Finding Your Transformation

The recent post on awakening your talent cited Courtney's performance on the talent show as a beautiful example of how we "become a different person" when we are doing what we're meant to be doing.  We can be one person in day-to-day life and quite another when we enter our performance zone.

This is an important characteristic of great relationships and great careers:  they bring out the best in us and transform us.

It's important to note the opposing reality, however.  Just as we're trans-formed when we're activating our strengths and values, we are de-formed when those are chronically frustrated.  Consider a few examples:

*  Employees start their careers with enthusiasm, but quickly become caught up in office politics and playing the games that can move them up the ladder.  I have seen talented people become "yes-men", completely lacking in integrity--all in the name of protecting and advancing their positions.  For a while, they gain status, but in a more enduring way they lose their souls and become bitter, cynical, and unproductive.

*  Couples start their relationships with real feeling, but soon are caught up in a social whirlwind of impressing others and/or an indulgence of personal/material needs.  Meanwhile, the activities and values that brought them together are submerged and their relationships increasingly become ones of convenience and emptiness, with little empathy for or genuine connection to others.

*  Members join a social organization out of an initial desire to learn, grow, and connect to others, but eventually are drawn into ego battles for status and position, creating social rifts and alienation in the process.  I've met a number of people active in social organizations who know many people and yet have shockingly few genuine friends.  In the immersion in me, me, me, they never get to we.

*  Traders start out with eagerness and anticipation, but before long are drawn into the consensus chats online and on trading floors.  They trade the same ideas in the same ways as others, never truly adding original, creative elements to their trading.  As they achieve the same, undistinguished returns as others, they become increasingly frustrated and discouraged, losing their energy and wasting day after day doing more of what doesn't work.

Sometimes we find ourselves stuck in the hell of situations that are de-forming rather than trans-forming.  A beautiful outcome occurs when we use those deforming situations to transform us:  to become so revolted by emptiness and superficiality that we double down on what is most meaningful to us and that helps us find our voice.  

Consider:  role models are everywhere.  We can find positive role models who inspire us, or we can find negative role models that so fill us with disgust that we're able to do what Courtney does at the end of her song:  turn our backs, throw up our hands, give a little "mwah", and move in a different direction.  

There is a lot of positive that can be derived from negative role models.  Utilizing the deformation of negative role models as positive life motivation is the ultimate transformation. 

Further Reading:

Awakening Your Talent

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Finding Your Drinking Accountability Buddies

We've been hearing a lot lately about the importance of having a "trading accountability buddy" to help you avoid mistakes and stick to good trading processes.  That is very helpful, but let's focus on what traders really need:  Drinking Accountability Buddies.  You know what I'm talking about:  people who will go out with us and make sure we don't do things we'll regret in the morning.  After all, if you make a bad trade, you can always battle back the next day.  If you bring home the wrong person from the bar, you've probably exceeded any reasonable stop out level.

So how can a Drinking Accountability Buddy help us?  Here are three situations they help us avoid:

1)  The Joint Closers - Look, at real bars there are always guys who are there until the bitter end, drinking away until the joint shuts down.  Very often they get more surly and belligerent as the night goes on, because they're frustrated that they haven't found any cute young thing to take home.  You're just starting to have a good time and a couple of the closers give you the evil eye.  That's when, nursing your third strong one, you're tempted to dust off your Andrew Dice Clay line and ask the closers, "Hey, are you Neil and Bob or is that just what you do?".  Well, you know how that goes down.  Faster than you can say, "Katie bar the door," the surly dudes get off their barstools and it's all flying fists and broken glass.  Your Drinking Accountability Buddy will see the evil eye and knows that you can mouth off, so he'll quickly get your ass out of there.  Think of how much you'll save on a 24-hour bail bondsman.   

2)  The Newbs - OK, you decide to go out after the market close with a few traders and you head out to a good craft beer spot.  You know, one that's rough enough to have some color and action but not one where there are so many joint closers that a beer and a shot is likely to mean a beverage and a handgun.  You find the right spot and you place your order, maybe a good bourbon barrel aged stout or maybe you up your game and get a double shot of a good reposado.  The next guy orders and, along with the others, cheerfully announces that they'll share a pitcher of Bud Light Lime.  Well, at that point you are screwed.  Your evening is about to be spent with complete idiots.  Because the fact that they are drinking newbies usually means that they are trading newbies and will ask you questions about strange chart patterns and "what the algos are doing".  Your Drinking Accountability Buddy will see this situation before it gets underway and steer you to a bar where you can maintain a normal blood pressure and avoid week-long bilateral hemiplegic migraines.

