Are You Taking Enough Risk In Your Trading?

 

This is going to be a little technical, but please bear with me.  It is super important to your trading.

Imagine a variable that captures danger at one end of the spectrum and opportunity at the other.  Now imagine that life offers most of us a relatively normal distribution of dangers and opportunities, such that we mostly experience small risk and small opportunities in day-to-day life, but once in a great while encounter very large dangers and very large opportunities.  Such a normal distribution of outcomes looks like this when we plot it:

In such an idealized model, we encounter really large dangers roughly 2% of the time and really large opportunities similarly.  Over two-thirds of the time, we're dealing with modest opportunities and dangers.

Odds of 2% seem quite low, but over an annual period, we're likely to encounter a handful of really big risks and really big rewards.  On over 240 of those days, there will be no truly great opportunities or dangers.

Sounds a lot like trading, doesn't it?  

The personality trait of extroversion tends to be associated with risk-seeking.  To some degree, the trait of openness to experience also plays into risk appetite.  Think of a skier who goes after the largest mountains and steepest slopes.  That person is focused at the far right end of the continuum, seeking to capture the greatest opportunities.  Of course, in extreme sports as in trading, seeking those rare huge opportunities can also entail taking significant risks. 

The personality trait of conscientiousness is associated with risk-prudence.  The highly conscientious driver will not exceed the speed limit on highways and will only ski the safest slopes.  That person will generally never have the thrills of extreme sports, but will rarely have bone-crushing accidents.

OK, now we get to the juicy part:

Early in our development as traders, risk-prudence is paramount.  We cannot win the game unless we stay in the game.  At firms where I work, such as SMB Capital, the initial goal is not to become a hugely profitable trader.  The goal is to become a consistently profitable trader.  In skiing terms, the consistently profitable trader is one who can master small hills, then somewhat larger hills, then small mountains, etc.  It is the repetition of success--the consistency of successful experience--that builds confidence and inner security.

Imagine if we were simply risk-seeking and began our trading career by placing large bets.  Inevitably we would also encounter large losses and that would shatter our development of confidence and inner security.  (Recognize that, in trading, risk is relative to the size of our portfolios.  If I limit my daily losses to $1000, that may seem like modest risk-taking, but not if I'm trading a $10,000 account!)

The path toward becoming a highly profitable trader is first becoming a consistently profitable trader.  It is consistency of process, mindset, and selection of opportunity that provides us with the emotional capital to go after larger rewards.  I cannot emphasize this too highly.

However, there is a danger that the comfort and security of being consistently profitable can lead us to never go after those larger rewards.  Think of an entrepreneur.  The successful new enterprise requires consistent profitability, but what if the entrepreneur never takes the larger risks of opening new stores, developing new products, or forming new partnerships?  The entrepreneur might end up as a profitable local businessperson, and that might be fine for them, but they will never grow the kind of business that they could eventually take public.

In becoming that consistent trader, we can so emphasize conscientiousness that we never take the greater risks that are associated with larger rewards.  In poker, it would be like being dealt three aces and still placing modest bets.  Once in a while, life--and markets--present us with those 2+ standard deviation opportunities that come along 2% of the time.  When we stand aside on those occasions, we ensure that we will never reap great rewards.

So there it is:  greatness, in any endeavor, is a distinctive blending of general risk-prudence and selective risk-seeking.  Greatness is staying in the game, adapting, and winning--and then pouncing on occasional unique opportunities.  The mindset of consistent winning is what provides the resilience of big winning.

Now you see why I emphasize trading psychology methods that increase our access to intuition and implicit knowing.  Very, very often, it is that intuitive knowing that alerts us to the larger opportunities, those 2% of occasions when we're meant to take larger swings.  Consistent trading will not help us if we do not also cultivate consistent openness of mind.  Most of the time, the military sniper lies in the weeds and takes little to no risk.  But once in a while, the high value target appears and it's worth taking the shot that may alert the enemy.  The mindset while in the weeds is calm focus and patience, but also extreme openness to and readiness for the high value opportunity.  

So much of the challenge of trading psychology is the challenge of sniping:  blending consistency of shooting and the patience of waiting with the aggressiveness of taking the risks associated with special opportunities.  Once you have learned and mastered the patterns associated with consistently profitable trading, it's time to master the intuitive knowing that alerts us to the greatest rewards.  In my next video, I'll outline a method for cultivating and acting upon this knowing.

