Many thanks to a savvy portfolio manager who passed along this dramatic account of what professional football players go through to recover from their weekend games. One of the big points of the article is that the longevity of a professional career is partly a function of the time spent in recovery on Mondays. Tending to the body after injuries allows for faster healing and prevents those injuries from compounding to the point where they lead to disability. The principle of recovery is important for all performance professionals, if not so dramatically as in football. In performance, we push beyond our comfort zones, and that effort taxes us. A great example is willpower. When we've focused and made critical decisions under pressure for an extended period, that willpower runs out of power. We become fatigued, and in the fatigued state we're more likely to make mistakes and fall into old habit patterns that cost us money. Imagine a person who works nonstop planting grass seed and becomes so exhausted that they fail to water the areas they planted. We can wind up pushing ourselves to the point where we fail to water ourselves. We fail to take the time to renew our energy and that takes a toll on performance. We often hear that traders should plan their trades and trade their plans. Less appreciated is the importance of plans and routines for recovery. What are you doing on evenings and weekends that renews you? Of the four main sources of well-being, which ones are you cultivating in your time away from markets: * Happiness, and doing things that are fun and enjoyable * Satisfaction, and doing things that are meaningful * Energy, and doing things that energize you mentally and physically * Relationships, and doing things that bring you closer to the ones you care about A good recovery plan should include healthy eating, high quality sleep, and activities that check all four of the boxes above. It's the watering you do at night and on weekends and holidays that allows your career to blossom during the work day. Further Reading: A Personality Questionnaire for Traders
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Here's a great exercise: Review your trading journal and/or your written goals and plans over the past several months. How many items appear repeatedly, over many days per week and over many weeks? Change is rarely instantaneous. Enduring change requires repetition. Repetition requires persistence. If your notes and journal entries don't have items you work on repeatedly, over time, then you're simply logging one good intention after another. The path of least persistence rarely is the path to success. And if you're not persisting in keeping a journal, setting goals and plans, and chronicling your progress and learning? We don't win by persisting at trading. We win by persisting at working on our trading. Further Reading: How Ordinary Traders Become Extraordinary .
The above chart of sector performance over the past three months from FinViz really is quite remarkable. There have been big moves during this recent period, but the moves have been very different across the sectors. If you have been long industrial conglomerates and commodity-related shares, you've likely done well. If you have been long consumer staples shares, healthcare issues, or utilities, your returns have been significantly negative.
Here's another interesting perspective, courtesy of the excellent Index Indicators site. As of Friday's close, we had 48% of SPX stocks trading above their three-day moving averages; 43% above their five- and ten-day averages; 58% above their 20-day averages; 60% above their 50-day averages; 54% above their 100-day averages; and 61% above their 200-day averages. In other words, at every time frame, there have been a large proportion of stocks you could identify as weak or strong purely on a moving average basis. In short, we've had less of a true stock market than a market of stocks. From a cycle perspective this is important, because the bull and bear phases of cycles are characterized by trend and momentum. When we are in a true bull or bear market move, the tide tends to lift or lower all boats. When markets spend significant time topping or bottoming, we see a meaningful degree of rotation, with the stronger and weaker sectors diverging in performance.
