Indicator Review for April 14th

Last week's indicator review noted significant buying pressure among stocks as we approached important resistance near 1400 in the S&P 500 futures contract. That post further observed some potential negatives on the horizon--weak advance-decline lines, an overbought market condition, and worrisome credit spreads--but anticipated a breach of the overhead resistance, given the market's apparent double bottom. "What would change my mind from this scenario," I explained, "would be reversals of the dynamics we're currently seeing in NYSE TICK, money flows, and the expansion of stocks making new highs. Particularly worrisome would be an expansion in the number of stocks making fresh 20-day lows."

Well, guess what? As we see from the bottom chart, the cumulative NYSE TICK did indeed roll over, as we failed to sustain the test of the important resistance area. Stocks fell back last week, ending Friday on a particularly weak note. New 20-day lows expanded through the week, with a Friday reading of 450 new highs and 545 new lows. My five-day indicator of money flows into the Dow Industrials stocks turned positive with the market's rally, but fell to a modest negative level by the end of the week. Those weak advance-decline lines weakened even further, making new bear lows across several sectors and, for the broad market (NYSE common stocks), is now near bear lows. Moreover, my measure of technical strength stalled out early in the week and intermarket themes associated with stock market weakness reasserted themselves.

So where does that leave us? My cumulative Demand/Supply indicator, which has done a terrific job of identifying recent short-term market tops and bottoms, is back in neutral territory. Given the recent expansion of stocks making new lows, the declining NYSE TICK line, and the weak advance-decline performance, the best we can say is that we are trapped in a trading range between that resistance near 1400 in the ES contract and the March price lows. A retest of those lows is not at all out of the question, particularly if we continue to see further weakening among these indicators. I'll be updating the indicators daily in my Twitter posts to keep readers up to speed.

It is not at all clear to me that the current weakness will bring a new bear market leg. The number of stocks registering fresh 52-week lows has been drying up since January. For example, among NYSE common stocks, we had over 700 new lows in January, but only a little more than 300 new lows at the March price lows. This past Friday, we had 19 annual new highs among NYSE common issues and only 42 lows. That cumulative NYSE TICK line shown above has indeed turned down, but is very well off its March lows. In the past, that has set us up for divergences and reversals of tests of trading ranges. Should we fail to sustain a move below the March lows, I believe we could see some real opportunity to the upside, given the market's historic oversold condition.

As long as the indicators continue to weaken, I remain defensive. I think it's fair to say that I'm cautiously bearish on a day-to-day basis and cautiously bullish on a longer-term basis. How we resolve the aforementioned trading range will have significant implications for stocks and the broader economy.
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Is Market Weakness Offering Opportunity? A Long-Term Perspective on Stocks

With a major shout-out to Decision Point, here's a long-term perspective on the NYSE Composite Index ($NYA), which is a pretty good reflection of the broad stock market. The top panel shows price movement in $NYA, and the bottom panel shows the percentage of NYSE issues trading above their 200-day moving averages. I labeled the points at which we moved below 20% in the indicator. As you can see, those points captured major market bottoms in December, 1987; October, 1990; December, 1994; October, 1998; October, 2002; and most recently in January, 2008.

The percentage of stocks trading above their long-term moving averages is not a bad indicator of "overbought" and "oversold". If you think about it, we can define a bull market as one in which we see successive overbought and oversold levels at higher prices. A bear market is one in which we see successive overbought and oversold levels at lower prices.

I'm well aware of the market's short-term weakness, and I'll be commenting upon it in tomorrow morning's indicator update. But I wanted to pull up this longer-term perspective because, unless my eyesight is failing me, $NYA remains in one helluva bullish configuration. For all the sky-is-falling worries about housing, weak dollar, national debt, and toxic credit, we remain far above our 2002 lows and less than 15% off all-time highs.

Now maybe this time is different, and maybe the sky will fall. If so, my shorter-term indicators will pick up the expanding number of stocks making new lows; the sustained weakness in cumulative TICK, money flows; etc. But we've seen dwindling new lows since January, and the percentage of NYSE issues above their 200-day moving averages has been on the rise since then--even as we made price lows in March. If we cannot sustain the recent weakness and decisively take out the March lows, I will approach the long-term the way I approach short-term trading, entering an established trend on a pullback.

RELATED POST:

Getting Close to a Bottom?

Cracks in the Bear Foundation
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Two Stock Market Sector Ratios I'm Watching Closely

The above charts represent price ratios between pairs of sector ETFs within the S&P 500 universe. Each represents a theme that I consider to be a driver of the recent bear market. Accordingly, I am watching these ratios (and themes) for indications of a continuation vs. reversal of bear market dynamics.

The first theme (top chart) represents the price ratio between the Materials ETF (XLB) and the Financials ETF (XLF). It depicts the relative valuation of physical assets--raw materials--to financial assets. In a weak dollar environment, as well as an environment of low confidence in the banking sector, raw materials should be more attractive than financials. A reversal of this ratio would suggest that the dynamics underpinning the weak dollar (expectations of further interest rate cuts by the Fed; lack of G-7 action toward a stronger dollar; recessionary expectations; fear of bank failures) were shifting.

The second theme (bottom chart) represents the price ratio between the Consumer Staples ETF (XLP) and the Consumer Discretionary ETF (XLY). It depicts the relative valuation of defensive stocks--those traditionally deemed relatively recession-proof--vs. those that are more vulnerable to contractions in consumer spending. In a recessionary environment, Staples should outperform Discretionaries as investors flee to sectors representing relative safety. A reversal of this ratio would suggest that the dynamics underpinning the recession (weak housing market; weak consumer confidence; weak employment market) were shifting.

What we see clearly in both charts is that, since mid-2007 (the period recently highlighted as one of changing intermarket dynamics), these ratios accelerated significantly as the stock market sold off. The XLB:XLF ratio topped out in mid-March (when the stock market made its price lows), pulled back sharply, and has since been clawing its way back toward its highs as stocks have fallen back. The XLP:XLY ratio topped out in early January (when the number of stocks making new 52-week lows maxxed out), dropped back sharply, and has bounced back in a choppy manner since then.

Both of these ratios capture something of the psychology of the current stock market. A move to new highs would suggest that the psychological drivers of the recent bear market are intact. A failure to advance to new highs, even as the number of stocks registering fresh 52-week lows is dwindling, would have me questioning the bear's longevity.
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Five Lessons Traders Can Learn From American Idol

* It's a Marathon, Not a Sprint: You don't have to finish #1 to have a very successful career, and some top finishers have short-lived careers. Check out Chris Daughtry.

* Many Are Called, Few Are Chosen: For every Idol, there are many deluded wannabees. Know your strengths, and go with them.

* Be Yourself: Much of success comes from picking the right song (market, trading style) and making it your own, rather than mimicking others. Check out David Cook.