Further Resources:

How To Become A Significantly Profitable Trader - Video

Where Does Our Trading Edge Really Come From? - Video

A Radical Method for Quieting the Mind

How We Turn Our Talents Into Actual Trading Edges

Taking The Risks Of Accountability

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Turning Your Talents Into Trading Edges

 

This is a somewhat  long academic paper about the development of confidence and talent among elite swimming champions, but it is well worth studying.  The key point made by the author is that excellence is mundane.  Greatness is not necessarily a function of unique talent or special opportunity.  We achieve excellence step by step, through intensive deliberate practice, where we perform a skill, monitor our performance, make small but steady improvements, and gradually perform at elite levels.  The example I used in my recent presentation for Traders4ACause was the meter that I use to measure my blood glucose levels through the day.  Each day I learn what contributes to high and low readings: the foods I eat, the types of exercise I do, my sleep patterns, etc.  By tweaking each of these, I've been able to stay in my target zone range well over 95% of the time.  Prior to the use of the meter, I never came close to that control. 

When I was a student in college, I would read each professor carefully to see which points were emphasized, what was written on the blackboard, what was included in handouts, etc.  This would guide me in what to study.  When I missed items on a test, I went back to my notes and figured out what I had missed and how I could have included it in my studying.  That then guided my preparation for the next test.  By the end of the course, I was unusually good at figuring out what would be on my exams:  my overall GPA was 3.87.  That wasn't because I was so much brighter than other students.  I simply learned how to play the game.

Great traders learn how to play the game, only there are many potential games to play.  Your edge doesn't come from the game itself, but from the process of mastery that allows you to win at the game.  This is why trading journals have to incorporate detailed analyses of trades and how those trades could have been conceptualized, structured, and managed better, so that you constantly refine what you do.  Many traders simply summarize their day or their feelings in a journal and wonder why they don't achieve mastery.  Mastery comes from the mundane practice of taking one skill after another and honing them until consistency is achieved.

Talent is inborn, but it develops through exercise.  What builds our trading performance is what builds us up in the gym:  the steady tackling of challenges performed the right way.  This is why there can be no trading edge without our pursuit of discomfort.  Honing performance means embracing our shortcomings and turning those into learning and development.  When that honing becomes an ongoing process, great things can happen.

Further Resources:

Improving Your Performance By Radically Quieting Your Mind

Where Does Our Trading Edge Really Come From?  - Video

Figuring Out The Settings For Your Technical Indicators

Is Trading Your Path To Greatness? - Video

How To Get The Most From Your Trading Practice

Videos From The Three Minute Trading Coach

Trading and Spirituality - Free Blog Book

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Making Friends With Discomfort

 

Life is a gym.

Every day is an opportunity for a workout, to make ourselves stronger, more fit.

We can exercise our relationships, our patience, our focus, our persistence, our discipline, our learning, our trading--or we can go through the motions and never build ourselves up.

A good workout on the treadmill has us breaking a sweat.

A good workout on the weight machines has us straining to finish that final set of reps.

If a workout doesn't challenge us, we don't grow.  If we don't experience discomfort, we don't change.  Indeed, if we don't use a capacity, we lose it.  

Successful people are always working out, always growing their capacities.  That means that they make friends with discomfort.

No one has ever grown by remaining in their comfort zones.

Trading success is so much more than "following your process."  Your premarket preparation, your trading activities, your reviews and goal-setting for the next day's trading--all must be workouts, not rote processes.  

Those who don't workout are quickly out of work.

Further Resources:

Video:  Using Your Calendar to Build Your Trading Psychology

Drawing Upon Strengths to Improve Weak Performance

How We Avoid Burnout in Trading

How Our Strengths Shape Our Trading Psychology

Radical Renewal - Spirituality and Trading - Free Blog Book

YouTube Channel:  The Three Minute Trading Coach

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You Are Your Own Role Model

 

Here's a great exercise:

Look at how you prepare for the trading day from the moment you wake up.  Look at how you approach your trading, how you make your decisions, how you deal with the ups and downs of P/L.  Look at how you review your trading day and how you spend your time outside of markets.  

If someone were filming you throughout all of these parts of your day, would you be proud of the film?  Would you want to show it to developing traders as a role model for how they should approach their craft?

We internalize what we do.  We are always our own role models.  If we would not be proud to display our lives to others, what does it say about what we're willing to accept for ourselves?

Think of all the qualities you associate with good trading and be those things in your day to day life.  There is so much more to preparing for success than jotting notes in a journal.

Radical Renewal:  Spirituality and Trading

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How To Make Big Changes In Your Trading Psychology

 

Hate can be your ally in making changes.

If you get to the point of actually *hating* your trading problems, you push those problems away from you.  You don't identify with them.  You don't lazily fall into them.

If you *hate* frustration and what it does to your trading, you're not likely to mindlessly fall into a frustrated mode.

What if you visualized your trading problem as being the one thing standing between you and success, between you and a bright future?  If a person stood in the way of your fulfillment, you would hate that person and fight them with everything you had.  Suppose that was your attitude toward your overtrading, your trading on TILT, your reluctance to take signals?