It is not clear to me that the moves off the election evening lows represent a fresh bull market in stocks. Yes, we did see significant share creation in the SPY ETF after the election; this has leveled off and even dipped a bit since mid-November. And, yes, we did see an expansion of the number of stocks making fresh 52-week highs following the election. That has leveled off in the past week, but interestingly 100-day new highs minus lows among the SPX stocks only hit 94 at their recent peak, below levels seen off the late June bottom. Much of the breadth strength in the aggregate market numbers are a reflection of relative strength among small caps and mid caps. As long as that aggregate breadth stays positive, with few shares actually registering fresh new lows, I don't expect any major near-term corrections or transition to bear market conditions. When I see all ships not rising, however, I question the tide. End of year performance dynamics for fast money participants have led markets to price in a significant degree of expectation for the new Presidential administration. I am watching breadth statistics carefully to handicap the odds of continuation versus consolidation, and I'm carefully tracking the relative performance of the strongest and weakest sectors to determine the staying power of the post-election themes. Further Reading: The Momentum Curve
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Character is more than personality. Character reflects our deepest values and priorities and our most fundamental commitments. When someone has a good personality, we might like that person. When someone has a good character, we're likely to admire that person. Here are three simple but powerful measures of character: 1) How does the person spend his or her free time? Per Ayn Rand's observation above, what does he or she do for enjoyment? 2) How does the person respond to your successes? Many people are willing to commiserate with you when you're down and elevate themselves in the process. A person of genuine goodwill celebrates your successes and is happy for your happiness. 3) What strong beliefs does the person voice and live through their actions? Character means standing for what you believe in and living your beliefs. Go along and get along might be comfortable, but commitment is what powers effective action in the world. Now apply the three criteria of character to yourself. What do you do for enjoyment? How do you respond to the successes of family members and colleagues? If someone were to read your writings, hear your speech, and observe your actions, what would they conclude about your beliefs, values, and commitments? Character is a magnet: who we are determines who is drawn to us. Further Reading: Personality and Character in Trading
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A rule that has held up well is that successful traders tend to look at unique data and look at common data in unique ways. It's pretty difficult to distinguish ourselves from the herd if we're part of what the herd is looking at and listening to each day. Some of the best traders I know view unique data uniquely. That means they're looking at things others aren't.
Above we see an indicator created by tracking every stock listed on the NYSE and whether it is giving a buy signal, no signal, or a sell signal on the Parabolic SAR system created by Wilder. The indicator, in red above, simply cumulates the buy signals minus the sell signals and keeps them as a running total, like an advance-decline line. I scrape the raw data from the excellent Stock Charts site daily. The indicator provides a useful sense of overbought and oversold. More to the point, when values have been in their strongest quartile since 2014, the next 20 days' return has been superior. That's a momentum effect. When the values have been in their weakest quartile, we've also seen a superior average return over a 20-day period. That's a value effect. The trajectory of the cumulative measure acts reflects the cyclical nature of market movement, with returns shifting between value and momentum at various phases of market cycles. Note that we've shifted downward from a peak in the measure recently and have been heading lower, though are not yet near oversold territory. Thinking of market movement in cycles has helped me frame when I expect prices to trend and when I expect mean reversion. Tracking cyclical behavior over time has been useful in identifying longer-term market strength and weakness. Perhaps most of all, having a cycle framework means understanding that no market move will last forever. "This, too, shall pass" helps place many things in a useful life perspective.
Here's one you can take to the bank: The most successful traders can talk in detail about the patterns that they perceive in markets and how they have traded those patterns. The patterns make sense to them and represent some manner in which markets are "offsides" and thus offer a favorable reward relative to risk. The least successful traders talk about catching moves in markets and are not focused on particular patterns or setups. They let market movement define opportunity, rather than allow their definition of opportunity guide their involvement in the market. In other words, the best traders, to use Mike Bellafiore's phrase, develop a playbook just like any football or basketball team. The plays they practice are ones that make use of their strengths and that exploit weaknesses in the opponent. The playbook defines opportunity set. As a trading coach for developing traders, I can readily identify the traders on the right track. The ones who are progressing talk about their playbook trades and how well they are exploiting their opportunity set. They are getting better and better at running their plays and, every so often, they develop new plays as they see new patterns and fresh opportunity. The ones who aren't progressing talk about their feelings, how they missed the last move, whether the market will go up or down, etc. What is your playbook: the patterns that you see setting up and that make particular sense to you? How well are you recognizing those patterns in real time and running your plays? How well are you exploiting those patterns once you get into the plays? What factors help you make the most of your plays? Which interfere with pattern recognition and acting on your areas of opportunity? Before you ever get good at trading, you'll become good with specific trades. Grade yourself on how well you ran *your* plays. Get better and better with your playbook and gradually add to it. If your trading journal doesn't reflect your playbook, is it really going to help you play the game better?