3)  The Classy Drinkers - This is where you end up going out with "successful traders" who, of course, have to hang out at the kind of place where successful people hang out.  Nice soft music, in-your-face cocktail service, and a wine list 30 pages long.  And, sure enough, that's what all the classy drinkers drink:  petite goblets of wine that they sip with their pinkies turned out.  Meanwhile, you're sitting there with your 18 year old single malt, wondering why the major topic of conversation is "toxic masculinity".  One time it got to me so bad I started singing The Rodeo Song and telling stories about growing up in a trailer park and dating my cousins.  That didn't end well.  A Drinking Accountability Buddy will notice right away that everyone in the joint is wearing way-too-tight clothes and nibbling from veggie plates and steer you the hell away from there.  Then you can go to a dive bar and have yourself a fun evening telling jokes like, "What's the similarity between Michelob Ultra and sex in a rowboat?  They're both very close to water..."

Well, there it is.  Trading Accountability Buddies are fine, but it's the Drinking Accountability Buddies that really have your back.  Hell, they're almost as valuable as that near-perfect market indicator I discovered and that infallible wave structure I wrote about.  The main thing is to have a good time--in life and in trading--and never lose your sense of humor!

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Finding Psychological Techniques for Traders That Actually Work

It is common that I hear traders describe techniques they are using to make changes that sound good on the surface but that, in fact, are not effective.  A great example of this would be the use of trading journals to review the day.  Such review might be helpful for learning and, if focused, could help with goal-setting.  But the process of making personal changes is not going to be fulfilled by doing some writing.  Change requires a different focus and a very different mindset and emotional state.  Writing down an intention to be more disciplined in trading is worlds apart from using psychological methods to rehearse that discipline and create a sense of emotional urgency around the rules and practices.

In the most recent Forbes post, I lay out an important principle:  the challenges that impact our trading are closely related to the personal challenges that bring people to counseling and psychotherapy.  We first encountered this notion in the Psychology of Trading book, but the idea of a continuum linking all of our challenges is broader.  As the Forbes post lays out, an important implication is that the techniques that help people with anxiety, depression, anger, and the like are effective for parallel problems in the performance domain:  stress, negative thinking, frustration, etc.

This is huge.

There are evidence-based psychological methods known to help people with diagnosable emotional disorders.  Every one of them can be adapted to help us with normal, developmental challenges and with the unique problems associated with the quest for peak performance.  Moreover, all those techniques accomplish their goals relatively quickly, as the most recent research review of brief therapies lays out.  

We would never consider turning to unproven home remedies when research-backed medical help was available.  Similarly, it makes no sense to turn to pop-psych, feel-good solutions when there are reliable methods for lasting change readily at hand.  In upcoming posts, I will review some of these methods and their application.

Further Reading:  Proven Techniques for Peak Performance

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Making Sense of the Market's Split Personality

December was pretty much straight down in the stock market, with accompanying weakness in other assets, such as oil and high yield bonds.  January has been pretty much straight up, with reversals in all those asset classes.  How can we make sense of this "schizophrenic" market behavior?

An excellent blog post from David Moenning on the NAAIM site offers worthwhile perspective.  When Fed Chair Powell indicated continued shrinkage of the balance sheet and the possibility of future rate hikes, the market sold off hard that very afternoon and didn't look back.  The weakness was broad:  on December 24th, we registered 50 stocks making fresh one-month highs and 3158 hitting new one-month lows.  On that day, among the SPX stocks, we saw fewer than 5% of all shares trading above their 3, 5, 10, 20, 50, and 100-day moving averages.

In other words, pretty much everything was down.

Fast forward to Friday's close, January 18th.  Over 90% of SPX shares are trading above their 3, 5, 10, and 20-day moving averages.  A total of 1916 stocks across all exchanges registered fresh one-month highs against 67 new one-month lows.

In other words, pretty much everything is up.

Moenning, in his post, traces this reversal to the Fed's walking back their earlier "hawkishness", as they indicated flexibility in navigating the rate and balance sheet paths going forward.  Their hawkish stance was a game changer for institutional investors and led to a broad risk off.  Their flexible stance was an equal game changer and led to broad risk on.

What does this tell us?  Several things, I believe:

1)  Any effort to foretell the market's path with technical indicators, chart patterns, and wave structures is inherently limited in value.  We cannot operate with a crystal ball when game-changing events are occurring in real time.  Flexibility in managing money is just as important as "conviction".

2)  Monetary policy is a major driver of asset pricing.  This is the message from Ray Dalio's recent work.  The Fed is walking a narrow bridge in normalizing rates and not adding fuel to a strong economy versus pulling away the punch bowl and risking weakness.  The Fed has told us they don't want to fall off either side of the bridge, so we can expect balancing messaging at market extremes, as Chairman Powell and Co. seek Dalio's "beautiful deleveraging".