* It Takes More Than Dreams: Some of the worst tryouts are contestants with the loftiest dreams. Without talent and skill, dreams are mere fantasies.

* Listen to Feedback: The verdicts of the markets may sound more like Simon than Paula, but they provide important information for the next performance.

RELATED POST:

Ten Lessons I've Learned From Traders
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How Markets and Intermarket Relationships Have Changed Since Mid-2007

One of the great dividing points between experienced, successful market participants and amateurs is that the former realize that markets are continuously changing. They make active attempts to identify and adapt to these changes. Amateurs look for fixed patterns across all markets and all periods of time. For them, financial markets are relatively static entities.

This post illustrates how markets do, indeed, change over time. The chart above tracks volatility--the median price movement--for equities (S&P 500 Index, SPY) and interest rates (10-year Treasury rates, $TNX) both during the overnight period (close to open) and during the day period (open to close). Note that we're looking at the absolute size of movements--pure volatility--not the directionality of those moves.

What you can see is that the volatility of those movements has expanded significantly since mid-2007. In each case, the red bar is quite a bit higher than the blue bar, meaning that volatility since July, 2007 has increased for both stock price movements and the movement of interest rates. Indeed, for the most part, the movements lately have been twice as large since July, 2007 as they were from 2006 through June, 2007.

But it's not only the *size* of these movements that has changed dramatically. The relationship between stock price movements and the movements of interest rates has also shifted meaningfully. Below, here are the correlations between equity and rate movements:

Overnight, 2006 - Mid 2007: .16
Overnight, Mid 2007 - Present: .45

Day Session, 2006 - Mid 2007: .09
Day Session, Mid 2007 - Present: .40

In other words, the size of movements in equities are rates were relatively uncorrelated from 2006 through mid-2007. Since mid-2007, however, the size of those movements has been significantly more correlated: when we see big moves in one, we tend to see large moves in the other.

And, of course, when we look at the directionality of those movements, we see greater correlation during the recent period as well. In past periods, falling interest rates (rising Treasury prices) have been associated with bullish movements in stocks, as reduced rates have spurred lending and economic activity. Since mid-2007, however, Treasuries have acted as a safe haven when there has been uncertainty about stocks and the economy. As a result, we've seen a tight correlation between falling yields and falling stock prices.

Specifically, the correlation between end-of-day changes in SPY and $TNX was -.03 from 2006 through mid-2007. Since mid-2007, that correlation has soared to .56.

Volatility has changed, intermarket relationships have changed. We've also seen dramatic changes in trending over these time periods, across bonds, commodities, currencies, and stocks. Identifying and understanding these shifts is essential to successful investment and portfolio management. I would also argue that, on a day-to-day basis, it's also invaluable for intraday and swing traders.

RELATED POST:

Intermarket Relations
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Tracking the Impact of Recession Fears on the Stock Market

* Advance-Decline Weakness - The above three charts from the excellent Decision Point site show how we are testing bear market lows in the advance-decline lines specific to S&P 500 stocks (top chart), NASDAQ 100 stocks (middle chart), and Dow 30 Industrials (bottom chart). The themes of weakness noted recently continued through week's end.

* Sector Deterioration - My recent review of sector strength and weakness found strength confined to a very limited portion of the S&P 500 universe. In the last two weeks, the percentage of Consumer Discretionary stocks trading above their 50-day moving averages has plunged from over 70% to 30%. The corresponding percentage for Financial stocks has dropped from 65% to 28%. Meanwhile, we're still seeing 59% of Consumer Staples stocks trading above their 50-day averages, as money flows continue to reflect defensiveness and fears of recession.

* New Flight to Safety? - I've been watching the tax-free bond funds of late, largely because I committed a chunk of long-term portfolio money toward those. Interestingly, when we had stock market selloffs in August and March, there were selloffs among tax-free bonds, reflecting fears of default. During the recent stock market weakness, however, a number of tax-free funds have been making six-week price highs. We're also seeing some strength carry through to investment-grade corporates. Even as we price in recession, we may be discounting the probability of Armageddon.
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An Effective Technique for Preventing Frustration and Its Effects on Trading

The first post in this series dealt with stilling the negative thoughts that are triggered by trading-related frustrations. The second post outlined three steps for breaking patterns of frustration as they're occurring. In this final post in the series, I will describe my personal favorite among the strategies for dealing with frustration, one that I use extensively myself as well as with traders I coach. The appeal of this methodology is that it is preventive: it is designed to head off frustration before it occurs.

To understand the method, let's take a simple, practical example. Suppose you find traffic jams to be especially frustrating. You often lose your cool during periods of traffic delay, ruining your mood for the remaining morning or afternoon. How could you prevent this from occurring?

Telling yourself to not overreact doesn't work: emotions are amazingly refractory to such willpower efforts. Interestingly, the best approach is to actively *plan* for the very frustration you hate. If, say, you *knew* you were going to be delayed in your commute due to a snowstorm, you could prepare in advance. You might bring extra music, snacks for the car, or an audiobook for listening. You might plan out conference calls you can make from the road while you're stuck in traffic. Once you are actually sitting in the traffic, you find that it's not so frustrating: you are prepared--and that takes the emotion out of the event.

Let's take a step back and examine the causes of frustration. We become frustrated when we have a goal or purpose in mind and when this objective is hindered by forces beyond our control. Thus, we might be frustrated by an airline delay when we're in a hurry to a business meeting, or we might be frustrated when we're looking forward to a good night's sleep, but are kept awake by noise outside our window.

Frustration hits us when we experience these impediments as *threats*. The airline delay might be a mere annoyance if we're not in a rush to an important event. If, say, that event were a crucial job interview, we could be frustrated indeed.

When a trader emotionally accepts losing as part of the business, loss is not so threatening. With proper money management, it can be contained and need not pose more than an annoyance. But if a trader *needs* to make money--perhaps because of perfectionism, or perhaps because of dire financial circumstance--then normal loss might be experienced as unusual frustration. It's the overriding *need* to make money that sets the trader up for acute frustration.

As in the above example of anticipating the traffic delay, we can anticipate losses and prepare accordingly. For example, let's say I'm preparing myself for a potential reversion to a mean trading price as we're trading near the bottom of a multi-day range. I know that, as we approach the lower end of that range, that we'll either get the anticipated reversion, or we'll see a downside breakout. Either way, there will be a good trade in the offing.

Before the market opens, I seat myself comfortably and breathe deeply, slowly, and rhythmically, focusing my attention on relaxing music playing through headphones. Once I'm calm and focused, I walk myself through the anticipated trade, imagining in detail how the market trades near the bottom of its range and bounces higher, how I wait for the first pullback from that bounce, and then how I enter with my long position to capitalize on the return to the average trading price within that range. It's as if I'm watching a movie, visualizing vividly myself executing the trade idea.