Here's an update of the multivariate trading model I keep for SPY. A number of variables go into the ensemble model, including buying pressure, selling pressure, breadth, sentiment, and volatility. Readings of +3 or greater and -3 or less have had particularly good track records in and out of sample, anticipating price change 5-10 days out. Note that we hit a -3 reading on Friday; prior to that we saw +3 readings shortly before and after the election. Thus far, we are not seeing significant breadth deterioration in stocks. For ten consecutive sessions, we have had fewer than 200 stocks across all exchanges register fresh monthly low prices. This breadth strength generally occurs in momentum markets; weakening of breadth--particularly an expansion in the number of issues making fresh lows--tends to precede market corrections. It is not at all unusual for momentum markets to correct more in time than price. We've seen selling pressure the past two sessions, but not significant price deterioration. This dynamic allows momentum markets to stay "overbought" for a prolonged period as price consolidates and often grinds higher. Further Reading: Previous Model Update
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The recent post emphasized pattern recognition as a core trading skill. That same skill is key to trading psychology. One of Freud's central insights was that of the "repetition compulsion": the idea that we unconsciously repeat patterns in our lives, often with negative consequences. Change in therapy occurs when we become aware of our patterns and are able to interrupt and change those. The different approaches to helping--psychoanalytic, behavioral, cognitive, family systems, solution-focused--are simply different ways of understanding and changing the patterns we unwittingly relive. One trader I worked with never felt fully accepted and valued by his parents. He was compared with his brothers and often found wanting. He latched onto trading as a way of making a name for himself and becoming wealthy and successful. Each time he lost money in the market, he experienced the loss as something more than the dollars and cents. The losses felt like confirmation that he really was inadequate. With his self-esteem riding on each trade, he found it difficult to make sound decisions. He took profits quickly to regain the feeling of winning and took losses very reluctantly, unwittingly repeating those mistakes.
When we track our trading mistakes--and our trading psychology--in journals, we can often detect patterns that sabotage our profitability. This is particularly the case when the same emotions crop up in trading situations, such as frustration, depression, or overconfidence. Once we become aware of those patterns, we can begin to identify triggers that set us off. That enables us to anticipate the patterns and rechannel our emotions and actions. The trader I worked with learned to take breaks after losses and process his self-talk at those times. Gradually he learned to separate his self-worth talk from his trading talk, allowing him to accept losses without experiencing himself as a loser. It all starts with self-awareness. We can't change a pattern if we're not aware of it. When we become observers to our patterns, we are no longer immersed in those patterns. As observers we can control those patterns and ensure they don't control us. If you're experiencing repeated emotions and self-talk during your trading, the chances are great that there's a life pattern controlling you. Market mastery and self mastery go hand in hand; working on ourselves can be the best way of working on our trading. Further Reading: How to Break Negative Trading Patterns
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A concept central to trading is that of pattern and pattern recognition. Different approaches to trading frame patterns differently, but all focus upon relationships that are deemed to be meaningful. After all, any particular configuration among market elements can occur and reoccur through random happenstance. It is when patterns happen for understandable reasons that we find them meaningful. We may or may not be able to predict when that pattern will occur next, but that is not necessary for successful trading. If we become very sensitive to meaningful patterns and their myriad expressions, we can identify their occurrence as they unfold. A psychologist, for instance, might not be able to predict when a patient will next experience a depressive episode, but can become highly attuned to occasions in which depression is starting to set in. Similarly, when couples make progress in their counseling, they can recognize patterns to their arguments and circumvent those by doing something more constructive. Many active traders look at a very limited number of markets--often, only those that they are trading or thinking of trading--and so they miss important patterns that occur *among* markets. These intermarket relationships often reflect macroeconomic factors that are driving the participation of large market players. Recognizing when those relationships are waxing