3)   Investors are behaving as a herd.  For over 90% of stocks to be above their 20-day moving averages, all sectors have to be bought.  Ditto when fewer than 5% were above their moving averages.  Everyone is singing from the same hymnbook.  This makes short-term breadth measures and short-term measures of upticks versus downticks handy in trading with the market's momentum.  It also means that fighting the herd is a losing proposition.

Of course, this, too, shall pass.  At some point valuations will matter and we'll see diverging behavior among stocks and assets.  So far, however, it appears that momentum is the upcoming starting pitcher.

Further Reading:

Reading Market Cycles

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Awakening Your Talent

I'll be writing much more on this topic in my upcoming book on trading and spirituality.  Here is an important perspective:

When we access our strengths--what we do best--we gain access to what we call the "zone" or the flow state.  In that state, we tap into parts of ourselves that are relatively submerged during normal, day-to-day life.  

In a very important sense, when we are in sync with our talents, we become different people.  I couldn't agree more with Market Wizard Ed Seykota when he pointed out that great traders have absorbed their talent:  "They don't have the talent--the talent has them."

Good traders have talent--and skill and motivation and discipline.  But great is a different beast.  It's when the talent drives everything and the performer becomes a channel for his or her strengths.  When the talents have us, we are transformed.  Success depends upon our ability to effect that transformation: to go from the good to the great.

The key is structuring our work so that we are continually tapping into our greatest strengths and what is most meaningful to us.  

We recently got to see a good example of this when Courtney Hadwin, a painfully shy and awkward 13-year old singer who placed sixth in America's Got Talent returned at age 14, wrote her own song, and competed in the Champions show.  She explains, "When I sing, I become a different person."  She "gets into the music", moves her body, and accesses wholly different aspects of herself.

If you're trading in your normal state of consciousness, you have not awakened your talent.  That doesn't win singing competitions and it doesn't win in markets.

Further Reading:

The Role of Spirituality in Trading

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Some Things To Look For In This Market Going Forward

In my recent Forbes article reviewing historical patterns of bear markets, I noted that it was common to see extended bounces even within the context of longer-term declines.  Indeed, we could be seeing just such a bounce in recent markets, which have taken stocks, oil, and high yield bonds meaningfully higher following significant declines.  Speaking with investors and traders, I observe a high level of uncertainty and many questions.  Is the decline over?  Are we beginning a new bull market?  Will we retest the lows?  

Thanks to a savvy trader for pointing out this perspective from The Fat Pitch, who evaluates historical evidence regarding bounces from highly oversold conditions.  See also this useful preview of the coming week from Dash of Insight. In my own trading and investment, I have found it useful to track the relative performance of ETFs as a way of detecting market themes and the unfolding of strength and weakness.  Here are a few ETFs that I view in this relative manner.  Each of the charts is indexed to 100 as of the start of January, 2016 and each looks at the ETF versus SPY:

*  EFA - Here we're looking at stocks outside the U.S., including Europe, the Far East, and Austral-Asia.  Note the ongoing weakness of EFA versus SPY.  Many of the market vulnerability themes (disarray in the E.U.; concern over Italy and debt; concern over China and trade wars) stem from overseas.  Watching the relative performance of EFA helps me walk forward, day by day, to see if those concerns are growing or waning.

  *  HYG - This tracks high yield bonds, which have been weak for a while, but which rallied strongly on the Fed chair's recent reassurances regarding the pace of shrinking the balance sheet.  When high yield bonds decline in price, their yields rise.  That is not necessarily a good thing, as it can mean that the market is pricing in growing odds of default.  When we see high quality bonds (AGG, for example) outperform high yield bonds, it's a sign that smart bond investors perceive risks and seek safety.  Watching the relative performance of HYG is one way of tracking their sentiment going forward.

*  XLF - This familiar ETF tracks the performance of financial stocks within the SPX universe.  In a stable and growing economy, banks should perform well and other financial firms should benefit from loan activity and loan demand.  If we encounter threats to the financial system, such as we saw in 2007-2008 with the housing crisis, then banking and financial stocks should show particular vulnerability relative to the overall stock market.  Lately we've seen relative weakness from the financial sector and a so-so bounce.  I remain concerned about the European banks, which have been unusually weak:  DB and CS are examples.

*  DBC - This ETF tracks commodities and is sensitive to oil prices, which were quite weak and which have rallied nicely in recent sessions.  In a growing global economy, rising production and consumption and increased building lead to an increased appetite for many commodities.  Conversely, economies in recession will tend to consume less and that can lead to declining commodity prices.  Oil and industrial metals are especially valuable to follow in this regard.