You can make big changes in your trading psychology when your priority is conquering your enemy, not making money.  The P/L is the payoff; the battle is with your enemy.  

You cannot truly love your success without hating what stands in its way.

This week's Three Minute Trading Coach video provides some perspective on how we can win our battle with our enemy.   

Radical Renewal:  The Spirituality of Trading

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Why You're Having Trouble Getting To The Next Level Of Trading Success

 

In the last blog post, I described how I think about markets and trade successfully.  When I follow that framework, I generally do well.  When I attempt to view and trade markets in other ways, I rarely succeed.

The most recent Forbes article is important, because it emphasizes the role of self-management in our success.  Each of us is our own manager, whether we embrace that role actively or neglect it.  Many problems in our trading come from mismanaging ourselves.

This is a very, very important concept.

The starting point of any good relationship is acceptance.  How can we be close to someone; how can we be supportive of them; how can we truly understand and appreciate them if we don't accept them?  

There is an important difference between expanding our trading edges and failing to accept ourselves and our strengths as traders.  Expanding your edge means finding new and different ways of doing the things that already make you successful.  That means applying your strengths--what you do distinctively well--in new ways:  new markets, new market conditions, etc.

Many times we tell ourselves that we're expanding our edge when, in reality, we are trying to be someone and something we are not.  When we make large changes in our holding periods or strategies, we often require ourselves to process information in radically different ways and take on very different levels of risk.  We get away from what we do well and that dilutes our results.  It does not expand us in the least.

We have trouble getting to the next level of trading success because we haven't taken the time to fully identify, appreciate, and embrace our trading strengths.  Perfectionism can be deadly:  it tells us we're not good enough as we are.  An important theme in the Forbes article is that the quality of our performance depends upon the quality of the relationship we have with ourselves.  If we're not good enough as we are, will we ever be able to make the most of what we have?  Can we manage ourselves and our trading well if our relationship with ourselves lacks acceptance?

How To Stay Open Minded In Your Trading:  Video      

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What Settings Do You Use For Your Technical Indicators?

 

This was a question recently asked of me during a webinar.  It reminded me of an observation of a trading software vendor who provided expert support for his product.  He said that, whenever he spoke with traders needing support and discussed how they were using the software, in 90+% of the cases, they were using the standard, default values for the indicators.  Very few traders explored or adjusted parameters; they stayed with the familiar.

I have found this to be true among users of very specialized software as well.  Many times, there are very powerful tools that can be found on the platforms, but those go unnoticed by a great majority of users.  The enemy of trading success is not emotion; it's mediocrity.

I do look at some technical indicators, particularly oscillators, but not really in a predictive way.  As one wise observer noted, technical indicators are like weather vanes:  they tell you which way the wind is blowing; they don't provide weather forecasts.

The reason I use oscillators and indicators such as those in my recent posts is that I am trying to gauge the presence of cycles within market trends.  If I can identify a trending market with tools that assess buying and selling pressure, then I want to use cycles within the trend to provide entry and exit points with good risk/reward.

So back to the question:  what settings do I use to identify potential cycles in the market?

Quite simply, I look at the settings that were most effective in tracking cycles for the previous day or two and use those settings as long as the current day's relative volume is not unusually high or low.  Since early 2018, the correlation between today's volume and yesterday's volume in SPY is approximately +.86.  The correlation between today's true range and yesterday's range in SPY is about +.77.  In other words, a solid early estimate of today's market participation is yesterday's participation.  I then track relative volume in real time to see if movement and volume are meaningfully diverging from yesterday's values.

If today is tracking yesterday pretty well, I conclude that, over the short time horizon, we have a relatively stable time series and the presence of cycles yesterday should provide information about cycles we expect to see today.  So that means that the technical indicator settings that were most useful in tracking yesterday's cycles aren't a bad starting point for estimating today's ups and downs.  Of course, this logic applies to multiple time frames and is important when considering the interaction of time frames.

For the active trader, there are few considerations more important than *who* is in the market.  That tells us a lot about how markets will move.  The failure to adapt to changes in the market's movement lies behind many trading failures.  The best trading opportunities don't occur in strong, weak, busy, or slow markets.  The best opportunities occur in relatively stable markets: those moving similarly to the recent past.  That provides a unique insight into "edge" and an important criterion for when to not trade.  

The Three Minute Trading Coach

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How To Identify Market Strength And Weakness In Real Time

 

I recently posted on the topics of training for trading success and the factors that lead to success among developing traders.  Here is an example from my own trading.  

TraderFeed readers are familiar with the NYSE TICK measure that identifies how many stocks in the NYSE universe are trading on upticks versus downticks at any given moment.  It's a great real time measure of market strength and weakness.  How price responds to the upticks/downticks is just as important as the absolute value of TICK.

