we are. We are born with certain talents and capacities. These lead us to seek certain experiences and those help build our skills. When we align ourselves with our interests, strengths, and values, we operate in a zone and good things happen. When we try to become someone we are not, we swim against our own psychological current. If you're not in the zone on a reasonably regular basis, you are probably not in a setting, not in activities, and not with the people that bring out the best in you. 5) Put the "I" in "Love" and then we "Live" - Love transforms. It is very difficult to be filled with doubt, fear, frustration, anger, or resentment when we connect with those we love. There are all sorts of psychological exercises to reduce negative emotions. Next time you're feeling down or upset, don't try to quell the bad feelings. Try to amplify the loving ones. Recently when I was feeling pressured by a growing workload and a confusing market, I started to take a power nap and was quickly joined by Mali, who curled up by my side and placed her face against mine. I got a lot of work done--and really enjoyed it--after the shared nap.
When trading the day time frame in the stock indexes, two questions are important: 1) Who is in the market? 2) How are they positioning themselves in the market? At the most basic level, I want to generate an estimate--as early in the day as possible--whether the day is shaping up as a potential trend day or range day. Who is in the market is addressed by volume. As I've stressed in the past, volume is important because it correlates quite highly with volatility. Knowing whether we're trading above average, average, or below average volume gives us important clues as to whether we're likely to have a daily range greater than, equal to, or lesser than the average range. That, in turn, impacts whether moves are likely to extend or reverse on a given time frame. So let's take Friday's trade as an example. We had a very strong payrolls number, so traders were justified in thinking that we could have a catalyst for a strong market day. I was less convinced of that, given weakness that had been showing up in the market. During the first five minutes of trading in SPY, we transacted just a bit over 2 million shares. The average first five minute volume in SPY over the past three months has been a little over 3 million shares. During the next five minutes, we transact about 1.8 million shares. The average for that five minute period is almost 2.5 million shares. You get the idea. Right out of the box, we have modest participation in the market. When volume is below average, it's not that market makers have taken the day off. Rather, it's the shorter and longer-term directional participants who are not active. It is much more difficult to get a vigorous trend day when those directional players aren't playing. So you could tell yourself every pretty story in the world about how the payrolls number was a game changer, but market participation in stocks--at least for the day session--was giving a resounding yawn.
OK, so once we see who is participating, we can then take a look at how they are participating. Notice the top chart of the NYSE TICK, which is the net number of upticks vs. downticks among all stocks in the NYSE universe. (Chart is for the day session, where each bar = five minutes). What do we see early in the session? First, there is no significant selling. The average low figure for each five minute period is a little less than -300, with a standard deviation of a little over 300. Early in trading we're not getting even a standard deviation's worth of selling. Once again, we can tell ourselves all we want about how weak the market has been coming into the day session. There just aren't any sellers in significant proportion to be found early in the day.
We also don't see a tremendous surge of buying early in the day, as we get only one upside reading in the first half hour exceeding +600. But if we look at the yellow zero line in the top chart, we can see that we're spending more time above that line than below. Net activity is skewed modestly toward the buy side--more because of the absence of selling interest than the presence of statistically significant buying. That view is confirmed by the bottom chart, which tracks the percentage of NYSE stocks trading above their day's volume-weighted average price. In a strong or weak trending market, the great majority of stocks will trade above or below their VWAPs. When we have more balance between buying and selling pressure, that percentage will look pretty mixed and not deviate far from 50%. For the most part, early in the day, we hovered between 50 and 60%. Again, a modest skew to the buy side. Within the first minutes of the trading day, we can generate a reasonable estimate of whether the day is shaping up to be a busy or quiet one; a trending or balanced one. Note that this has nothing to do with chart patterns, wave structures, or economic fundamentals. It's based upon how participants are actually behaving in the marketplace. We then can track that participation over time to identify whether the market is getting stronger, weaker, or more balanced and whether it's getting busier or quieter. Many problems in day trading occur when we impose our own views on markets and do not focus on how markets are actually behaving. Problems also occur when we do not stay sufficiently flexible to continually update our views of how markets are behaving. With a strong payrolls number, we could have imposed a view of a big market day. We could have conducted studies of how the market has behaved with past big payrolls numbers and used those to guide our expectations. It's fine to enter the day with a hypothesis, but as Ayn Rand liked to point out, the ultimate arbiter is objective reality. And that reality told us that, both in level of participation and the skew of participation, this was not shaping up to be a big day. A reader recently asked about trading with a positive mindset. When I am trading well, I don't have a positive mindset. I also don't have a negative mindset. I have a very open mindset. As a trader and as a psychologist, I'm best off listening before acting. Further Reading: Keys to an Upside Trend Day Identifying Downside Trend Days Identifying Trend Days With Intraday New Highs and Lows