Then, however, I include the frustrating event in the visualization: I vividly image the market reversing and trading weaker, with volume now hitting the market bid. I imagine myself feeling frustrated that my trade hasn't followed through, and I visualize myself stopping the trade out once we trade below the point at which the above-mentioned bounce began. Then, I further visualize waiting for a fresh downthrust (confirming the weakness) and immediately entering the market on the short side on the first bounce, flipping my position to capitalize on the downside breakout. That is my preparation for the frustration, just like the preparation of the driver who knows he'll be stuck in traffic in a snowstorm. Instead of viewing it as threat, I'm mentally rehearsing it as opportunity. The stopped out "reversion" trade tells me that we're not going to stay rangebound. Instead of focusing on the loss, I stress the information gathered from the loss and prepare in advance to flip my position.

As with the earlier exercises, this exercise requires repetition and the willingness to take time each morning to prepare for frustrations with vivid scenarios. Readers of my book on trader performance will recognize this approach as a variation of the exposure methods I described in the chapter on behavioral techniques for change. My experience is that traders can learn these methods for themselves as part of becoming their own trading coaches. My upcoming book will describe this in considerable detail. The key is embracing frustration by anticipating it and turning it into opportunity. That removes the threat from emotional triggers, enhancing a trader's self-control.

RELATED POSTS:

Overcoming Anxiety

Consumer's Guide to Coaching Traders
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A Few Thursday Thoughts

* Tracking Adverse Excursions - This is an excellent post worth thinking about. Henry Carstens has tracked the average amount a position taken at the market close will move against you by the close of the next day. You'll see why the current market has been challenging for traders and investors alike.

* Imminent? - A number of observers are predicting Middle East war. See also this perspective from Stratfor.

* Economic Realignment? - Given the new oil and gas boom in such places as the Dakotas and Western Pennsylvania, as well as a farming boom worldwide, the commodity bull market is creating a new set of economic winners and losers, as well as a new set of winners in the stock market.

* Commodities in a Weak Economy - One analyst sees weakness among industrial commodities, but strength among those linked to the US dollar.

* Thanks - To those who have passed along congratulations regarding the recent Business Week accolades.
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Currencies, Interest Rates, and Stocks: It's All One Market

* Intermarket Relationships - The ES futures (top) and Yen (middle) charts look like mirror images. As the yen has strengthened vs. the US dollar, stocks have weakened. This relationship is carrying forward this morning as I write and provided some nice intraday tells regarding market direction on Wednesday. Similar tells have been evident in 10-year Treasury yields (bottom chart), which have paralleled stock moves of late. When there is a flight from stocks, we see a flight to quality in Treasuries (rising prices, falling yields). Not shown is the euro vs. the dollar, which is moving to new highs this morning. The falling U.S. dollar has not been helping stocks, as interest rate gaps among countries continue to weigh on the currency. By way of comparison, two-year rates are down to 1.73% in the U.S., but are 3.93% in the U.K.; 3.44% in Germany; and 6.18% in Australia--even as the Fed is expected to ease rates further. The charts show different asset classes but, in times of fear, these trade as one market--which suggests that intermarket correlations are not a bad measure of investor psychology.

* One of My Better Posts - This one came in handy on Wednesday and very much supports the above intermarket observations.

* A Word of Thanks - I've received a number of positive emails about the Twitter posts, which link daily themes in markets and summarize market indicators. My goal has been to create a blog within a blog via Twitter, and the rising number of people subscribing suggests that this has been useful. For those new to the blog, the last five Twitter "tweets" appear on the blog; the entire list appears on my Twitter page.
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Quick Market Update

* Broken Support - The NQ futures were the first to break below multi-day support on Wednesday, as consistent selling sentiment (NYSE TICK) and weakness in the financial sector eventually led the entire market lower. The shrinkage in stocks registering new highs as we approached the 1400 area of resistance in the ES futures and the loss of upside momentum among stocks--both noted in the Tuesday post--anticipated this breakdown. Now we're seeing an expansion of stocks making fresh 20-day lows amidst continued negative momentum. A rundown of Wednesday's indicators will be posted to tomorrow's Twitter comments.

* Deterioration of Technical Strength - Among the stocks in my basket of S&P 500 issues evenly selected from eight sectors, we're now seeing only 16 in uptrends, 9 neutral, and 15 in downtrends. Energy issues continue to shine, given strong oil prices. If you take those shares out of the mix, however, you see that strength is difficult to find among the sectors.

* Tale of Three Markets - We're seeing bull market highs for the Advance-Decline line specific to the S&P 500 energy stocks that comprise XLE. We're also seeing fresh bear market lows for the Advance-Decline line specific to the S&P 500 financial stocks that make up XLF. It's not a good sign that the AD Line specific to the S&P 500 consumer discretionary stocks that comprise XLY has also made a bear market low as of Wednesday. If we were on the verge of an economic turnaround thanks to central bank and government intervention, one would think that the lines would be moving higher in unison, in anticipation.
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Market Review and Resources for Wednesday

* Banks Continue to Lag - Here we see a chart of the S&P 500 Index ($SPX; top chart) since the mid-March bottom. Beneath it is the equivalent chart for the banking sector ($BKX). Whereas the large cap market overall has vaulted above its 3/24 highs, the banks have not. Moreover, the large caps have only retraced a modest portion of their early April rally, but the banks have retraced about 50%. As my recent post indicated, the strongest sectors of late have been energy and materials--a reflection of weak dollar and strong commodities. That's not a theme that is a good foundation for a sustained bull move in stocks. The 1400 area remains important resistance for the ES futures; I don't think we'll sustain an upside breakout unless something ignites these banks.

* More on Mind and Body - An interesting research report links depression as a causal factor in Alzheimer's Disease. As some of the links I posted recently indicate, depression is also implicated in heart disease--and negative patterns of thinking are implicated in the genesis of depression. It's not too difficult to connect the dots and see fascinating patterns between how we think, how we feel, and how healthy we are. The exercises from my recent post (and the one from my upcoming post) might be helpful for more than trading alone.

* Establishing a Track Record - I see Rob Hanna's trade ideas from his tested historical patterns have performed nicely. Rob generously shares many of his patterns in his blog. If you didn't catch my Twitter link to his pattern post, it's worthy of study. And, while we're on the topic, Rennie Yang maintains a continuous track record for his "trend catcher" system and provides intraday alerts of signals. That system recent moved to new equity curve highs, amidst an increasing incidence of trend days. Excellent resources; you have to admire newsletter writers that test their ideas in advance and then track their performance in real time.

* Gaming Stocks Ahead of Earnings Reports - Kirk takes a look at issues that make his stock screening cut and then examines their earnings report patterns and expectations prior to announcements. This could be a nice way to play behavioral finance biases associated with underreactions to surprise news events. While you're at it, check out The Kirk Report's interview with economist and contrarian Irwin Yamamoto. His outlook on housing, consumer debt, and the Dow is sobering.