On the top chart (from Sierra Chart, Friday's market), you'll notice a TICK measure specific to the NASDAQ 100 Index.  On the bottom chart, is a TICK measure for the Russell 2000 Index.  I've drawn yellow arrows to show the divergence between the TICK readings for the two indexes around 10:16 AM.  There was also a divergence between the TICK readings for the Dow 30 Index and the Standard and Poor's 500 Index.  By looking at TICK measures specific to each index, we can identify strength and weakness in real time.

I review these patterns each day and find ones associated with trading opportunities.  The continual review--and the focus on unique, informative measures--has greatly helped the consistency of my trading.  For a while, my trading performance was lagging.  It was when I doubled down on one of my strengths--pattern recognition--that I was able to identify and exploit new opportunity.  

How to Use Our Strengths to Improve Trading Performance

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One Tough Question To Ask About Your Development As A Trader

 

Imagine that you are an aspiring athlete.  You want to make the cut to join a championship team.  Here is the question:

If you trained as hard for your sport as you currently train to improve your trading, what would be your odds of making the team?

Reviewing markets, reading about markets, talking to people about markets: all those might be helpful, but they are not training to improve your trading.  What are you doing to actually train for improved performance?

As the most recent three-minute trading coach video suggests, we become what we do daily.  That is how we reach our trading psychology and trading goals.

Perhaps traders run into problems in their trading simply because they are out of shape.  Without the training that pushes us to use it, we tend to lose it.

The Three Minute Trading Coach

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Relative Volume: How Much Opportunity Is In The Market Today?

 

For short-term directional traders, opportunity often boils down to movement.  It's tough to take a lot out of a market that is moving in a narrow range.  This is why a common topic I hear among the traders I work with at SMB is whether they should be focusing on trading the market vs. trading individual stocks that are moving.  In lower volatility market environments, it's often promising to shift the trading focus to those "stocks in play".

That is why I carefully track the relative volume in the overall market on an intraday basis.  Above we can see the last two trading days in SPY (top), with five-minute bars going into the market close.  The bottom panel consists of color coded relative volume bars.  Relative volume tells us, at each time period, whether the volume we are currently seeing in the market is above average (green), average (blue), or below average (red) compared to the last five trading sessions.

Let's think about what that means.  If we see unusually low relative volume, it means that large, directional participants are not active in the market.  In relative terms, market makers and short-term traders are dominating the price action.  The players we need to see in the market who can create sustained momentum and trends are not a force to be reckoned with in the market.  To some degree, in today's market, that is a function of institutional participants sitting out of the market ahead of tomorrow's Fed meeting.  You can see from the yellow arrow and the sequence of declining red bars that, as the day proceeded, volume was low and became even more relatively restrained.

That was important to the day's trade because we had gapped up with decent initial breadth.  A trader seeing that might wonder if we would see upside momentum through the day and a possible vigorous trend day.  Noting relative volume, the trader would have questioned this hypothesis, which turned out to be a good decision.

Relative volume also provides important information relevant to how much we can take out of each trade.  Early in the morning, I bought a pullback in the market and, noticing the low volume, sold it for a quick four-point gain in ES.  Had the strength attracted greater participation, I might have sought a more distant profit target.  Low volume means, not only less movement per day, but less movement per bar.

Many problems in trading occur when traders don't properly identify and adapt to the opportunity environment.  They play for momentum when the participants who create momentum are not present.  They add to positions that initially go their way only to see the market reverse amidst lower volume.  It isn't enough to focus on trading "setups".  We need to know how the market is likely to move when conditions set up.  It's yet another example of how having the right tools can help us master the craft of trading.

Brett's Articles for Forbes

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Free Group Coaching and Mentoring at Traders Summit

 

Traders Summit is a large online event, free of charge, that will feature a number of well-known presenters, many from the Forex trading world.  You can check it out here.  On Saturday, September 26th at 8:45 AM Eastern Time, Joe Perry of Forex Analytix and I will be hosting a large coaching and mentoring event, where we answer any questions you have about trading, markets, trading strategies, and trading psychology.  The entire session will be Q&A and discussion, so that we can learn from each other's questions and integrate mentoring and learning with coaching.

Do you have questions you'd like to see Joe and I address in the session?  I'll be happy to put the questions from readers at the front of the queue.  All you have to do is send your question to the email address I use for the blog site (steenbab at aol dot com) and we will tee it up for the Summit session!

Thanks for your interest.  I look forward to seeing you bright and early a week from Saturday!!

Traders Summit

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What Is The Psychology Of Other Traders In The Market?