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The world would be a far less beautiful place without the artistry of creativity. If there's one relationship I've seen over the years as a psychologist, it's that fresh viewing leads to fresh doing: When we see life's challenges through new lenses, it opens the doors to new actions, novel solutions. Sticking with one mode of thought is a great way to stay stuck in any action pattern. This morning I was up at my usual 4 AM time, aided by the hungry cats that serve as my daily alarm bell. Seemingly out of nowhere I posed a question to myself: Suppose we were to measure, every few minutes during the day, how many stocks in the broad market were trading above and below their day's volume-weighted average price. And suppose we were to keep a running, cumulative total of that number. Would that create an effective diffusion index assessing market strength and weakness? So, after feeding the cats, I went back in time, pulled the data, and assembled the spreadsheets. What I saw looked promising as a first approximation. I now have my homework for the day to refine this measure and put it to some challenging tests. If history prevails, the new measure will either overlap old ones--or merely overlap contemporaneous price movement--so that it adds little fresh information to the analytical arsenal. As I've mentioned earlier, however, my strategy is to generate at least one such fresh idea per week. If ten percent of those prove unique and useful, I will have added meaningfully to my understanding of markets over the course of the year. The compounding effect over several years is particularly significant.
But there is another, deeper benefit to this work: When you are generating new ideas and stimulating yourself with fresh perspectives, there is no need to seek stimulation in (over)trading. If your mind craves activity, you will keep yourself active--even if that activity is not constructive. The answer to overtrading is not to discipline yourself to be less active, but rather to channel activity in creative and constructive directions. Nietzsche observed, "Under peaceful conditions, a warlike man sets upon himself." When markets are quiet, that is when we can work on ourselves. That is when we can generate and test ideas. Much of long-term success comes, not just from trading, but from what we're doing when there are no sound trades to place. Further Reading: Cultivating Emotional Creativity Conflict and Creativity in Trading Performance
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It's been a great run in stocks from the mid-October lows, fueled by significant buying pressure coming out of those lows. By mid-November, my measures were showing diminished upside momentum, but not the kind of weakness that would normally lead to meaningful intermediate-term corrections. By the end of November, pockets of outright weakness became evident in the market, with smaller cap issues and commodities-related stocks showing particular weakness. This led to a recent situation in which stocks making fresh three-month lows actually outnumbered those making new highs, despite SPX hovering near its all-time highs. Not only have we been seeing signs of weakness within the U.S. stock market; globally stocks have not kept up with SPX. Recall that I track the number of upticks and downticks across all stocks in the NYSE universe. That buying and selling pressure measure has been quite useful in tracking strength and weakness during the evolution of intermediate-term cycles. What we see in the top chart is that the buying-selling balance has been below zero for a number of recent sessions, a pattern we have seen during the topping phases of market cycles. In itself, that simply indicates a waning of broad buying interest and some pick up of selling, though not to the degree we saw prior to the early October drop. Truly outstanding has been the plunge in my measure of correlation among stocks, which looks across both capitalization levels and sectors. Indeed, this is the lowest correlation level I have seen since tracking the measure since 2004. Correlation tends to rise during market declines and then remains relatively high during bounces from market lows. As cycles crest, we see weak sectors peel off while stronger ones continue to fresh highs. As those divergences evolve, correlations dip. Right now we're seeing massive divergences, thanks to relative weakness among raw materials shares (XLB), energy stocks (XLE), regional banks (KRE), and small (IJR) and midcap (MDY) stocks. Why is this important? Going back to 2004, a simple median split of 20-day correlations finds that, after low correlation periods, the average next 20-day change in SPX has been -.33%. After high correlation periods, the average next 20-day change in SPX has been +1.43%. A very interesting sentiment measure that I track is the amount of capital flowing into and out of various ETFs. The number of shares