* Not Shorting a Dull Market - Trader Mike notes a short-term sell signal, but he's holding off until he sees volume confirming the intentions of sellers. So far, we've seen dwindling new 20-day highs among stocks in recent days, but no expansion of 20-day lows. It's the latter that would turn me bearish on this market.

* Going for the Yield - Anyone looking to park money relatively safely and achieve any kind of real returns has to be disappointed with the yields available for Treasury instruments and bank certificates of deposit. With baby boomers fearful of returns from stocks and real estate, it's only a matter of time before they swarm to AAA-rated tax-free yields that continue to exceed the aforementioned taxable rates. The Vanguard funds (intermediate-term: VWITX; long-term: VILPX) are ones I've been nibbling at, given low management fees and good diversification among AA and AAA-rated issues. Also on the radar are investment-grade corporate bonds, with long-term instruments pushing a 6% yield (VWESX). Not all safe bond funds are safe, however; check out the links at Abnormal Returns.
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A Quick Look at Technical Strength

The stock market's rally has stalled out as we've approached the resistance area emphasized in the most recent indicator update. Short-term momentum has turned negative, with Demand (an index of stocks closing above the volatility envelopes surrounding their moving averages) finishing Tuesday at 21 and Supply (an index of those closing below their envelopes) at 81. Stocks making fresh 20-day highs dropped to 706; new lows were 236. By contrast, we were seeing over 1900 fresh 20-day highs at the middle of last week.

So which sectors are strong and weak in technical strength? My measure of short-term trending across 40 stocks (five from eight S&P 500 sectors) looks like this:

Materials: +240
Industrials: +60
Consumer Discretionary: +140
Consumer Staples: +200
Energy: +360
Health Care: +40
Financial: +40
Technology: -80

Once again, those commodities/weak dollar themes of Materials and Energy continue to lead the stock market, whereas growth themes (Technology, Discretionary) somewhat underperform defensive themes (Staples). I find the lack of follow-through in relative strength among the Financials particularly concerning and strongly suspect that, if we're going to sustain a break above the 1400 SPX resistance, the strength will need to come from confidence among those Financial shares.
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Three Steps for Breaking Patterns of Frustration in Trading

In my recent post, I recounted the example of Rick and the frustrated thoughts that were interfering with his trading decisions. A major idea from that post was that Rick's thought and behavior patterns were not really overreactions (as he thought they were); nor were they signs that he was "crazy" or "immature" (also things he called himself). Rather, Rick's patterns represented conflicts from his past that were triggered by events in the present, setting off old (and out of date) ways of thinking and behaving.

Research that I recently cited finds that "willpower" is much like physical energy: it can be depleted with effort. When we expend effort on following markets and containing emotions, our reserves of self-control dwindle. This, in turn, leaves us ever more vulnerable to those situations in which present events trigger automatic thoughts and actions from the past.

It is for this reason that "controlling" or fighting emotions is not helpful for the trader. Even if we succeed in keeping a lid on feelings, we take ourselves out of that performance "zone" in which we'll make our best decisions. Only by removing ourselves from the trigger situation and putting ourselves in a different physical and emotional state can we short-circuit the negative patterns (make them less automatic) and enable ourselves to re-enter that decision-making "zone".

So let's break this down: the first steps in changing negative, automatic patterns are threefold:

1) Recognizing the triggers for our patterns - Typically, there are a limited number of situations that set us off. For Rick, for example, a trigger situation was one in which the market moved suddenly against him. This set off feelings of frustration, which then triggered self-talk about markets were "rigged" by the "big guys". Those thoughts, in turn, triggered efforts to fight the big guys, leading Rick to double down on his now-losing trades. This sequence can occur relatively quickly, but notice how there are many points at which Rick could interrupt the cycle. One technique I've found consistently useful is having traders keep a journal in which they look back on periods of frustration and identify the triggers. Reviewing this journal helps us become more aware of--and sensitive to--our triggers. This brings us to our second step.

2) Recognizing that the patterns are occurring - This means monitoring your state of mind and your physical state at regular intervals during the trading day. One tool I've used with traders is a simple picture of a thermometer, in which traders can fill in the time of day and their "stress temperature". The idea is to recognize frustration *before* it triggers ongoing, negative, automatic patterns of thought and behavior. (One trader I worked with stayed hooked up to a biofeedback unit while trading for this very purpose. He stopped trading temporarily when he exited the "zone" to a significant degree). The idea is to generate a mental red flag when we recognize that frustration has been triggered. A journal can be helpful here, as well. In this case, the entries would be in real time: How am I feeling right now? What am I thinking? What is the state of my body? Such a journal strengthens our ability to act as an observer of our patterns, reducing the likelihood that we will become lost in them. This, in turn, brings us to our third step.

3) Taking the break from trading and entering a new state - Once you exit the situation that is triggering frustration, you can engage in an activity that greatly shifts your physical state. The odds are good that this will also move you to a different cognitive and emotional state. A quick round of active exercise (such as jogging on a treadmill, calisthenics, or push-ups and sit-ups) can work very well. Conversely, you may find it more effective to listen to very quieting music and then perform a meditation exercise: vividly imagining yourself in a peaceful location while you rhythmically breathe very deeply and slowly for a few minutes. If you use biofeedback, this would be the time to engage in one of the biofeedback routines. One unit I use, for example, (em-Wave) includes on-screen "games" in which you keep a balloon aloft by staying "in the zone". The idea would be to only return to the trading station once you've kept the balloon aloft for a few minutes. That completely short-circuits the negative behavior pattern. It will take some creative experimentation to find the specific activities that work best for you in shifting your state. In many cases, just taking a break, putting on some music, getting a bite to eat, and walking around are enough for me to clear my head and start fresh.

Notice that the most important step in the above is the decision that a trader makes to not buy into the frustration and the resulting negative self-talk. The market is not the problem. Other traders are not the problem. "My terrible luck" is not the problem. The problem is buying into negative thinking and letting it control trading decisions. That is why the most important step of change of all is the decision to actively fight these automatic patterns. They--not you, not trading--are the problem. Once they're triggered, your sole priority is to interrupt them and prevent them from controlling your behavior. With each interruption, you distance yourself from the patterns and make it easier the next time to extricate yourself from them.

If you find that you cannot identify the triggers and recognize them as they're occurring, you may want to try some of the techniques highlighted in the two chapters in the Enhancing Trader Performance book devoted to cognitive and behavioral methods. I wrote these chapters specifically as self-help mini-manuals for traders. If you find that even self-help methods are not working for you, that's the time to consider professional assistance. Here's a reputable website that offers referrals of licensed professionals in various geographic areas.