 

In recent posts, I have illustrated some of the market information I track to gain an edge in my trading.  This post took a look at one of my favorite indicators and how I use it to identify market trends.  This post and this post examined how I find longer-term edges in the market that are related to momentum/trend and value/reversal.  This post took a unique look at market breadth and concerns it posed for the market.  Now we'll take a look at information that can help us identify the psychology of the traders who are active in the market.  That's like taking a look around the poker table and gathering the "tells" that give you some idea of who might be holding strong and weak hands.

(By the way, I share this information as a way of giving back to the trading world that has been good to me, but also as a way of connecting with other traders doing and sharing unique things in the market.  Who we are determines who we will attract, and I want to attract and surround myself with talent.  There is no better way of attracting rational, inquisitive, and creative minds than to make those qualities visible to others.  Over time, that has enabled me to build a rich and rewarding network.)

OK, so click on the chart above that is taken from my Sierra Chart platform.  The top panel shows the December ES futures on a five minute basis, looking at Friday's morning session.  The red and green MESA adaptive moving averages are based on the work of John Ehlers and are constructed to minimize false signals from whipsaws.  We get a buy signal when the red line crosses above the green and vice versa.  The slope of the green moving average gives an idea of trend.  We get a crossover signal to the upside at 10:45 AM, but note that we're not in a trending mode.

The next panel shows the volume traded in each five-minute period, color coded green or red depending upon whether that period was up or down.  Note some expansion of volume on the selling at 9:55 AM and some contraction of volume at the top at 11:05 and 11:10 AM.  That is worthwhile information.

The third panel is a 3-period moving average of the amount of volume that is transacted at the market offer price minus the amount of volume transacted at the market's bid price.  This tells us the psychology of other market participants:  how many are aggressive in buying (lifting offers) and how many are aggressive in selling (hitting bids).  The moving average acts as a nice short-term overbought/oversold measure.  Note how we make a short-term oversold level at a higher price low at 10:55 AM.

The bottom panel is a table with two values.  The top values represent the volume traded at the offer minus the volume traded at the bid price during each five-minute bar.  The bottom values are a cumulative running total of volume traded at offer vs. bid, similar to an advance-decline line, but now providing a running measure of the psychology of other traders in the market.  

Note the yellow arrows and the values underlined in yellow.  Notice how we're actually showing more volume at bid than offer over the course of the morning going into the market's high at 11:10 AM.  Yes, we had a moving average crossover and, yes, we had an oversold signal at a higher price low.  But as we moved higher, the sellers were actually dominant.  The cumulative numbers are getting weaker, not stronger, as we move higher.  It's a great example of a false breakout, and notice how we reversed after 11:10 AM on significantly increased selling pressure.

What goes into a perfect trading psychology is intellectual independence and the willingness to look at information that others neglect; dedicated focus and the willingness to analyze the market bar by bar every day to identify patterns and become better at recognizing them in real time; and open sharing and the willingness to give back in order to connect with the right people and learn from them and with them.

You will never be a champion playing someone else's game.

Three Minute Trading Coach Video Series

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Tools To Improve Market Timing From John Ehlers

 

I understand John Ehlers will be retiring in the not too distant future and is holding a comprehensive four-day workshop from October 19-23rd that will cover the scope of much of his work.  For those unfamiliar or uncomfortable with the math behind his methods, the workshop could provide a user-friendly, hands-on introduction.  For those willing and able to wrestle with new indicators and ways of processing market data, John's books are excellent resources.  And, on top of it all, there is his MESA software that implements his research.  I'm going out of my way to write this blog post about John and his work because I have always found him to be rigorous, evidence-based, and free of hype.  He publishes the real time track record of his stock picks on the Stock Spotter site and makes himself available to answer questions and help traders.  

Two key insights behind John's work are:  1) by creating better filters for market data, we can create superior technical indicators; and 2) by preprocessing market data (including detrending), we can identify market cycles more robustly.  As I have emphasized many times in this blog, all market time series consist of linear (directional/trending) components and cyclical components.  It is the interplay of the directional and cyclical elements that creates momentum and value patterns that can be traded.  One powerful strategy for trading is to go with market trends and make use of shorter-term cycles within those for timing.  John's work borrows tools from engineering to more readily identify these trends and cycles.

If you click on the chart above, you'll see a 60-minute chart of the September ES futures contract.  Notice in the top panel the red and green lines going through the chart.  Those are shorter- and longer-term MESA adaptive moving averages derived from John's research.  (This particular chart was drawn in Sierra Chart).  The yellow arrows show crossover points.  The MESA averages, because of their construction and filtering, provide crossover signals that are more free of whipsaws and thus more reliable than the standard version.        

Show me a master craftsperson, whether in trades or the arts, and I'll show you someone with superior tools.  No credible subspecialty surgeon uses off the rack, generic instruments and materials.  Similarly, high performing traders cannot expect exemplary results from preset levels of generic indicators.  Our psychology and mindset can be just fine, but they cannot in themselves elevate our craft.  