outstanding in an actively traded ETF changes daily, reflecting underlying buyer and seller interest. Trim Tabs follows these ETF flows and notes that we are at extremes that were seen prior to the 2008 market meltdown. My own figures for SPY find that shares outstanding recently have hit double digit increases over the past 20-day period. That reflects bullish sentiment in the top 90% of all values I have tracked since 2006. Going back to 2006, when sentiment has been in the top bullish quartile, next 20-day returns have averaged a loss of -.57%. When sentiment has been in the bottom, most bearish quartile, next 20-day returns have averaged a gain of +1.57%. I put all that together and find it difficult to see good upside risk/reward from this point. When I saw lack of strength turn into outright weakness in mid-September, my bullish chips came off the table. Now I find myself in a similar mode. Could ECB or the Fed come to the market's rescue and inject fresh catalytic strength into stocks? Absolutely. Could investors pour money into stocks and chase late December seasonal strength? Of course. I am confident those developments will show up quickly in my buying/selling strength measures and I will report them duly. Right here, right now, however, I see global signs of disinflation and economic weakness; a Fed that has been talking about exiting QE; low equity put/call ratios; and persistent relative weakness in high yield bonds (HYG). It will take a fresh catalyst--and fresh evidence of buying interest--to get my chips back on the bull's table.
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We don't have to be exposed to the financial media for long before we're inundated with market predictions. How valuable are those prognostications? Do market prophets truly bring profits? An excellent 2014 review of market prophecies from The Mathematical Investor answers this question: as a group, the prophets have not been profitable at all. The performance of funds has largely fallen short of benchmarks; the doomsayers have brought doom to their followers; and even those forecasters who beat the market over a prior ten year period are likely to underperform the following year. Markets by their very nature possess a high degree of uncertainty as well as risk. It is understandable that traders and investors would seek an illusion of control by either listening to the predictions of others or by investigating so many relationships that finding significant ones becomes inevitable. This is particularly the case when market participants become wedded to particular bearish or bullish views. Their predictions are particularly susceptible to confirmation bias. There is, however, a deeper problem at work. It is an epistemological problem: a problem with understanding how science truly operates in generating knowledge. Before scientists render predictions, they observe phenomena and try to make sense of them. Understanding and explanation precede prediction: that is the role of theory. Predictions follow from good theories, not from endless data manipulations. If you want to judge a prediction, you don't have to wait to see if it plays out: you can evaluate the explanatory framework from which it is derived. I recently visited a very successful trader. When asked what he thought the market would do the next day or week, he candidly acknowledged that he had no idea. In fact, he said that, when he becomes wedded to predictions, he is most likely to lose flexibility in markets--and also lose his shirt. What made this trader successful was that he had a sophisticated understanding of different market participants, the markets in which they typically participate, and the times of day in which they typically execute their trades. When he saw these participants do certain things in one market at a certain time of day, he knew that there was a high likelihood of follow-up events in other markets during the next time interval. He was less interested in market prediction than in understanding what other traders were doing and responding to that. To be sure, his underlying theory of market participation did lead to an anticipation of future events--his trades, in that sense, represented the predictions following from his understanding--but, for him, prediction was the end point of an intellectual process, not the starting point. It certainly was not the main point. Prophets typically put predictions front and center because they place themselves front and center. More show horses than work horses, they rarely put in the effort to generate insightful theories as to why markets should move in a particular way. They might cloak their prognostications in pseudo-mathematics or in convoluted wave counts, numerological sequences, and chart patterns, but what is missing is understanding: a coherent explanation of why markets should behave in the anticipated way. All too often, prophets fit world events into their preconceived views. Profits come from identifying what is happening, explaining it rigorously, and acting accordingly. Further Reading: Market Cycles
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Here are three simple practices that can improve alertness, concentration, and overall cognitive performance: 1) Hydration - Thanks to Henry Carstens for pointing this one out. A lack of proper hydration has been found to negatively impact mood among women and decrease alertness and concentration among men. A wide range of studies link dehydration to declines in short-term memory, concentration, alertness, visuomotor tracking, motor skills, and computational performance. Water is essential for feeding the brain.