Note that overseas equities, high yield bonds, financial stocks, and commodities are all below their 2017 levels in relative terms.  Should we see economic weakness not only overseas but in the U.S. as well, these measures could weaken further.  Conversely, if we retest lows and these measures hold up well in relative terms, I will be open to a more benign thesis.  The key is staying open-minded and letting the evidence speak for itself.  We can't be open to possibilities--and profit from them--if we can't tolerate degrees of market uncertainty.

Further Reading:

Relative Strength as a Sentiment Gauge

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How to Make Improvements in Your 2019 Trading

There are several ways that we can make improvements in our trading:

1)  Become a better idea generator; become better at spotting opportunity;

2)  Become a better trader/portfolio manager; become better at implementing ideas as favorable risk/reward opportunities and constructing portfolios of trades;

3)  Become more consistent in drawing upon best practices; become more grounded in personal and professional processes that keep you in peak performance mode;

4)  Become more consistent in recognizing and intercepting your worst practices; become more mindful of triggers and pitfalls that set you up for your worst performances.

In working on any one or all of these, it is important that the efforts are daily.  We internalize what we do.  The idea is to start our changes with motivation, but continue them with positive habits.

Tomorrow (Thursday, Jan. 10th, 4:30 PM EST), Mike Bellafiore and I will join the good folks at Futures.io to present a free webinar on how you can implement these four areas of improvement in your trading.  We are working with developing traders who are making meaningful strides in their trading, so we see what is and isn't working in real time.  Our hope is to leave attendees with specific ideas and strategies that they can use to move their trading forward in 2019.  

Here is the link for webinar registration; we look forward to seeing you there!

Brett
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The Two Ingredients of Trading Success

There are two necessary ingredients of trading success and it sometimes seems as though they are at odds with one another:  prudence and aggressiveness.

Prudence is all about staying in the game with proper risk management, position sizing, and selectivity of trading.

Aggressiveness is all about making the most of the game with proper risk taking, position sizing, and assertiveness of trading.

Depending upon the frequency of your trading, it is good to have a loss limit to constrain the downside each day, week, and/or month.  If that loss limit is set prudently, it will keep you in the game (psychologically and financially) during normal, expectable periods of drawdown.  

Less well appreciated is that the daily/weekly/monthly loss limits should also serve as benchmarks for your profitability.  If a trader has a loss limit of X, he or she should make X or more during that period of time.  Thus, for a developing trader who has a $1000 daily loss limit, we should see in the span of a month occasional daily gains of $1000 or more.  It is that ability to make the daily limit and not lose it too often that provides good risk-adjusted returns:  the ability to make a good amount of money per unit of risk taken.

Many traders lack prudence and trade aggressively, so that their big losing days outnumber their big winning ones.  Eventually this leads to trading stress and possible blow up of the account.

Many other traders trade with prudence but not aggressively, so that they don't have many large losing days and they also don't have many large winning days.  Implicitly, they're trading to not lose.  Eventually this leads to a lot of wasted effort and frustration.

Trading with prudence and aggressiveness means that--during the life of the trade and during preparation for the day/week--you must engage in prudent self-talk and planning and you must engage in aggressive self-talk and planning.  In practice this might mean mentally rehearsing where your trade is wrong and planning a stop out (prudence) and also mentally rehearsing what tells you your trade is right and planning an add to the position.  In practice it might also mean using the information from a losing trade to place an even larger trade in the opposite direction.

The point here is that your planning and your self-talk have to embrace both prudence and aggressiveness if your trading is to integrate these elements.  Many performance fields--from being a fighter pilot to being a chess champion to being a race car driver to being a football quarterback--require the combination of prudence and aggressiveness.  Your trading statistics will tell you how well you are doing with both of these vital trading ingredients.

Further Reading:

Trading Like a Sniper

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Why Trading With Confidence Doesn't Work

One of the interesting dynamics I've observed during this recent period of market volatility is that many traders see large moves and thus want to make *the* big trade.  They develop a market view and they trade that view doggedly, often ignoring actual price behavior.  

What makes this worse is that it masquerades as "confidence" and "conviction".  In reality, it is ego.  It is us saying we know what the market we do and then digging in and looking for opportunities to express our view, so that we can be right.  The need to be right can blind us to evidence that goes against our ideas--and it can especially blind us to opportunities on the other side of the trade.

We indeed see what we're prepared to see, which is why we should prepare ourselves for a multiplicity of scenarios.  Once we decide we *know* which scenario will unfold, we're no longer prepared to see what could unfold.  And that leads to losses and poor trading decisions.  Feeling strongly about a view is as much a risk factor as a trading virtue.