--

 Added 9/12/2020:

Here's a screenshot from my tradestation viewing Friday's trade in ES.  The bottom panel is a five-period detrended oscillator that makes it easier to identify short-term cycles in market data by taking trend out of the calculation.  My experience is that market time series are made more stationary (stable) when looking at volume-based bars rather than time-based ones.  In the chart, each bar represents 12,000 contracts traded so that we can see how the day session unfolded.  Note (bottom panel, blue arrows) that we make short-term cycle lows at equal or higher price lows and that the MESA Adaptive Moving Average crosses over between the two cycles (yellow arrow) to shift to a buying mode.  I love buying cycle lows at higher price lows in an early rising market where prior shorts are likely to be trapped.  Note also how the volume transacted at the bid vs. offer price shifted as the market made its low during this period, showing how buyers were becoming more aggressive (lifting offers) ahead of the market turn.  Again, the right tools make all the difference if you're going to master your craft.

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What Goes Into A Perfect Trading Psychology?

 

What ingredients go into an ideal trading psychology?  Here are a few that stand out in my experience:

1)  Planning - Think of an elite boxer going into the ring with a plan; a football or basketball team that plans for an opponent; a surgeon that plans the procedure; a military unit with a battle plan.  Wherever we see high level performance, we see evidence of extensive, detailed planning.  The ideal mindset for the trader, like for the entrepreneur, is focused on a plan and its execution.

2)  Focus - Without a plan, there is nothing to focus upon that is within our control.  It's not enough to have a plan; we also have to be laser-focused on that plan so that we can implement it automatically, as the result of considerable repetition.  The analogy I often use is that of the military sniper.  All focus is directed to the target and the execution of the plan.

3)  Calm - An excited mindset is a distracted one.  No sniper, no surgeon, no chess grandmaster emotes during a performance.  The intense focus on the plan creates a flow state, a sense of being in the zone:  total absorption in the task at hand.  It is in this flow state that we are best able to discern what markets are doing and respond.

4)  Purpose - Before the performance there is a sense of challenge, opportunity, and enthusiasm.  The focus is on doing something special, something meaningful, something important.  After the performance, there is a sense of accomplishment, appreciation, fulfillment.  The elite performer is motivated by purpose and that drives an energized mindset that motivates the calm, focused planning.

Think of the Broadway actor or actress before going on stage.  There is anticipation and enthusiasm and the desire to connect with the audience and provide an amazing experience for all.  And that drives a complete absorption in the role and on everything that has been rehearsed.  It's all about calm focus and being that person you've rehearsed so often in practice.  Preparation for trading and going live each day in markets is not so different.

Resources for Trading Psychology

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What Predicts Success Among Developing Traders?

 

I've spent many years working with developing traders and have learned a good amount about what makes some successful and others not.  Below is a summary of what I've learned:

1)  Motivation and passion for trading and succeeding are not predictive of success - Not all who profess motivation are hard workers and not all hard workers work the right ways.  Starting out with a drive to make money is, if anything, associated with greater odds of failure and emotional upheaval.  There *is* an association between dedicated effort and success (see #2 below), but it's the ability to channel motivation into constructive effort that is key to success.  The louder the trader professes passion and motivation, the more I dig to look for substance.  I generally come away with very little.

2)  The learning that goes on before a trader puts money at risk and the effort that goes into learning when markets are not open are predictive of success - The consistency and intensity of the learning process distinguish those who succeed.  The amount of detail in their journals/reviews and the ways in which the reviews build upon one another over time are big predictors of success.  Unsuccessful traders take away isolated, fragmented bits of learning from each day and week.  Successful traders have a curriculum in mind:  they learn in a cumulative, coordinated fashion.  True deliberate practice is a significant predictor of success.

3)  Innovation is predictive of success - I consistently see successful traders develop multiple ways to profit in markets.  They don't look at the same things as everyone else, and they don't think about markets the same way.  I recently spoke with a trader who utilizes options structures to trade patterns associated with macroeconomic data releases.  Sometimes his trades capture patterns of volatility, sometimes directional patterns, sometimes patterns of relative value.  He is playing on a multidimensional chess board, and that provides him with multiple ways of winning.

As Mike Bellafiore and I emphasized in our recent podcast with Tradeciety, success in markets comes in stages:  first with learning concepts; then by observing patterns in markets; then by practicing trading and developing consistency in performance; then by sizing up risk and cultivating new sources of edge.  A very common source of failure among traders is the temptation to short-circuit this process.  