2) Power Naps - Sleep is a restorative. Although sleeping on the job has a negative connotation, research finds that power naps improve creativity, memory, energy level, and general cognitive functioning. Naps also improve decision-making and problem-solving, with naps of different lengths offering different benefits. A 20-30 minute nap is ideal for improving alertness. 3) Moving Around - Prolonged sitting carries a number of health risks. Standing at the desk for a portion of the day can also increase energy and improve mood. Exercise during the day improves sleep quality, energy level, and mood. So what does that tell us? The traditional way of working as a trader--sitting at the desk all day, hunched over and focused on screens, guzzling coffee and soda--is bad for our cognitive performance and bad for our health. If you're a world-class athlete, you will do everything possible to maintain your body in peak condition. If you're a world-class trader, keeping your brain in peak condition is equally important. It makes little sense to spend time looking for more and better trade setups when our minds are poorly maintained to act upon those. Further Reading: Improving Concentration and Productivity
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Here we see charts since July of U.S. large cap stocks (top; SPY); emerging market stocks (second from top; EEM); European stocks (second from bottom; VGK); and Asian stocks (bottom; VPL). What we can see clearly is only the U.S. index has achieved new highs in recent weeks. Emerging market stocks are very well off their highs and not so far from their October lows. Stocks in developed European and Asian markets have only retraced a fraction of their losses during September and October. This is consistent with global deflationary concerns and overseas economic weakness. It is also part of what has been weighing on U.S. stocks recently. With a strong U.S. dollar and weak trading partners, there are headwinds for U.S. companies as well as tail winds from lower energy prices.
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* The recent post noted growing weakness among small cap stocks as well as commodity-related shares. Above we can see that the number of NYSE stocks closing below their lower Bollinger Bands has decisively exceeded the number closing above their upper bands for the first time since the recent rally began.
Recent posts have focused on continued net strength in the stock market. Friday's shortened session was an interesting one, however, given the significant weakness in the oil market. Energy and raw materials shares sold off sharply, even as the SPX hovered near all-time highs. As you can see from the top graphic from the excellent Finviz site, we've seen an unusual divergence in performance between consumer-related sectors and commodity-related ones. The weakness in energy-related shares in particular contributed to a situation on Friday in which 841 stocks across all exchanges closed at one-month highs, but 615 closed at fresh monthly lows. That's the highest level of monthly lows since the October bottom. As the bottom three charts reveal (credit to the ever-informative Index Indicators site for these), growing weakness has not been limited to the energy shares. When we look at the large cap average (SPY; second chart from top), we see many stocks making new 20-day highs over lows and prices near all-time highs. Midcap shares (MDY; second chart from bottom) have also made new highs, but only marginally so. Among the midcaps, 20-day new highs and lows were about even on Friday, well off the levels reached at the end of October. When we turn to the small caps (IJR; bottom chart), we can see that fresh 20-day lows outnumber new highs and are well off the late October peaks. Note that the small caps have yet to make a fresh yearly high--quite a contrast from the large cap strength. Recent posts have stressed that it takes more than a pullback of buying interest to sink a rising market: we need to see outright evidence of weakness. Not only among energy stocks, but also the smaller caps, we're starting to see such weakness. I couldn't help but notice on Friday that 128 stocks in the NYSE universe closed above their upper Bollinger Bands, an above average reading. A total of 300 stocks, however, closed below their lower bands.