Further Reading:

How Overconfidence Derails Our Trading

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Creating New and Better Habits for the New Year

Recently, Mike Bellafiore at SMB Capital has been emphasizing the idea of positive habit formation with his traders.  It's a great focus for the new year:  developing the patterns of thought and behavior that help us achieve our goals.  Here's an excellent video from James Clear, based on his new book, Atomic Habits.  An important point made by the video is that we can transform our experience of ourselves one small behavior at a time, as we internalize whatever it is that we do.  Of course, that can also work in reverse:  when we fall into bad habits, we can internalize the sense of being lazy, unproductive, undisciplined, etc.

Here's an interesting video from Tony Robbins that connects changes in our behavior to changes in our emotional and physical states.  The implication is that we don't have to repeat the common pattern of making new year's resolutions, only to see them fall by the wayside.  We can use our emotional and physical states to trigger the right behaviors and we can change our behaviors to form new and powerful habit patterns.

In the book that I am currently writing, I describe how the great spiritual traditions of the world provide us with powerful tools for changing our states and accessing our strengths.  This has important implications for traders:  the great trades come from the soul, not the ego.  In developing ourselves spiritually, we can find greater success in the material world.  This is because we move beyond ego-based motivations and reactions and more consistently access who we truly are.  

In short, we will not transform our trading by staring at screens, hanging on each tick of profit or loss.  We will not transform our trading by pushing, pushing, pushing to get bigger, bigger, bigger in our trades.  Nor will we transform our trading by focusing on every move that we don't monetize.

Spirituality, too, can become a habit.  Lots of good things can happen when our best practices and greatest strengths become our consistent processes.

Further Reading:

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Navigating Turmoil and Opportunity in Markets

In life we find that periods of turmoil are often the periods of greatest growth and development.  Psychologically, turmoil shakes us up and challenges our assumptions.  That opens us to new experiences and major life changes.  My marriage (going on 35 years strong) came after a period of personal and career turmoil; those taught me what I needed in life.  Similarly, it was the sting of losses I took in markets in the early 1980s that led me to re-evaluate my trading and take a more promising and profitable quantitative direction.  From a spiritual perspective, our task is to find the opportunity in turmoil.

In financial markets, one manifestation of turmoil is volatility.  When we look historically, periods of high volatility have generally corresponded to longer-term opportunity for investors.  The hard part is weathering short-term gyrations in order to participate in that bigger picture.  Secular bear markets (and I am open to the thesis that we may have entered into one in the stock market; see this debt-cycle analysis from Ray Dalio) can last quite a while:  consider how long it took for the market to return to its 1929 and 1972 peaks, for example.  For that reason, the bulk of our family capital is tied up in safe fixed income instruments that can provide a 3+% annual yield during a period that could prove disinflationary and not too friendly to risk asset prices.

Still, it would be foolish to hide under the bed covers and ignore the possible opportunities that can arise from the recent period of volatility.  One site that does a great job of separating signal from noise is A Dash of Insight, which has an excellent post looking at the year ahead.  Jeff Miller makes the important point that today's turmoil provides an opportunity to invest in tomorrow's themes and strong companies; see his list of "timely ideas".  

Yet another valuable resource is the new book The Lifecycle Trade from Boboch; Donnelly; Krull; and Daill.  The authors study IPOs and super growth stocks to identify their common trajectories and ways in which traders and investors can participate in their growth.  The idea is that today's turmoil fertilizes the soil of growth for a new generation of market leaders and promising technologies.  Stocks and industries that maintain their upward paths even during bear market times are candidates for tomorrow's large opportunities.

So that is our challenge during periods of turmoil.  To win the game, we have to stay in the game.  That requires prudence.  But to truly win, we have to use turmoil to find opportunity.  That requires optimism, resilience, and vision.  A solid business plan addresses threats and opportunities...we may be entering a period replete with both.

Further Reading:

Renewing Our Trading and Finding Opportunity

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Investing In Your Trading

Margie and I have adopted another rescue cat, so now we're back to four after Mali passed away last year at the ripe old age of 17.  Bringing in a new one requires considerable time and patience.  We start off with the new cat in his own bedroom, with the two of us taking turns sleeping with him, playing with him, feeding him, etc.  Eventually he learns to feel safe and comfortable with us and we start the bonding process.  Gradually we introduce the new one to the other cats and monitor their interactions closely.  By playing with all of them in an open area, we create a non-threatening environment.  As the cats bond, it becomes possible to play with them together.  Just last night, the new boy, Aries, slept in the crook of my arm while Mia slept on top of me.  To put it mildly, I got little sleep!  But there was a lot of purring and it was a big step forward in the bonding of those cats.

The big takeaway is that relationships succeed when we approach them as investments, not as trades.  It is when we focus on short term returns that we fail to put in the time to cultivate depth and cement a future.  As a psychologist, I've spoken with more unhappy couples than I care to count.  The common feature is that each member of the couple is focused on what they are not getting out of the relationship.  No one is losing any sleep building long-term bonds.