and waning can provide important clues as to whether particular market moves are likely to continue. I've been reading a large--and excellent--book from John Netto called The Global Macro Edge. It touches upon a number of worthwhile ideas, including the importance of viewing performance (one's own and those of markets) in risk-adjusted terms. One idea I particularly liked was the ongoing tracking of correlations in the price movements among markets as a way of identifying market regimes and shifts in those regimes. The same concept is valuable in tracking correlations of moves among equity sectors. When we see dramatic changes in correlations, those patterns can alert us to the emergence of important themes that are driving market action. For example, after the recent election, we saw dramatic co-movement among equity sectors (industrials and financials versus higher yielding sectors) and markets (US dollar, rates, developed markets versus emerging ones). New flows were coming into markets, and the patterns of correlations alerted us to the drivers of those flows. Let's combine two of Netto's ideas and imagine a situation in which your dashboard is tracking the risk-adjusted returns of different markets (a way of tracking quality of trend behavior) *and* the correlations among markets. The combination would tell you when shifting correlations are manifesting themselves as growing trends. That would be sweet for trend-following macro traders. It would also provide useful alerts as to when markets are becoming choppy and less patterned. After all, it's the pattern of patterns that ultimately defines the opportunity set for traders. Further Reading: The Greatest Mistake Losing Traders Make
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Imagine a child diagnosed with attention deficit disorder (ADD). Unable to sustain concentration, ADD impairs school performance, but also interferes with social life. Lowered attention often brings diminished impulse control and unwanted consequences in relationships. Our child, depicted above, is connected to a biofeedback unit that measures small changes in forehead skin temperature that reflect activation of the brain's executive center, our prefrontal cortex. This hemoencephalography feedback controls a movie watched on the computer screen. When the child's emotions are engaged by the movie and the forehead temperature drops as a result, the movie stops. To continue playing the movie, the child must sustain a neutral, quiet focus. Over time, the child learns to keep the movie going, building the capacity to flexibly shift between emotional, limbic processing and frontal, executive processing. Why is this important? As Kotler notes, heightened concentration and absorption in activity is a gateway to the flow state, the state we know as being "in the zone". He observes an interesting relationship between flow state and creativity: in flow, we have heightened focus, but diminished self-focus. In other words, we turn off our self-critical, self-conscious activities and instead lose ourselves in what we are doing. If our child became frustrated with the movie turning off, for example, and criticized himself for not being able to keep it going, the movie would remain paused. Only an absorbed, calm, neutral focus on the movie can make the movie move. I first encountered hemoencephalography (HEG) feedback when I heard of Dr. Jeffrey Carmen's work with migraine patients. Interestingly, shifting blood flow patterns is significantly helpful in controlling migraines. That same technology was helping children with ADD and, I later learned, was helpful in helping autistic children with their executive functioning. As I wrote on this blog, this raised the possibility that HEG feedback could similarly train traders for enhanced attention and self-control, minimizing distractions and impulsive overtrading. Kotler's observations go one step further. The zone not only brings greater self-control, but also higher levels of creativity. When we are in a state of enhanced awareness of our world, we perceive the world in new ways. Patterns and relationships in markets that we would miss when we are self-focused and frustrated with P/L jump out at us when we've quieted the self-critic and redoubled our market focus. I recently wrote on the topic of creativity as a form of play. When we witness children hard at play, we see them immersed--operating in a zone. To play deeply, we both focus and relax. It is this calm focus that appears to lie at the heart of creative synthesis. If we can enhance the cognitive functioning of children with ADD and autism, can we take the normal cognitive functioning of professionals and turn it into an enhanced capacity to operate within the zone? Can we become more flexible in our emotional and cognitive processing, thereby performing with greater self-control and creativity? This remains truly frontier territory for trading psychology. Further Reading: How to Cultivate Our Creativity
Note: Thanks to Dr. Jeffrey Carmen for pointing out errors in the original version of this post, which I have endeavored to correct.