That having been said, my experience is that the most common reason that self-help methods don't work is that traders don't stick to them. Patterns that have been acquired over a period of years and reinforced by years of repetition will not go away simply by talking with a coach or trying an exercise a few times. If traders faithfully carried out the three steps above every day for a month, I'd expect to see significant progress in the vast majority of situations. What happens, however, is that traders don't see progress after a few days and give up. It's not the time with a coach or counselor that generates change--it's the consistency of hands-on efforts day in and day out to interrupt and change our patterns.

For my last post in this series, I will outline a specific routine that I use to work on myself. It will illustrate a different aspect of working on changing our automatic patterns: preventing them from occurring in the first place.

RELATED POSTS:

Brief Therapy Techniques for Traders

A Framework for Rapid Behavior Change

Solution-Focused Change
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Markets and Minds for a Monday

* Sector Strength - The above chart shows how stock sector ETFs have fared since the January and March market bottoms. Interestingly, Materials (XLB) and Energy (XLE) are strong performers since the January lows, but have not been so dominant since the March lows. Conversely, Financials (XLF) have moved only modestly since the January lows, but are leaders in the recent period since the March bottom. Homebuilders (XHB) show up strong since both bottom periods. The most recent rally has been led by beaten down sectors, as investors are showing less fear and more optimism regarding housing and banks. Health Care (XLV) has been something of a laggard, perhaps anticipating challenges following the upcoming election.

* Building Willpower - Thanks to a reader for passing along this research perspective on how to build self-control and willpower. That is exactly what biofeedback and meditation are all about. An interesting implication, supported by research, is that efforts to contain our emotions deplete our reserves of self-control. This could be one way that emotional arousal is connected to poor trading performance, as our efforts as self-containment leave us less capable of making disciplined efforts.

* Health and Emotions - Research conducted at Duke University suggests that, individually, depression, anxiety, and anger are positively correlated as traits with the risk for heart disease. When those exist in combination, however, the risk of heart disease rises dramatically. This suggests that the overarching trait of "neuroticism"--the tendency to experience negative emotion--may bring more than just psychological consequences. Indeed, hostility may be more predictive of heart disease than such risk factors as smoking and cholesterol. It appears that the combination of hostility and depression elevates inflammatory proteins in the blood. Moreover, hostility and negative patterns of thinking are directly associated with the risk of depression. How we think thus can affect how we feel, but also how healthy we'll ultimately be.

RELATED POST:

Negative Thoughts and Trading
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Tracking a Flight From Safety

Clawing Back? - After a harrowing decline from 40 down to 16 during 2007, the Homebuilders ETF (XHB) failed to make new lows when the major averages hit new lows in March. Since their lows, the group has risen 50% and is making new year-to-date highs.

Buying Surge - If today holds up, it will represent the 16th day out of the last 19 in which the Adjusted NYSE TICK has been positive on the day. What that means is that, across the broad universe of NYSE stocks, large traders are dominantly lifting offers rather than hitting bids. A similar pattern holds true for the Dow TICK (TIKI) as well. The chart from my recent indicator review clearly shows the consistent pattern of buying.

Flight From Safety - Two-year Treasury notes, which captured well investors' flight to safety, dropped to a yield below 1.3% in March and now, with quite a drop today in bonds, are pushing a 2% yield. It's not difficult to surmise that the money that had found safe haven in Treasuries are being put to work in stocks, given the dynamics of the TICK noted above. Financial issues, so far today, have once again led the upside.
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Two Early Morning Themes to Start the Week

* Knocking at the Door of Long-Term Resistance - This chart of the June ES futures is annotated with the number of NYSE, NASDAQ, and ASE stocks making fresh 65 day highs (green numbers) and lows (red numbers). You can see that we had many fewer lows on the market's second dip down and, this past week, new highs have expanded. A breakout above the 1400-area resistance on an increased number of stocks making new highs would be a bullish development for this market. The market has behaved well since registering an overbought signal in my Cumulative Demand/Supply Indicator; that tends to occur during strong bull legs in the market. We need to see an expansion of Wednesday's level of 455 new 65-day highs to keep the rally going.

* Drumbeats of War? - The report from Debka suggests that the U.S. and Israel are coordinating a pending military action against Iran. This source has been wrong before on the Iran issue. Still, this report from Britain perked up some ears, especially given recent Israeli decisions to distribute gas masks to the population amidst week-long civil defense drills.

* A Note of Thanks - Shout out to Business Week for its recognition of Trader Feed as one of the top financial blogs.
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Indicator Review for April 7th

Since bottoming on March 10th, buying interest in stocks has remained quite high, as we can see from the chart of the Cumulative Adjusted NYSE TICK above. I had noted in last week's review that money flows were not impressive despite the rally off the price lows. This changed with Tuesday's rally, which brought significant buying across a broad range of stocks. By Wednesday, we had 455 NYSE, NASDAQ, and ASE issues making fresh 65-day highs, the highest level of 2008. Moreover, the stocks in my basket of S&P 500 issues, which are evenly divided among eight sectors, moved solidly into uptrends, as noted by my Twitter posts this past week. The charts from my Friday post show how we made a double bottom in the major averages with an important non-confirmation from the new 52-week lows. That has been followed by a pickup in the proportion of stocks trading above their moving averages, as well as by the expansion in the number of stocks making new highs.

Does this mean that we've finished a bear market and are now in bull mode? Not necessarily. The 1400 region in the S&P 500 Index represents important resistance, and--as noted recently--we're quite overbought. The Advance-Decline lines for the NYSE common stocks and S&P 500 issues do not look healthy; they've budged only moderately from their bear lows. Yield spreads--corporate and municipal vs. Treasuries, for example--and interbank loan rates still suggest a healthy measure of risk aversion.

Still, I have to go with the indicators and, for now, they're suggesting that we've put in a double bottom and should enjoy an intermediate-term advance. My expectation is that this should take us above the 1400 resistance and flush out the bears. What would change my mind from this scenario would be reversals of the dynamics we're currently seeing in NYSE TICK, money flows, and the expansion of stocks making new highs. Particularly worrisome would be an expansion in the number of stocks making fresh 20-day lows. If we're to enjoy an intermediate-term advance, I'd expect that number to remain below the 547 new 20-day lows registered on 3/28.

Those financial issues have continued to exercise leadership on an intraday basis, as they capture relative confidence and lack of confidence in the financial system. I will be watching them, as well as how well price holds up on any consolidation from this overbought level, to handicap the odds of our breaking above that 1400 region in SPX.
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What Are You Doing Between Trades?

I want to thank readers for excellent comments and perspectives on my recent post that addressed the question of why trading is so difficult. In particular, I thought that Charles and Ziad identified a most important issue: the trader's engagement with markets *between* trades.

To take a step back, if I were asked the question, "What makes trading so difficult?", my response would echo Victor Niederhoffer: "Trading is difficult because of the ever-changing nature of market patterns".