So it is with trading.  If we approach our trading as a trade, then it's all about the next trade and the most recent P/L.  Yes, we might keep a perfunctory journal regarding the day's activities, but is that really investing in the future of our trading?  As I'm writing, we've been seeing VIX levels in the stock market in the 30 area, much higher than we saw months ago.  To illustrate the difference, consider that for the month of August, we saw roughly 1000 bars of price action in the ES futures, where each bar represents 500 price changes.  In December thus far, we've had almost 3000 bars.  Each bar averaged a range of .11% in August and almost twice that in December.  In short, we're seeing much more activity, much more volatility:  markets doing a lot more per unit of time.  That takes every bit as much adaptation as bringing a new animal into the home!

Some traders I know step back and make those adaptations.  They are investing in their trading future by learning how to trade different market conditions.  Other traders forge ahead, doing the same things as they've always done, gunning for short-term returns.  They may make money, they may lose money, but they surely don't grow their business.

As we come to the close of the calendar year, it's a good time to reflect on the investments you're making--and need to make--in your trading.  How is December going to make you a better trader in 2019?

Further Reading:

What Market History Says About Bear Market Paths

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The Psychology of Trading a Crazy Market

It's been a while since we've seen a VIX greater than 30.  It's also been a while since we've seen three consecutive days where there have been fewer than 100 stocks across all exchanges registering new monthly highs and well over 2500 making fresh monthly lows.  And it's been a while since we've seen fewer than 10% of all SPX stocks trading above their 3, 5, 10, 20, 50, 100, and 200-day moving averages.  I recently wrote a Forbes article on what market history tells us about the paths of bear markets.  Over this holiday period alone it has generated well over 40,000 hits.  That tells us something about market psychology.

I recently participating in a podcast with J.C. Parets of All Star Trading.  If you haven't checked out his series, I suggest you do so.  You'll find a wealth of trading perspectives.  In my session with J.C., we discussed how the volatility of markets can induce our own emotional and behavioral volatility.  An important priority in trading crazy markets is doubling down on our own sanity.  That means mentally--and emotionally--rehearsing being wrong on trades so that we are prepared to take the right actions if the stuff hits the fan.  As a rule, the more we face the heat of battle, the more we want to keep a cool head.  When we *anticipate* the losing trade, we allow ourselves to normalize it emotionally--and that helps us keep the cool head.

Indeed, it's not at all unusual that I will structure a trade that looks like it has momentum in its favor.  I put on a price stop in case of reversal, but I also put on a time stop.  If the move cannot materialize in a relatively short period of time, momentum on that time is not what I had expected.  That itself may disconfirm my idea.  Exiting the position for a modest loss can set up a trade the other way.  In such cases the loss is a tuition we pay for valuable market education; a fee we fork over for useful information.

When we take the threat out of losing, we open the door to using losses as learning lessons that make us better.  That's a great psychology for a crazy market!

Podcast With J.C. Parets

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Trading With Hypotheses, Not Conclusions

Noticing some good buying activity late Thursday and a holding above the Thursday lows in the evening session, I started Friday morning with a hypothesis.  I believed we could see meaningful short covering and buying pressure if early weakness during the morning trade could hold above those overnight lows.  That did indeed happen, and we saw solid buying come into the market a little after 10 AM EST.

Before long, however, the buying rolled over and sellers began to take control.

Two ideas crossed my mind as this occurred:

1)  This shouldn't be happening if we're putting in a bottom.  An oversold market should generate more meaningful and sustained buying, reflecting the interest of value buyers operating on a larger time frame.  The failure to sustain buying goes against my hypothesis and suggests we haven't yet made a durable bottom.

2)  The Fed indeed was a game changer.  As I had pointed out in the previous post, the participation in the market completely changed after the Fed's announcement.  The inability to sustain buying from the oversold condition supported the hypothesis that this was a new and important input into the stock market.

In both cases, I have hypotheses and update my belief in those hypotheses given market action.  If I had traded as though these were firm conclusions and not hypotheses, I would not have been sufficiently flexible to first anticipate strength and then later trade the market's short side.  Being on the lookout for information that disconfirms our views--including trades that don't work--is essential to risk management.  It's also critical to our trading psychology.  We want to embrace disconfirming evidence, not become threatened by it.

So where do we get hypotheses from?  This is where quantitative analysis intersects nicely with discretionary judgment.  The quant work tells us what has occurred in the past under conditions that we're seeing at present.  Sometimes that work suggests the presence of a significant directional edge.  One excellent source for such studies is the Quantifiable Edges letter, which reviews potential edges in the stock market each day.  The most recent letter notes the very oversold condition of the market and goes back 20 years to examine what has occurred in similar circumstances.  By viewing the market through several different lenses (including recent Fed activity), Quantifiable Edges is a fertile source of hypotheses.