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The flow state is one in which we become highly absorbed in our activities, losing a sense of time and experiencing deep pleasure. A great example of flow comes from the drumming movie mentioned in the previous post. The drumming greats are not explicitly thinking about what they are doing, what they should do, or what they should have done. The skill is flowing through them, and they are performing in a profoundly fulfilling zone.
The capacity for operating within a flow state is one that can be developed. Indeed, we can look at deliberate practice as a training ground for flow. As we tackle one challenge after another, we also extend our capacity to sustain the flow state. Flow requires an ability to operate outside our comfort zones, but our limits of willpower make it difficult to stay outside our sphere of comfort. A fascinating study by Judith Lefevre found that people experience flow more often in work than in leisure, and yet they are more motivated to seek leisure than work. She notes:
"It is possible that the higher levels of concentration and activation in flow cannot be tolerated by most people for extended periods of time. In making the choice to spend their leisure time in the low challenge, low-skill context rather than flow, the workers may be indicating their preference to rest from the demands of work, even at the cost of an overall reduction in the quality of experience." p. 317 If the research on flow is correct, then much of traditional trading psychology is wrong. The elite athlete, drummer, or chess player does not achieve flow by controlling emotions, imposing discipline, or basking in awareness of their feelings. Rather, flow is achieved by shifting to an entirely different state of consciousness, not by rearranging the components of normal consciousness. That different state requires sustained, relaxed focus and immersion in experience. That shift of state is one in which we experience ourselves and the world differently. It's also one in which we become sensitive to patterns in the world around us. A wonderful portion of the drumming movie pans to the lake surrounding the camp and the sounds of the insects and lapping water. It is impossible to not hear a poly-rhythmic drumming in the sounds of nature--something we would have never apprehended prior to watching the film.
It is in this context that Campbell's observation is profound: when we follow the bliss of operating within the zone, doors open to seeing the world in new ways. Patterns that are hidden to us in normal, distracted consciousness pop out when we in a flow state. In our normal state, we try to perform well; in the zone, performance flows through us. Are you trying to correct your mistakes while you're trading? Are you trying to avoid poor trading practices? If so, you're trading in a flaw state, not a flow state. Flow requires a loss of self-awareness; not thinking positively or negatively about ourselves, our P/L, or our performance. One of the greatest dilemmas we face as traders is that we benefit from following our bliss, but we are limited in our capacity to sustain bliss. It may well be the case that the greatest value of preparation for trading and review of trading is the exercise of the capacity for relaxed concentration. In building our capacity for flow, we cultivate the state of consciousness in which we're most sensitive to the flows of markets. Further Reading:: Why It's Important to Go With the Flow State
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Thanks to an unusually creative and savvy trader for recommending the movie "A Drummer's Dream". The movie, available via Netflix, takes place at a camp for young drummers in Canada. The instructors at the camp are some of the world's most talented drummers. The movie interviews the drummers and shows them in action, both as performers and teachers. A few fascinating takeaways from the movie: * Many of the drumming greats started at an early age and practiced intensively, reaching a high level of talent early in life. Watching someone like Mike Mangini, it's clear, per the Seykota quote in Market Wizards, he doesn't have talent; the talent has him. * Several of the drummers talk about being in a zone when they are performing at their best. They also talk about drumming as fun. There is an exuberance to their performance that suggests that immersing oneself in the fun of exercising a talent is essential to reaching and staying in that zone. * The learning process for the young drummers was one of observing the greats in action, having the great drummers explain and model techniques, copying those techniques under the watchful eye of the instructors, and repeating skills until they are familiar. * There is an unusual bond among the drumming legends based upon respect for one another and a sharing of a common passion. Many of the legends have performed with one another and value that collaboration. Now think about the learning process for most traders: * Do most traders begin early in life and engage in intensive deliberate practice before actually performing in real life settings? * Do most traders find a zone of performance based upon love of what they do or does P/L emphasis and pressure make that zone difficult to find? * Do most traders truly learn by observing and copying masters and intensively repeating techniques and skills? * Do most traders find a collaborative bond with peers and mentors that sustains their passion and learning?