In statistical terms, this is called nonstationarity; in my previous writings I described it as playing blackjack when the number of decks in the "shoe" periodically changes. You the card counter are keeping track of the number of picture cards dealt, not knowing that the supply of picture cards has just increased multi-fold.

Similarly, from one time period to the next, market patterns can change: we can see altered patterns of trending and altered patterns of volatility. This occurs within the day--the market's behavior is different in morning than midday--and across days, weeks, months, and years. (We currently are experiencing far more volatility than a couple of years ago).

A nice example of Niederhoffer's "ever-changing cycles" is the recent shift in one-sided days that I wrote about. When we get such shifts, traders who internalized the previous patterns (and, in this case, fade opening strength or weakness) become caught in the new patterns and lose money. This is a major cause of frustration in trading, and it is a major reason that successful traders can rather quickly become unsuccessful ones.

It is because of these changing cycles that traders need to stay actively engaged with markets *between* trades. At any time, trends can reverse, breakouts can occur, markets can become quiet, etc. Only by following the market's emerging patterns can traders hope to adapt to them and eventually profit. Charles provided an excellent example in his comment to the post: because he is actively figuring out what the market is doing, he avoids what I called the "fireman" syndrome among traders, in which periods of boredom oscillate with periods of intense emotion and action.

Ziad makes the valuable point that one does not need to approach the markets quantitatively to stay actively engaged. In my own trading, for example, I stay engaged by watching unfolding sentiment (NYSE TICK, Market Delta), seeing how price and volume behave at the edges of market ranges, and by seeing how markets correlated to my own are behaving. The time between trades is never boring, because my interest is captured by reading the emerging market patterns.

Herein lies the problem beneath the fireman syndrome: If the trader is more interested in trading than in understanding markets, the period between trades will not be productive. That period will either be boring (which will incite overtrading), or it will be dominated by negative thinking about recent performance (which will color future decision making).

This is why structuring one's time between trades with processes to examine markets--and to examine oneself, when needed--is very helpful for trading. The mind, like nature, abhors a vacuum. If we aren't prepared with constructive activities between trades, the mind will latch onto non-constructive ones.

I strongly suspect that a reliable way to identify a good trader is to observe what he or she is doing *between* trades.
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A Few Weekend Views

* Overbought - We can see from the above chart that my Adjusted Cumulative Demand/Supply Index--a measure that compares the current Demand/Supply reading to its long-term moving average--is quite overbought. In my research, on average this has led to subnormal returns 20 days out. To be sure, a market can stay overbought for awhile; it's when we see the overbought readings also correspond to a period of rising 20-day new lows that stocks are most vulnerable to correction. So far, new 20-day highs have held up well (Friday showed 1630 new 20-day highs against 237 lows) and new lows have steadily contracted.

* Interview - Many thanks to the ATB Finance site in France for publishing this English-language interview with me on trading psychology and performance.

* Performance and Self-Perception - Thanks also to an alert reader who passed along this very interesting article on how our stereotyped thinking about ourselves affects our performance.

* Looking for Trend Days - On the heels of my recent post, Ray Barros shared some ways that he identifies trending days in the stock market.
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Cross-Talk: Why Trading Is So Difficult

Trader's Narrative recently posted an excellent piece on "Why Is Trading So Difficult?" The gist of the post is that, while trading is simple on the surface--it amounts to either buying or selling--it is psychologically difficult, because it requires the ability to meld patience and the tolerance of boredom with the ability to act swiftly and decisively during periods of "adrenaline induced action". I hereby dub this the "fireman's view of trading", as it portrays the trader like the firefighter in the station, sitting around for long periods of time playing cards and washing the trucks, and then suddenly responding to five-alarm events.

There is truth in this portrayal, of course. Trading does require the ability to restrain oneself from acting, just as it requires action in the face of risk and reward. Babak's point that traders need to be both serene and patient as well as decisive--able to analyze as well as act--is well taken. It is possible to be both overly analytical and indecisive or overly impulsive and out of control.

Yet, there are myths embedded in the "trading is simple, but psychologically difficult" formulation.

The idea that trading is easy--that it consists of either buying up markets, selling down ones, or playing for countertrend bounces--is a bit like saying that surgery amounts to either reshaping things, pulling them out, or replacing them. Any skill can be simplified via surface description, and it is precisely such surface description (and the ease of opening an account and trading, as Babak notes) that lures the unwary and unprepared into trading.

Of course, the entire idea that trading is about profiting from directional movement is a gross simplification shared by many traders. Take the example of an energy trader who notices that markets are deviating from historical norms and puts on a complex position of futures and swaps to capture a reversion to those norms. Such a "relative value" trade is anything but simple, as it requires accurate modeling of current markets vis a vis those historical norms. Much stock trading, in fact, is not directional, but rather an attempt to capture abnormal deviations between pairs of stocks or between markets.

It is the very simplification that trading is all about catching directional moves that helps make trading so difficult. The directional trader enters a very crowded space in which market inefficiencies are ruthlessly arbed away. It's when the trader examines more complex relationships--let's say the relationship between fixed income and currency movements and valuations among housing futures--that unexploited patterns are more likely to appear. Perhaps New York real estate will perform better than, say, Chicago properties if reduced interest rates and a falling dollar bring more overseas buying.

This idea that opportunity is to be found among more complex market relationships also changes the trading game psychologically. It is relatively difficult to find a hedge fund portfolio manager who would subscribe to the fireman's view of trading. The reason for this is that the time spent between placing trades is anything but boring. This is the time when you figure out those market relationships, developing/updating your models, assessing deviations from those, and constructing proper hedges following relative value movements. In fact, the actual act of trading is so diminished in importance at many institutions that portfolio managers don't even place trades. Rather, they call in the orders to execution desks, so that they are freed to continue their "real" work: figuring out market themes.

What makes trading difficult is the fact that, for many traders, the time between trades is dead time. Such inactivity--mentally--is what creates the boredom. Locked into a simplistic view of trading, traders perceive nothing to do when markets are providing setups for trades. They don't see their job as figuring out markets--in fact, the entire concept of "figuring out" may be discarded as overanalysis. Instead, they wait for trades like firemen wait for alarms to sound. But where the fireman engages in decisive physical action in the face of adrenaline pumping, the trader has no such outlets. Adrenaline pumping itself becomes a factor that interferes with sound decision-making and trading performance.

So what makes trading difficult is a fundamental misunderstanding of trading. Once a trader views placing trades as a simple matter of anticipating direction and the goal of trading as placing trades, he or she is locked into a perspective in which the goal is action and the challenge is the boredom of inaction. This brings trading perilously close to gambling. It is also not how the best bank traders and portfolio managers operate. Their more elaborated views of markets and trades means that the time between trades is when the real work is done; such time is intrinsically interesting and rewarding.