Right now, the work from QE suggests a high probability of a rally.  Rob Hanna, however, notes that, in situations when we *didn't* get a bounce under these circumstances, the downside was ugly.  Plus, Rob's work suggests the Fed is not being accommodative at present.  So right away this sets up a flexible thought process for Monday:  looking for evidence of putting in a bottom and seeing buyers take control, but also being sensitive to the possibility of ugliness and a deeper capitulation.  

With proper risk management, a hypothesis disconfirmed is not a failure; it can be the source of opportunity.

Further Reading:

Tracking Market Strength and Weakness With Intraday New Highs and Lows

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Asking The Right Market Questions

A while back I wrote a blog post about three questions to ask about any market.  It turned out to be the most popular TraderFeed post ever.  That says a lot.  Readers are interested in approaching markets intelligently--by asking the right questions--not just in finding out someone else's answers.  

The U.S. stock market has played out the weakness discussed in recent blog posts.  We've also seen weakness in overseas equity markets, weakness in Treasury bond yields, weakness in high yield bond prices, and weakness in many commodities tied to economic activity.  The movement across asset classes tells us that this is about something fundamental.  The increased volume tells us that this is connected to larger, institutional market participants, particularly those involved in macroeconomic investment.  

We saw this clearly in the aftermath of the Federal Reserve meeting and announcement.  Going into the announcement we were seeing some decent buying flows, as measured by the number of stocks trading on upticks versus downticks.  Upon the announcement we saw very strong selling flows on very enhanced volume.  That told us that fresh participants had come into the market (institutional flows) and that they were aggressive sellers (hitting bids in the ES futures).  Among the people I speak with, the consensus was that the decision to continue to shrink the balance sheet at the current pace was effectively a monetary tightening just as we're seeing global economic weakness.  Market participants anticipated that this would exacerbate the weakness.

As I mentioned to the traders at SMB in their morning meeting, this is the time to ask the right market question.  If the Fed decision was indeed a game changer, we should not see a meaningful retracement of the decline from the pre-announcement highs.  In other words, if the lower prices post-Fed cannot attract significant value buying from higher time frame participants, then we have to assume that the macroeconomic sellers are in control of the market.

Sure enough, we did get some early buying and sure enough it could not retrace a significant portion of the post-Fed decline.  That set us up for a further leg of weakness on Thursday.  Finally, later in the afternoon on Thursday we saw some decent buying flows come into the market, and we held the afternoon lows in late session trading.  Those pre-Fed highs remain a significant level and I will be watching buying versus selling flows this morning to see if we can get any buying more substantial than the typical short-covering.  The only way we start to put in a bottom is if prices get to the point where longer time frame participants come into the market, attracted by bargain prices.  That would give us very strong upticks among stocks, not just waning downticks.

These are the questions that I find helpful in active trading:  who is in the market (volume); what are they doing (buying versus selling flows); and where are they doing it?  An ancillary, important question is:  To what degree are buying and selling flows meaningfully moving the market?  This is the question of efficiency.  As we saw post-Fed, we can have buying flows, but if they cannot retrace a significant portion of the prior decline, we can anticipate that those buyers will be the ones trapped on the next leg down.  Can the sellers take us below yesterday's lows?  That's a good question to ask going into today's open.  Trading psychology is not just about the trader's psychology; it's also about reading the psychology of market participants.

Further Reading:

TraderFeed Home Page and Index

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What In The World Is Going On With The Stock Market?

Why are stocks falling like this?  That's the question I've been hearing from a number of investors and traders.  In the previous post, I posed the question of whether we might crash.  That post has received almost three times as many hits as my average post--and that is just in two days.  That tells me uncertainty is high.  The sentiment, as I noted in that post, is bearish.

But the question posed with anguish is *why* this is happening.  The U.S. economy is not in such bad shape despite political turmoil in the U.S. and concerns about tariffs and trade wars.  Nor do we have a Federal Reserve that is aggressively tightening monetary conditions.  Inflation overall is tame and there are few signs of overheating in the economy.  Indeed, with solid employment numbers, we were not so long ago hearing about being in a sweet spot of economic growth.

Alas, U.S. investors and traders can be horribly U.S.-centric.  One thing I love about working out of London is that the perspectives tend to be more global.  That is important when markets--and those managing capital--are so intertwined.  Perhaps what is going on in the U.S. stock market is not about the U.S.  Perhaps it is not about President Trump; not about the daily dose of polarized, politicized commentaries from MSNBC, FOX, CNN; and not about chart patterns and wave counts of American markets.