It is not surprising that there is a very high failure rate among new traders. What other field features people trying to make a living from performance before they've truly learned how to perform? How many traders, per Lionel Hampton, experience their work as a path to the divine? Further Reading: What It Takes to Trade in the Zone
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Too often, traders take in one piece of information after another, reading emails, scanning charts, reviewing research pieces, tracking news, and talking with other traders, and never get to the point where the information is transformed into knowledge. Someone trading the stock of a company may compile all sorts of statistics and news items about that company, but those in themselves don't ensure a knowledge of the company's competitive advantages and disadvantages or its growth potential. If someone gathered pieces of information about our lives, would they truly understand us? We often hear that the heart of trading psychology is discipline and the control of emotions. Other times, we hear that openness to and awareness of our emotions is crucial to enlightened decision making. Both perspectives have merit, yet both make the mistake of assuming that trading psychology is basically about what and how we feel. Not so.
Every bit as important to our trading as our emotional psychology is our cognitive psychology: how we process information and turn it into knowledge. Indeed, I would argue that, as we move from beginning traders to experienced ones, emotion becomes less of a central focus for trading and information processing becomes more critical. Lo and Repin, for example, found that traders responded to heightened market volatility with emotion, with inexperienced traders far more reactive than experienced ones. Experienced, successful traders may or may not wrestle with emotional responses to a market scenario, but they will always be actively involved in processing that scenario and searching for opportunity. Two cognitive psychology mistakes are common among traders: 1) Not making the time to assemble information into knowledge - Key to knowledge is finding meaningful patterns in data and placing those patterns into a framework for understanding. In my trading, I track statistics ranging from volume, breadth, sentiment, and buying/selling pressure, but it's the integration of the data that contributes to understanding. One form of integration is in the form of a mathematical model. Another form is a conceptual framework that is grounded in the concept of market cycles. If I get so caught up following the data that I don't engage in integration, I will fail to perceive valid trading opportunity. Equally problematic, I will tend to act on individual pieces of information that grab my attention without placing that information into proper context. 2) Not playing to our information processing strengths when we generate trading ideas - Each of us is quite different in how we make sense of the world. Some of us are quite mathematical and analytical, assembling views from the ground up. Others are conceptual and qualitative, looking for broad patterns to derive a top-down view of the world. My most native form of information processing is writing. Quite literally, writing is my way of thinking aloud and generating an internal dialogue that places information into perspective. Other traders accomplish the same thing by reading and taking notes; still others by engaging in multiple conversations. Far too often, traders fail to reach their potential because they're not accessing their cognitive potentials. They are making sense of markets in someone else's style, not their own. I've recently begun an experiment in which I engage in very extended journaling, writing out my assessment of the most recent day's market and where it fits into the broader picture of market cycles, but also writing out every single trade that I place, why I placed it, what worked and didn't work, and what I have done well or could have done differently. The depth of the journaling is far different from the typical end of day notes on trading and markets. In practice, I keep writing and writing until I get to the point where knowledge results from the information. It's early days, but the method so far has been helpful. One unintended consequence: I find myself feeling more confidence in trades when I've processed the opportunity in greater depth, in ways that are most productive for my sense-making. Further Reading: The Two Brains of Trading