That is not supposed to happen in markets sitting near their highs. Further Reading: Market Strength vs. Weakness
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The recent post took a look at working on the body to sharpen the mind. The speed exercise routine I described consists of five minutes of stretching (working down the body starting with neck and arms and progressing to shoulders, back, and legs); ten minutes of weight lifting (working neck/shoulders, arms/chest, stomach, and legs); and fifteen minutes of jogging on the treadmill (at target heart rate). What makes it a speed routine is that there is minimal break between the activities. It's meant to be a fast-paced body tune up to start the day, not a full conditioning program. If you recall the post on using constraints to bolster creativity, then you can see that the half-hour limit is a constraint that pushes us to use the time in the most energy-boosting, body-challenging way possible. Can we pack even more into the half-hour constraint? Can we design a workout for mind as well as body? As I discuss in my upcoming book, it turns out that the answer is a resounding yes. The key is found in yoga. At its most basic, yoga consists of a series of poses that build strength and flexibility, while promoting healthy posture, breathing, and mindfulness. Unlike traditional meditation, some forms of yoga are quite physically active and challenging, stimulating the body rather than quieting it. Yoga has been found to promote both physical health, as well as reduce stress and promote well-being. Yoga illustrates that it is possible to work on mind at the same time that we work on body. This is accomplished by keeping ourselves focused and mindful while we are working out vigorously. Tracking our breathing during each workout phase is a simple way of accomplishing that. In the most basic form of the speed routine above, you begin the session seated, keeping yourself completely still, breathing deeply and slowly. With each inhalation, you recite to myself, "Energy In" and feel your body completely expand with the intake of air. With each exhalation, you say to yourself, "Energy Out" and feel your body wholly relax with the release of the air. Once you are centered with this introductory exercise, you then begin the speed workout--already in a state of high mindfulness. Throughout the stretching, lifting, and running, you are mindful of your breaths and keep yourself focused on "Energy In", "Energy Out". Although the workout is quite vigorous and fast-paced, you'll find that your mindset stays very calm and focused throughout. In 30 minutes, you have a routine for pushing your physical comfort zone, pumping up your energy, and building your capacity to stay in the zone.
But there is a hidden benefit as well. I originally designed this routine to maximize the value of a workout to fit into a busy day. What I found was that the combination of physical exertion and enhanced mindfulness is extremely effective in training us to stay mindful whenever our bodies are worked up. During trading, you may become harried because of fast-moving markets; frustrated with a bad trade; or anxious about the possibility of loss. In each case, your body enters an adrenaline-fueled flight or fight state. If you have trained yourself--day after day--to stay mindful when your body is aroused, that capacity will come to you in the heat of battle.
In other words, when you train mind and body as part of a workout routine, you also train yourself to handle the workouts that markets give us. That is a tremendous benefit that pays off when we are most vulnerable, enabling us to trade more mindfully and intentionally.
I want to thank those who sent best practices to be included in the new book. I will be in touch shortly. One of my best practices is to conduct my work--market analysis, writing--accompanied by inspiring music. I find that the right kinds of music keep me positively focused and help the work flow. Here are a few musical favorites that have accompanied my recent work sessions:
Think of our experience as existing along two intersecting dimensions: positive vs. negative and high vs. low energy. That gives us four classes of experience: 1) Positive, High Energy - That's when we experience the greatest motivation, enthusiasm, and happiness; 2) Positive, Low Energy - Here we're calm and at peace, with a high degree of life satisfaction; 3) Negative, High Energy - This is when we are frustrated, angry, and stressed out; 4) Negative, Low Energy - In this state, we're discouraged, depressed, and burned out. Now consider how much time you spend in each of these states, particularly when you are trading. Indeed, a great exercise is to simply draw Positive - Negative and High Energy - Low Energy as intersecting dimensions and place a point on the graph where you stand each morning, afternoon, and evening. When you chart your state over time, you'll begin to see patterns: how your mood and energy level tends to vary over the course of the day; how your positivity and energy are affected by how you eat; how different activities add to or subtract from your mind states; how you respond to winning vs. losing trading days; and how your states impact your subsequent trading. One of my consistent findings is that our level of emotions and energy are closely tied to our physical states. Lately I've been experimenting with what I call speed workouts. The workout routine consists of five minutes of vigorous stretching; ten minutes of challenging weight lifting; and fifteen minutes of aerobic time on the treadmill. The key to the routine is speed: taking very little break between the activities, so that you're continuously energizing yourself over a half hour's time. This is a great way to start the day and also makes an effective mid-day activity, when you're feeling fatigued from effort. Research finds that exercise is effective both in increasing our emotional well-being and in lowering negative emotional states, with effects as strong in many cases as standard therapeutic treatments. Exercise also appears to be effective in improving our concentration, alertness, and memory. We commonly feel that we don't have enough time in the day to devote to exercise, but the enhanced productivity associated with a positive physical state typically more than makes up for the inefficiency of our work efforts when we're operating at low ebb. Charting your state as a function of your exercise regimen is a great way to see this for yourself. Can we extend our exercise routines to make them workouts of the mind as well? In my next post, I will draw upon an idea from my upcoming book and outline a workout routine for mind and body. Further Reading: Exercise and Goal Achievement
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One of the best ways to gauge a trader's state of mind is by tracking his or her entry and exit execution. Two traders can have the exact same idea and either make or lose money depending upon how they get into and out of the market. Here are three P's that I look for in excellent execution: 1) Planned - Do you have entry and exit criteria mapped out in advance, so that you know exactly your risk and reward at the time you enter a position? Too often traders fool themselves into thinking they have a feel for markets and simply enter and exit when it feels right. That means that they are entering when the market is going their way and exiting when it's going against them. In a low volatility market, that leads to getting chopped up. If you're looking for a great review exercise to improve your trading, track adverse price movement after your entries and favorable price movement following your exits. If you're entering at poor times, you will see sizable adverse excursions early in the lifespan of the trade. If you're exiting at poor levels, you will see the market move your intended way after you've jumped ship. Such a review will tell you whether the feel you think you have is really providing you with an execution edge. By planning entries and exits based upon tested criteria, good execution can become a part of your trading edge. For instance, entering longer-term buy positions in stock indexes when the majority of shares are trading below their short-term moving averages shows more favorable return characteristics overall than going long when the majority of stocks are already stretched to the upside.