Consider an excellent article in the Washington Post reflecting upon the difficulties of Britain, given the problems associated with Brexit and the problems associated with remaining in the E.U.  The author poses the scenario:  Suppose Italy defaults on its debt and Britain is asked to bear some of the load.  Will its citizens really want to take on more debt?  Will the Yellow Vests of France want to step up to the plate and shoulder that debt?  What happens in the event of sovereign debt default?  Could Italy be the epicenter of a crisis that the ECB would have trouble responding to, given already low rates?  As Robert Samuelson notes, the ingredients of a crisis are present.

So now let's look at some charts of banks.  Here is Deutsche Bank:

Here is Credit Suisse:

Here is Goldman:

Here is an ETF for European stocks:

Uniformly, it's been a straight shot down from early January, unlike U.S. stocks, which peaked in September.  Now, however, U.S. stocks are moving down alongside their European counterparts, with banking shares among the downside leaders.

Here is one last chart.  This one is a cumulative running total of all NYSE stocks trading on upticks minus those trading on downticks.  The measure is updated every second of every trading day.  It's one of the most sensitive indicators of buying and selling pressure, as it reflects the aggressiveness of buyers (lifting offers) and sellers (hitting bids).

Notice how, during the decline of early 2018, the cumulative uptick/downtick line did not move significantly lower and indeed held above its February lows when we bottomed in the spring.  The cumulative TICK line was not able to make a new high going into the ultimate peak in SPY and, indeed, started trailing off before we actually peaked in the index.  That was one yellow caution light I noted in September.

From there it has been straight down in the cumulative measure, reflecting aggressive selling across the entire stock universe.  In that respect, this decline has not been like the previous one.

As I mentioned in the previous post, my job, both as a trader and as an investor of family capital, is to stay open minded and consider a range of possible scenarios.  That means looking beyond the U.S. and trying to make sense of areas of the financial world that are weakest.  It also means collecting data that others overlook and looking at time frames wider than the norm.  My goal, per Helen Keller, is to ensure that my sight enables me to also have vision.  At the moment, I can't say I am comfortable with what I see.

Further Reading:

NYSE TICK as a Trading Tool

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Are We Going To Crash?

That is the question I've been hearing a lot lately.  I don't hear anyone talking about stocks running to new all-time highs.  I do hear about all the market woes, from tariffs and trade wars to discord in Europe to political turmoil in the U.S.  My job, as a trader and as an investor, is to entertain a variety of scenarios based upon the data in front of me.  As much as possible, I want to stay open minded to what others are not looking at.  Very often that is where an edge can be found.

For example, on September 24th my blog post highlighted caution signals for the overall market.  A variety of supply/demand flow measures had turned decidedly negative.  We've seen weakness in stocks overall since that time.  Reports indicate record amounts of cash being taken out of the market, with 49% of surveyed investors expecting a market decline over the next six months.  That is the highest percentage since 2013.

And, yet, with all the selling, all the negative news, and all the bearishness, we have merely roundtripped the early 2018 performance.

This chart shows the ES futures from May of 2017 to the present.  Each data point represents 50,000 contracts traded.  You can see that the entire bear period to date has, so far, been a relatively flat correction on a large time scale.  That is not so unlike the 1994 market, which dipped in the first and last quarters of the year, forming a range.  The upside break of that range lasted six years.

Thus far, the flow and breadth measures that I track are not telling me that the selling has dried up.  I need that confirmation before more seriously entertaining the upside.  The below chart from Index Indicators, depicting the daily SPX average versus the number of 52 week new highs minus new lows, is quite informative.  Notice how we hit a maximum number of new lows during the February decline, with new lows drying up over the next several months even as price moved lower for a while.  On the reverse side, note how new highs dried up as we made fresh index highs in September, per the blog post at that time.  At present, we've been seeing price weakness, but not a meaningful drying up of the number of stocks posting fresh 52-week lows.  My measure of cumulative upticks versus downticks continues to make new lows, reflecting net hitting of bids across the broad NYSE universe.

As long as I'm not seeing signs that the lower prices are bringing in fresh value buyers, my game plan remains to fade short-term overbought levels that roll over at lower price highs.  I'm open to both sides of the market, however, and am monitoring day over day strength versus weakness to handicap the odds of a big picture break from the longer-term range.  The key is stepping back and seeing 2018 as a range.  A break to new lows that still cannot find buyers will tell one story; a break that traps sellers and vigorously returns to the range could tell a very different story.  Right now I'm a bear who is uncomfortable having so much company in that view.

PS - I'm updating this at 8:35 AM EST on Saturday morning.  This was originally posted yesterday morning and already has gotten more hits than the majority of my blog posts.  That, too, nicely reflects current sentiment. 

Further Reading:

Three Lessons From Victor Niederhoffer

TraderFeed Home Page and Index

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