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We often think of a strong market as one in which many stocks are making new highs. Interestingly, a better indication of market strength has been the absence of weakness: few stocks making new lows. One way I track this is the daily number of listed stocks making fresh one-month new highs and lows. (Data from the Barchart site). When the number of shares making monthly lows is in its lowest quartile since 2012, the next five days in SPY have averaged a gain of +.32%. When the number of shares making monthly lows has been in its highest quartile, the next five days in SPY have averaged a gain of +.53%. All other occasions have averaged a gain of only +.02%. The absence of new lows occurs when we've had a momentum rise that has lifted the great majority of stocks. That has been the case recently. That momentum tends to continue over the near term. Conversely, when we make an important low, we see an expansion of fresh lows. That tends to bring in value participants and strength over the near term. Much of market strength can be traced to such momentum and value effects. It's but another example of how looking at different data in a different way can yield helpful trading insights. Markets are ready to turn around when one or more sectors show weakness and we start to see an expansion of new lows, even as the index might be hovering near highs. When there is very little weakness, we have an important clue as to strength. Further Reading: Strength and Weakness as Separate Market Dimensions
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Who is in control of the day session for stocks: buyers or sellers? A straightforward way to assess this is to track the NYSE TICK ($TICK), which continually updates the number of stocks trading on upticks versus downticks. If we see broad buying, we'll see very high (+800 or greater) TICK numbers. Broad selling gives us readings of -800 or lower. Above we can see the five minute TICK readings for yesterday's trading session. Note that we opened with significant buying interest and stayed above the neutral zero (yellow) line for most of the trading session. Most important, we never saw selling readings of -800 or less. Quite simply, many more stocks traded on upticks than downticks over time, not so much because upticks were extremely high as because we had a relative absence of selling pressure. That absence of sellers was a great tell that prices would remain firm through the session. By watching the distribution of TICK readings--and shifts in that distribution--through the trading day, we can become sensitive to demand/supply changes that typically occur at market turns. When the distribution is one-sided, recognition of that fact can keep us out of bad trades. Further Reading: Tracking the Stock Market With a Broad TICK Measure
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* Every serious trader is a leader, running a trading business. Would you want to work for the business you're creating? Would you follow yourself as a leader? Would you allocate your hard-earned money to someone who manages their trading the way you do? Inspiration follows from aspiration: We are most energized when we live up to our highest ideals. * Great weekly perspective from Jeff Miller; excellent focus on what's really important for markets. A useful way to read Jeff is to make it a point to visit the sites he links to in his posts. Enhancing your information set is essential to enhancing your ability to recognize opportunities and turn those into successful trades and investments. * Here's a useful post from Adam Grimes on how to calculate volatility in Excel. Every weekend I work on a new research project. This weekend I took a hard look at the volatility of buying and selling activity in the stock market by tracking the volatility of upticks and downticks. There was a distinct tendency for returns in SPY to be superior when buying and selling volatility have been high; returns to be subnormal when buying and selling volatility have been low. More to come on this topic. Recently, we've had relatively high volatility readings for buying and selling, helping fuel the current rally. * Another excellent site for perspective is Abnormal Returns. The most recent links include valuable views on the recent decline in bonds. AR is a very useful way to discover sites that enrich your thinking about markets. * A feature I like on Stock Twits summarizes the message volume and sentiment for stocks and ETFs. Small caps have been on fire since the election, and message volume for IWM has been high. Interestingly, though, 45% of participants have been bullish on IWM and 55% bearish. We're hovering near highs for the broad indexes, but I'm not seeing frothy sentiment so far. My "pure sentiment" measure, which takes recent price change and volatility out of the equity put/call ratio, has been surprisingly bearish during this rally. Have a great week trading! Brett
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One of the unique ways we can look at market sentiment is to track the number of shares outstanding in market ETFs. When there is demand for the ETFs, such as SPY depicted above, we see net share creation. When supply is dominant, we see net share destruction. Notice how, for the first half of the year, we had rising prices but little net share creation. That changed off the late June lows with significant share creation accompanying the momentum move higher. When we pulled back going into the election, there was little net share destruction. Now, in the wake of the election, we've once again seen an explosion in share creation and a momentum move higher.