Consider an analogy: relationships would be difficult if we viewed sexual relations as the overarching goal and purpose. Everything else--the time between escapades in bed, from conversing to sharing experiences--would be boring and difficult to tolerate. To someone who viewed relationships in terms of intimacy, however, those times outside the bedroom would be the heart and soul of encountering the other person--what makes the physical relations *meaningful*.

Trading is not difficult because it blends action and inaction. It is difficult when we view trading through the lenses of firemen, creating both adrenaline spikes and boring interludes.

RELATED POST:

Three Market Idiots
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One-Sided Days in the Stock Market

I've heard from a number of intraday traders who have been performing quite poorly during very strong or very weak market days. Interestingly, most of them have also been underperforming overall. My take on that is that the stock market has been featuring more one-sided days, in which stocks generally trend higher or lower intraday--a kind of herd effect. We would expect intraday traders who fade early market moves to suffer on these one-sided days, and we would expect their overall performance to suffer if these one-sided days are more frequent now than in the past.

So let's do what too few traders do and actually look at market data.

I examined the number of days in which advancing stocks outnumbered declining issues by more than 3:1 and those days in which decliners led advancers by more than 3:1 across all NYSE issues. These are relatively one-sided days: the vast majority of issues are either rising or declining. From 2002 through the end of 2006 (N = 1259 trading days), we had 101 such one-sided days. That's a little less than 9% of all occasions.

Since 2007 (N = 315 trading days), we've had 74 one-sided days. That's almost 25% of the total. In other words, since 2007, the proportion of one-sided days has increased dramatically.

The reason for this, I believe, is that large money managers (such as hedge funds) are increasingly managing their portfolios on an intraday basis. When they see risk aversion themes kicking into markets, they dump stocks; when they see risk-seeking, they snap up shares. This creates intraday herd effects that don't necessarily carry over to the next day's trade.

What that means is that skilled intraday traders need to distinguish between early strength and weakness that represents movements of the herd and early strength and weakness that is part of normal, random drift (and hence likely to reverse). Tracking risk-aversion and risk-seeking themes in fixed income and currency markets; tracking trader sentiment with tools such as NYSE TICK; and tracking intraday market breadth (and its trend) are useful in this regard.

RELEVANT POSTS:

NYSE TICK and Intraday Trend

Intraday Trend and Sentiment
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Themes and Thoughts for Friday

Tracking a Bottoming Process - These charts from the very useful Decision Point site show how we've been making an intermediate-term bottom in stocks. The top chart shows that, as we dipped a second time in the NYSE Composite in March, the number of common stocks registering new 52-week lows contracted meaningfully. The bottom chart shows that the percentage of NYSE stocks closing above their 200-day moving averages went below 20% in both January and March and is now on an upswing. With Tuesday's rally, money finally began flowing into shares in a significant way. We're now registering overbought in my Cumulative Demand/Supply indicator (Demand and Supply are tracked daily in my Twitter posts), so a period of consolidation following the market strength would not be surprising.

Stocks With Energy to Spare - It's very interesting to see that over 27% of the stocks showing up on Charles Kirk's screens are energy issues. The energy and materials themes have been quite durable, even through the period of market weakness, as the falling dollar, rising commodities, and anticipation of continued long-term demand from emerging nations provide solid fundamental support. See also some of the themes tracked in Kirk's recent links, including gold and utilities.

Visualizing the Market - Shout out to Trader Mike, who dug up this very worthwhile heat map of sectors and asset classes. At a glance, you can see what's weak and strong and infer some of the themes in the market. Great concept.

More Good Reading - Abnormal Returns finds more interesting themes, including a possible bottoming of interest rates, what unemployment claims are telling us, and alternative investments.

Who Makes It - There's a very accurate predictor of trader success I've found as a trading coach. The successful ones work as hard at figuring out and understanding markets as I do. If I work quite a bit harder at the markets than the traders I'm coaching, they're not going to make it. I suspect that's true of players and coaches in sports as well.
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Frustrated Trading: Stilling the Negative Thoughts in Your Head

One of the most disruptive emotional influences in trading occurs when normal, expectable frustrations encountered during the trading day trigger longstanding, habitual patterns of negative thought. At that point, as cognitive therapists emphasize, the negative thoughts follow a well-worn—and automatic—path, adding frustration to frustration. This is particularly damaging to trading for two reasons: 1) it prevents traders from constructively addressing the original, market-related sources of frustration; and 2) it escalates frustration to the point where it impedes future decision-making.

Take the example of Rick, an active intraday trader, who grew up in a family dominated by conflict and fighting. Hit and yelled at frequently as a child, he developed resentments toward authority figures that continued during his schooling. He likes to champion the underdog and often complains that “big guys”—those with power and influence in business and government—take advantage of the “little guy”. When he is trading, Rick can be very focused on his markets and keen in his observations. Every so often, however, his markets will move suddenly on news items, rumors, or large institutional (program) trades. That becomes his trigger: the market event that sets off his negative thought patterns.

When the market moves suddenly and sharply against Rick, his first reaction is anger and frustration. Automatic thoughts rush into his head: “I can’t believe this is happening again” and “I can’t believe how unlucky I am.” Although he voices these thoughts in a frustrated and often sarcastic tone, there is no doubting his sadness. He experiences himself as a victim of the market’s adverse movement. He has become the “little guy” hurt by the “big guys”, just as he was hurt during his childhood.

As the market moves further against him, Rick makes the transition from frustration to outright anger. He raises his voice, exclaiming that he can’t believe how unfair and “rigged” the markets are. He declares that it’s impossible to make money; the markets cheat the “little guy”. Eager to lash out at the big guys who are “taking my money”, Rick fights the trend and doubles down on his now-losing position. He rebels against the “big guys” just as he did against his parents, teachers, and bosses. The market, however, doesn’t listen and doesn’t care. It grinds Rick’s oversized position into a major loss, leaving him feeling saddened, defeated, and shocked at his own lack of “discipline”.

Rick vows to do a better job of keeping his cool and following his risk rules and, for a while, he keeps a lid on his frustrations. Inevitably, however, one of those market moves is likely to once again go against his position, and his thoughts and feelings return. It’s as if his brain is taken over by an alien influence—one deeply rooted in his past.

The important thing for Rick to recognize is that he is not simply reacting to the markets; his emotional reactions are colored—and exaggerated by—his past. In fact, this is a useful psychological principle: there are no emotional overreactions to events, only reactions that mix the past with the present.

At the time Rick is finding his negative, automatic thoughts triggered, he is not aware that this is a function of the past intruding into the present. He doesn’t see that he is transferring his anger and hurt toward his father (the first “big guy” who hurt him when he was a “little guy”) to the markets. Because he isn’t aware of this connection, he winds up repeating it again and again in a destructive fashion.

Many, many times, the “overreactions” of traders are reflections of unresolved issues from the past intruding into the present.