Now here's a key takeaway:  It's the quality of the learning process that shapes the positivity of a trader's mindset.  A positive psychology does not create success.  A positive psychology is the result of focused learning and the exercise of creative problem solving.  No amount of self-help exercises will substitute for skill development and the capacity to uncover fresh sources of opportunity.  There is a surprising overlap between the qualities of successful traders and the qualities of successful entrepreneurs.  Innovation + focus + detailed effort turns dreams into realities.

The Three Minute Trading Coach Video Series

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How To Ride Trending Moves In The Market

 
A common issue I hear from traders is that, if they miss an initial move in the market or in a stock, they have trouble participating in a potential trend.  Indeed, sometimes out of the frustration of missing the initial move, they will find themselves fading it and turning a missed opportunity into an actual loss.  Here is one tool I use to trade potential trending (directional) moves in the market and how I use it.

If you click on the chart above, you will see a one-minute chart of the SPX futures (ES; bottom panel) for yesterday's morning session.  Plotted above is the NYSE TICK readings, with the zero line highlighted in yellow and a green line providing a five-minute zero-lag moving average.  (Chart from Sierra Chart).  

What we can see very early in the session is net buying interest (upticking), with the moving average of TICK above the yellow line.  Notice, however, that the buying interest is modest and does not result in a higher early move in ES.  Then we begin making lower lows in the TICK and lower highs, with the overall distribution of the TICK values falling mostly below the yellow zero line.  As that occurs, we can see ES price moving lower.  Indeed the bounces in the TICK, representing efforts at market buying, simply cannot be sustained and result in greater selling pressure and now a directional move down in ES.

The key identification is that buying pressure in stocks is waning and, when it occurs, can only move the index to lower price highs.  Those modest bounces in TICK are great short-term entries to the downside, allowing us to ride the emerging trending move.

Notice how this approach fits very well with the idea of trading cycles within a trending market:  when we get lower price highs with each bounce, those become opportunities to ride the direction downward.  The cycles provide us with good risk/reward entries and can be used as opportunistic exits if we're trading around a core position.

Finding the right tools and conceptual frameworks for your trading will not guarantee you a great trading psychology, but it's hard to maintain a constructive mindset without those tools and understandings!

Added 9/4/2020:

For the past year, I have been studying buy and sell signals from common technical trading systems.  What I find is:

1)  A key is identifying technical indicators that are not highly correlated to each other;

2)  A key is tabulating buy and sell signals for all stocks in a universe as your primary measure, not the technical reading for an overall index.  This captures the breadth strength referenced in recent posts;

3)  When calculated in this way, buy signals and sell signals for each system are not highly correlated at all.  This suggests that strength and weakness are independent variables and should not be combined into composite indicators;

4)  The edges associated with strength and weakness for different indicators are quite different.  Modeling multiple edges without overfitting is a promising source for quant signals.

5)  Ultimately our edge comes from looking at things others don't think of and doing a level of work others are not willing/able to undertake.

6)  When you've done the hard research and see the edges clearly, that provides a level of confidence that cannot be derived from mere self-help techniques.

Video:  Is Trading Your Path To Greatness?

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More Ways Of Finding Edges With Momentum And Value

 

In the recent post, we took at look at short-term breadth strength and how that can help us identify opportunities associated with momentum and value.  Now let's extend that view by exploring breadth strength at longer time horizons.

Using the same database with SPX, what we find is that when the percentage of stocks closing above their 20-day moving averages is in the highest quartile of the sample, the next five days average a gain of +.51%.  When the percentage of stocks closing above their 20-day moving averages is in the lowest quartile of the sample, the next five days average a gain of +.33%.  All other occasions actually average a loss of -.17%.  In other words, in the rising market since 2014, essentially all short-term gains were achieved when the market was broadly strong and broadly weak.  If we look at next 20-day returns, we find out that when stocks were most broadly strong, returns averaged +1.76%.  When stocks were most broadly weak, returns averaged +.98%.  All other occasions averaged a gain of only +.17%.  

Now let's zoom out to the percentage of stocks closing above their 100-day moving averages.  When we have had the greatest longer-term breadth strength, the next 20 days have averaged a whopping gain of +2.36%.  When we have had the lowest level of breadth strength, the market has actually averaged a loss of -.33%.  In other words, breadth strength at the longer time frame has brought considerable momentum, but low breadth strength has also shown a level of downside momentum--not value!

We're starting to see that edges are complex:  the result of interplays among short, medium, and longer timeframes.  That cannot be captured by a single chart pattern or indicator reading.

But let's take another look:  We will divide the sample into quartiles based upon VIX readings.  When VIX has been in its highest quartile, the next 20 days in SPX have averaged a large gain of +2.40%.  The remainder of the sample has averaged a gain of only +.28%.  So here we see a large value effect (weak and volatile markets leading to reversals) and relatively modest evidence of momentum.  When we look at edges in the market, breadth strength matters but may show very different forward returns in low and high volatility regimes.