As you might expect, net share creation has exploded in the financials ETF (XLF) and industrials ETF (XLI), rising over 30% since the beginning of November. Over that same period, we've seen net share destruction in the utilities ETF (XLU), reflecting the move out of higher yielding stocks in the face of the bond market decline and higher rates. (All numbers from the State Street site). What I find interesting is that the share creation in SPY--the market overall--more closely resembles the pattern of the strongest sectors, not the weakest ones. That suggests that it's not just sector rotation impacting the market, but actual net dollars being put to work in stocks. Further Reading: Fresh Perspectives From New Data
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After a number of days in moderately bullish territory, the ensemble trading model has fallen back to a reading of -1. This is very modestly bearish over a several day horizon, and I take it more as an indication of a maturing trend than as an outright bearish signal. Indeed, as we saw in the rallies off the February and late June lows, the model will often pull back as a trend matures, with the upside continuing but moderating. There has been sufficient upward thrust to the present move--note the expansion in the number of stocks registering fresh annual highs--that such a moderating scenario is my base case. With VIX back to low levels and volume tailing off as we approach holiday season, I anticipate narrower trading ranges going forward--a change from the volatile action we saw after the election.
The election has been a game-changer in at least one important respect for US stocks: there is a sense that policy is going to shift from the monetary realm (ever lower interest rates as a function of further central bank buying of bonds) to the fiscal one (increased spending/stimulus). That has changed the market's psychology from disinflationary to inflationary, resulting in lower bond prices (higher yields), a stronger US dollar, and a boost in stocks--particularly industrial and financial shares. With considerable cash on the sidelines, we could see a move out of bonds and into stocks, which would be supportive of continued market strength. Interestingly, my model of sentiment, which looks at a "pure" put/call ratio with recent price movement and volatility stripped out, has remained above average in bearishness. It is not clear to me that, despite the vigorous stock rally, that sentiment has become over-the-top bullish.
Longer term, I harbor doubts that doubling down on debt will yield hoped-for growth. I felt that way when Democrats were proposing further spending, and I feel that way now that a Republican package is likely to come early in the year. That invites the possibility of stagflation and could return attention to (lofty) stock valuations. For now, however, we are responding to an anticipated fiscal boost and that has kept selling pressure quite modest, even when we've had short-term pullbacks. Further Reading: Quant Models and Discretionary Trading
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A little while ago, a trader who has been quite successful this year sent me a draft of his trading plan for the new year. Shortly after, he had his best day of the year. I have little doubt that he'll use information from the winning day to help him build on his strengths and hone his goals for 2017. That's what winners do. They learn from what they do wrong, they learn from their successes, and they translate their lessons into plans and actions. A big winning day is a double win if you can figure out what you did well and replicate that success going forward. Maybe the big day was a function of a particular type of market action that you recognized early on. Maybe the big day was a function of researching great trade ideas. Maybe the big day was a function of sizing up a position you had prepared well and saw clearly. Suppose you catalogued your top 10 trades of the year, where you fired on all cylinders, making the most of your trading process. What patterns of success would you discover? What best practices could you identify that you could bring into the new year? Good traders celebrate after a win. Great traders treat wins like losses and learn from both. Further Reading: How to Become a More Confident Trader .
Character reflects who we are as people: our deepest values, priorities, and strengths. Talent and skill leads people to do things right. Character is about standing up for and doing the right things. I am struck by how long-term success in financial markets often reflects character. Doing the right things leads people to not blow up; it leads them to attract the right people; it inspires loyalty. When I was doing recruitment interviewing at a hedge fund, I recall candidates talking about themselves, pounding on what made them special. They wanted to display confidence. Instead, in their exclusive me, me, me focus, they displayed a questionable character. Character shows up when trading the money of others. It shows up in one's dealings with peer traders. The truly great basketball players make their teammates better; true leaders act on principle even when that is not the most immediately popular or expedient course. Character means we stand up for what we believe and act in a way that is consistent with our highest values. We can train skill, but character is built upon role modeling. The character of those we're closest to is likely to reflect our own character. It's one thing to journal about whether you traded well or poorly, whether your psychology is positive or not. A different focus would be to consider your character and whether it's truly being expressed in your market-related dealings. We don't have to discipline ourselves to do the right things if those right things are intrinsic to who we are as people. Further Reading: Why Character Matters
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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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