2) Patient - Is the trader patient about getting into and out of the market, or do they become fearful of missing opportunities and chase trades at bad price levels? This is the natural outgrowth of planning. When we have an execution plan, we have a grounding for patience. We can choose to bet when odds are more favorable; stand aside when those odds are not present. Without planned criteria, it is easy for entries to be based on greed and fear of missing out and exits to be predicated on pain. A common problem faced by traders is dealing with the pain of gain: the temptations to book profits prematurely. This can lead to a deadly situation in which we let losses run longer than gains, ensuring fat negative tails in our P/L distribution. When we are patient with planned entry and exit criteria, we don't have to be glued to screens. That means that trading will deplete less of our willpower resources and we will be most likely to stay focused, in the zone, and grounded in good decision-making. 3) Prompt - Once our criteria for entries and exits are met, do we act decisively, or do we become anxious and perfectionistic, hoping that good levels become great ones. A common manifestation of performance anxiety is to wait for everything to line up perfectly before entering or exiting. This rarely occurs, resulting in lost opportunities at entry time and suboptimal exits. One advantage of planning trades is that it means you face risk and reward squarely before you get into the position. Being at peace with the risk/reward profile of a trade makes it much easier to act promptly when our criteria are met. One important point: It is very possible to be an intuitive trader and also one that is planned, patient, and prompt in execution. You may have a gut feel that stocks will break out of a range based upon patterns you've seen in the past. That trade idea may be entirely intuitive, but the trade itself can be set up with planned breakout criteria and stop levels that enable you to be patient and prompt in getting into and out of the trade.
And, oh yes, the chart above is a moving two-hour window of net buying and selling activity across all NYSE stocks from November 7th to the present. Think of it as an intraday overbought/oversold indicator that is not price-based. In an uptrend, the periods of net selling will occur at successively higher price levels. That provides a nice basis for planned, patient, and prompt entry execution and highlights useful price levels for stop placement. Further Reading: Executing the Trade
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The recent market update emphasized that we have been seeing a moderation of buying interest among stocks, but not an expansion of selling interest. The point was that we need to see the latter--not just the former--to turn a market cycle around. The most recent market action has continued this pattern: we've seen moderate buying interest among participants, but significantly below average selling pressure. In other words, what's been keeping stocks high is as much an absence of sellers as a historically large presence of buyers. When we examine net buying and selling activity, that means that buyers remain in control. Above we see cumulative net upticks vs. downticks: 1) across all NYSE stocks; 2) across all U.S. stock exchanges; and 3) across the Dow 30 stock universe. In each case, we've been on a steady ascent and most recently have moved to highs. That is wildly different from what we saw in September, when net selling exceeded net buying well in advance of the market peak. To be sure, market breadth has not been roaring: stocks making new one- and three-month highs this week have run about half the level we saw at the end of October. Still, those one- and three-month highs have continued to exceed new lows, as we're not seeing the kind of breadth of weakness that characterized the market tops in July and September. Simply assuming that overbought markets will reverse in the absence of demonstrable weakness can be hazardous to a trader's wealth.