In coming posts, I will explore ways of coming to terms with these patterns and isolating them from trading decisions. The first step, however, is for traders to recognize when their frustrations are boiling over—and to stop trading at that time. Above all else, do no harm is the principle. If you felt your car was not responding properly to your driving maneuvers, you wouldn’t keep driving, and you certainly wouldn’t speed up! So why keep trading when your mind is not responding to your planning and reasoning, and why especially trade more aggressively?

This is very important: developing the ability to stop yourself. By itself, it will not solve the problems from the past, but it will drive a wedge between you and your negative, automatic thoughts. You may not be able to stop the thoughts right away, but you can ensure that they don’t control your behaviors. All you need is a rule that you follow religiously that says: once you start yelling, swearing, pounding the table, clenching up, or talking negatively at the screen, you take a break until you’re calm. That’s it. You can choose to trade or not trade when you’re in or out of the zone.

You’ll be surprised how taking a break will help you still the voices in your head, regain your composure, and build your sense of self control. A few minutes of slow, deep breathing and focused concentration perform miracles in this regard. (I find biofeedback especially useful in this regard, as it tells you precisely when you're re-entered the zone). Many more traders would be successful if they only traded when they were in the right state of mind.

RELEVANT POSTS:

Therapy for the Mentally Well

Emotional Intelligence and Trading
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Catching Trend Days in the Stock Market

I received an unusual number of frustrated emails from traders after yesterday's strong trend day. All of these were daytraders, and all were not able to capitalize on the trend day. Frustration over missed opportunity led to attempts to make up for the deficient performance, which then worked against them and created losses. What to do about such a situation?

First off, let's get expectations right: daytraders, on average, will tend to underperform on trend days. The buy and hold trader will, on average, milk more of the move than someone who tries to enter and exit many times in a one-way market. In addition, many trend markets start strong, meaning that daytraders who wait for an indication of direction for the day will generally enter the move once it's under way. That's tough, especially when the trend day follows some choppy, range days. The intraday trader who gets frustrated because he/she doesn't catch the entire move is probably feeling as much frustration from perfectionism as from market action per se.

(One common version of perfectionism: waiting for the trending market to pull back before participating in the move. By definition, trending markets are not going to give sizable pullbacks; they tend to be one-way markets. This doesn't mean you have to buy highs and sell lows on such days; it simply means you redefine the notion of pullback. In my trading, I use pull backs to negative NYSE TICK as one guide).

Second, let's recognize that catching trend days is essential to success in the recent market. I notice that Rennie Yang of Market Tells points out that we've had more such days in the past year than in the past decade. Fighting such one-sided markets is a recipe for losing. In such a situation, frustration is a completely appropriate response, speaking to the need to identify trending moves as early in the day as possible. Focusing on frustration as the problem misses the reason for the frustration in the first place: the difficulty making early identification of trending moves.

One way I like to channel this frustration is toward studying the characteristics of the kind of trading day I'm trying to master. By studying many examples of trend days, you can find common features and learn to identify and act upon those in real time. Here are some features to look at:

1) Breakouts from short-term ranges (overnight range, previous day's range, multi-day range, opening range) on strong volume;

2) Persistently strong NYSE TICK (note that we didn't get a -500 reading until almost noon CT on Tuesday);

3) Persistently skewed volume at offer vs. bid for ES futures (This shows up nicely on a Market Delta chart; the cumulative Delta moves steadily higher, as large traders keep lifting offers);

4) Strength in market's leading sectors (Note how, once again, financials led the way for the broad market on Tuesday);

5) Confirmation from correlated markets (Note the upswing in interest rates/decline of bond prices as the flight to quality unwound; the Yen weakness);

6) Extreme readings in the day's advance-decline readings and TRIN.

Because trend days open near their lows (highs) and close near their highs (lows), you're generally safe entering on pullbacks in NYSE TICK. Entries after relatively flat price corrections often work well also.

But nothing substitutes for studying these markets and internalizing their distinctive features. The best treatment for frustration is prevention.

RELEVANT POSTS:

Catching Market Breakouts

Identifying Breakout Moves
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Opening Intermarket Patterns For Stock Market Daytraders

Two of the intermarket relationships that I follow closely to help frame intraday trades are interest rates on Treasury bills/notes and the behavior of financial stocks. When rates come down in Treasuries (i.e., when there is demand for Treasuries and higher prices), it means that investors are in a relatively risk-averse mindset. That often carries forward to stocks.

The second relationship is the relative strength and weakness of shares in the financial sector, including banks and brokers. When these stocks are weak, it means that investors are expressing doubts about the viability of the financial system, and that also often carries forward to stocks.

I went back to the start of 2007 (N = 312 trading days) to capture relationships in the recent market. When yields on the 10-year Treasury note ($TNX) have opened with a decline of more than half a percent, the day's trading session in the S&P 500 Index (SPY, open to close) has averaged a loss of -.17% (31 up, 46 down). By contrast, when yields have opened stronger than that, the coming day's trade in SPY has averaged a gain of .02% (125 up, 110 down). This is a simple example of how fixed income markets help set the tone for the coming day's stock market trade.

Do other intermarket relationships affect the day's performance among stocks? Also going back to the start of 2007, I found that when gold (GLD) opens down by more than .40%, SPY averages a gain of .18% (36 up, 26 down) for that day's trading session (open to close). Conversely, when gold opens stronger than that, the coming day in SPY averages a loss of -.08% (120 up, 130 down). Weak gold, which implies a strong U.S. dollar, appears to set a bullish tone for stocks in the coming day's trade.

I next examined the opening performance of financial stocks (XLF) vs. the day's performance of SPY. When XLF has opened down by half a percent or more, the day session in SPY has averaged a loss of -.08% (30 up, 41 down). On the other hand, when XLF has opened stronger than that, SPY has averaged a loss of -.01% (126 up, 115 down). This makes sense, given the dynamic described above: when investors and traders are showing less confidence in the financial system, their pessimism tends to spill over to the coming day's trading.

Finally, I took a look at the opening performance of energy stocks (XLE) vs. the day's performance of SPY. When XLE has opened down by .60% or more, the coming day session in SPY (open to close) has averaged a gain of .10% (29 up, 28 down). When XLE has opened stronger than that, SPY has averaged a loss of -.06% during the coming day's trade (127 up, 128 down). A weak XLE implies weak oil prices, which are helpful to economic growth and stocks overall. A more robust relationship might be found by examining oil prices themselves.

These are far from perfect relationships, but they are indicative and have informed my intraday trading. When these relationships occur in combination and in the context of multi-day patterns, they are especially helpful (something I encourage readers to research). By understanding the optimism and pessimism of large market participants regarding interest rates, commodities, and financials, we can make inferences about their likely behavior toward equities.

RELATED POSTS:

Trading by Regimes

Oil Prices and Stocks

Interest Rates and Stocks
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