What I have found is that it's when short-term patterns of supply and demand, such as the ones described here and here and here, line up with the multi-day patterns of breadth strength and volatility that the best trading opportunities occur.  There is a huge edge in clearly knowing where your edge lies.

Added 9/1/20:

Notice how we closed 8/31 with fewer than 50% of SPX stocks above their 3- and 5-day moving averages, according to the Index Indicators site.  That triggered the breadth signal from this post.  We can see from the chart below that we were getting a good amount of volume hitting bids in the ES futures, taking us to a short-term oversold point at a higher price low.  That is how price and volume behavior can confirm a signal from breadth.  Note how we have since bounced in premarket trading.

Trading psychology cannot substitute for understanding the psychology of the market you're trading.  Per Ms. Parker, when you hear someone say that your mindset is your edge, don't toss their advice aside lightly.  Hurl it with great force.  

The Three Minute Trading Coach Video Series

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Actively Trading Momentum and Value In The Stock Market

 

This post will begin a short series on finding edges in the broad stock market related to momentum (directional persistence) and value (directional reversal).  A good place to start would be to review the recent post on how to trade a trending market.  Notice how the signal described in that post captured the most recent upside opportunity quite well.  Not all movement in the market is meaningful and it's easy to get so caught up in short-term ups and downs that we end up trading randomness.  If we can backtest patterns of momentum and value, we can begin to ground our trading is what is meaningful.

So let's begin simply.  We're interested in the percentage of stocks in the SPX universe that close each day above their respective five-day moving averages.  (Data can be found via the Index Indicators site).  That provides an indication of what I call breadth strength:  the degree to which there is broad strength or weakness in the market.

My database goes back to August of 2014, so let's see what happens in the market after five days of broad strength and weakness.  To accomplish that, I first divide the dataset into quartiles and examine average forward returns.  When we have seen the broadest strength in the market (top quartile of readings above five-day moving averages), the next twenty days in the market have averaged a gain of +1.31%.  When we have seen the weakest readings on our indicator, the market has averaged a 20-day gain of +.97%.  All other occasions in the market have averaged a 20-day return of only +.48%.  

In other words, we have achieved superior returns by buying the market when we've had unusually strong breadth and when we've had unusually weak breadth.  The unusually strong breadth has provided upside momentum; the unusually weak breadth has provided value.  During the overall upward market from 2014 to present, that has been a way of capturing a good chunk of returns in the market trend, as the recent post observed.  This simple indicator has done a pretty good job of tracking the psychology of the market.

Are there ways of improving on this indicator and refining our ability to trade value and momentum?  That is what we'll explore in the next post.

Using Breadth, Strength, and Momentum to Capture Market Cycles

What Does A Professional Trader Work On In His Trading?

 

I jumped at the opportunity to participate in the upcoming Festival of Learning hosted by RealVision.  (Here is where you can sign up for the sessions that run from September 2nd - 4th).  My eagerness came from the chance to speak with Mark Ritchie, Jr., an experienced trader and fund manager.  I wanted to hear his take on trading psychology and the challenges he faces running his own fund.

So what was one of the very first things that Mark discussed in our pre-recorded session?  Was it managing his losses or staying in emotional control of his trading?  No.  It was letting his profits run.  He wisely pointed out that a trader can be great at limiting losses and getting stopped out, but still not make the most of his or her trades.

Mark questioned the wisdom of the old saying that you can't go broke taking a profit.  Because much of a trader's total return comes from a handful of top opportunities, taking profits prematurely can cap success.  This is why, in my work with traders at SMB, we focus on monthly statistics and pay particular attention to whether the average size of winning trades is greater than the average size of losers.  Many times that ratio needs improvement, not because the trader is letting losing positions go or adding to them, but because they stop out of winners before the positions have hit their targets.

Here's a big psychological point:

The traits and strengths that we need to limit our losses are different from the ones we need to maximize our gains.  We need to consider these as separate skill sets and work on them independently.

Limiting our losses is all about prudence and conscientiousness:  the ability to be careful.

Maximizing our gains is all about willpower: the ability to sustain a goal in the face of uncertainty. 

Mark's insight was that, for experienced traders, the prudence comes naturally.  If it didn't, they would never get to the point of being experienced!  But tolerating uncertainty is different.  When we watch our positions tick by tick, it's easy to see something concerning and use it as an excuse to bail.

There's an old saying:  failure to plan is tantamount to planning to fail.  If tangible targets for our positions aren't firmly set in our minds and mentally rehearsed, we will have no goals to focus on to get us through the uncertainty of price paths.  The real problem is not just getting out of trades too early.  The problem is failing to set vivid goals for our trades that energize us and feed our willpower.  Come to think of it, that's a problem many of us face in life as well as markets!

RealVision Festival of Learning

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