James Clear has an excellent blog post on the topic of how constraints can make us better. His example is futsal, a soccer-like game played in a small indoor space with fewer players. The combination of fewer players in a smaller space means that players touch the ball much more often than in traditional soccer and have to develop better ball-handling skills due to the lack of bounce of the futsal ball. Because of the constraints of futsal, it is an idea training ground for soccer players.
When we create new constraints, we force ourselves to adapt. This, in turn, exercises skills that otherwise might never be tapped. When I supervised interns at a Chicago proprietary trading firm, I found software that replayed the day's market action at twice normal speed. The faster price movement forced trainees to adapt and recognize market changes very quickly. When they returned to live action, it seemed slow by comparison and they were able to recognize patterns occurring in an unhurried way.
Another constraint exercise for traders that I have found useful is to approach the market day by assuming that you can only place three trades all day long. With only three bullets to fire, you have to adapt to the constraint by exercising unusual patience and selectivity, focusing on best setups at very good price levels. This selectivity can be cultivated as a habit, as the constraints prevent traders from overtrading. Clear's point is that constraints foster creativity. We have to perform in new ways to adapt to challenging constraints. If I only allow myself 30 minutes to read a book, I will cultivate the ability to skim chapters and glean main points. If I'm only able to meet with someone for three counseling visits, I will plan exercises for those sessions that will make the greatest use of the limited time. As Clear observes, limiting himself to 50 words enabled Dr. Seuss to write a best-selling book. Constraints are a great example of how we grow by challenging ourselves. Suppose you practice trading with a holding period one-tenth your norm...or ten times your norm. How would you adapt and make money? Suppose you could only watch one screen while trading...suppose you had to manage long and short positions that were entered for you randomly. How would you make the most of the situation? By imposing limits, we expand our performance. Further Reading: Priming as Trading Preparation
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When I began working at a counseling center years ago, waiting lists for services were the norm--both at that center and across similar centers. In many cases, people had to wait weeks to begin meeting with a counselor. From my perspective, waiting lists were an accident waiting to happen. It was only a matter of time before someone on a waiting list deteriorated significantly in their functioning, leading to an unfortunate outcome and potential legal liabilities. So when I was asked to lead a counseling center at my next institution, I set a policy of no waiting lists. In order to accomplish that, I engaged in exhaustive research concerning the types of clients who most could benefit from short-term intervention; those that were most likely to benefit from medication; those that were most likely to require longer-term therapy; etc. I also scoured the research literature for criteria to determine approaches to counseling most likely to benefit particular people and problems, drawing upon evidence-based guidelines.
Each research-based finding led to a best practice. For instance, I learned that outcomes were best for people with certain kinds of depression if structured cognitive-behavioral therapy was combined with anti-depressant medication. The combination of many best practices led to a best process: by routing people to the right kinds of help that were most likely to be successful, outcomes were improved and waiting lists evaporated. Therapy became more efficient as well as more effective once an evidence-based triage process was established.
The previous post reached out to readers to ask for their best practices: actions that have been most reliably associated with successful trading. These, too, should be evidence-based. That means that you are actively tracking what you're doing in markets and how you're doing it and seeing what works and what does not. It also means that you're tracking yourself and the personal factors that account for your good and bad trading. For example, I have consistently found that placing trades only when backtested relationships are providing current signals increases my hit rate and my profitability. Starting my trading day by investigating those relationships is a best practice. When we string together a number of best practices, we arrive at best processes. My best process for market preparation includes starting the day with exercise; eating lightly; updating markets for those backtested relationships; planning criteria for entries and exits; and writing down my game plan for the trading session. I have learned that each of these best practices is associated with my best trading. Combining them into a process creates a preparation routine: I am turning best practices into ongoing work habits.
The reason my new book stresses the creation of best processes from best practices is that the old trading psychology--the one that links trading success to "discipline"--is woefully limited. When we established the new triage system at the counseling center, no one had to work on their discipline to conduct the right kinds of assessments for new clients. Those assessments became part of an ongoing process: they developed into routines. The challenge for traders is not to motivate behaviors but to automate them. First you study yourself and learn your best practices; then you find ways to assemble those best practices into a replicable workflow. Thanks to readers who already have submitted their best practices. I especially encourage those involved in mentoring traders to share their best practices. By creating a database of best practices, we can generate the building blocks for best processes and lay the foundation for more consistent trading performance. Further Reading: Four Pillars of Trading Process
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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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