Midday Briefing for March 26th: In the Range

We've moved back into the day's trading range, and indeed are within a multiday trading range. Chartists will be tempted to see a head and shoulders pattern developing, as we see both momentum and strength waning even as we hover near bull market highs. I'm watching closely for relative performance of commodities and other risk assets, as well as small caps, to handicap the odds of that head and shoulders scenario playing out.

I'll be returning to Chicago today and will have more to say about markets and indicators when I return. Stay tuned!
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Divergences in New Highs and Lows

Note the deterioration in new 20-day highs minus lows in the last two weeks (pink line above), even as the S&P 500 Index (blue line) has been making bull market highs.

I noted earlier that there were significant divergences occurring within and across stock markets. Those are showing up in the new high/low figures.

At this juncture, we're not yet seeing a significant expansion of stocks registering fresh 20-day lows. Rather, we're seeing a narrowing of the rally, such that fewer stocks are making new highs.

An expansion of lows would suggest a more serious potential breakdown of the market uptrend.
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Friday Thoughts and Perspectives

* Two killer words in the trader lexicon: "should have";

* The power of embracing frustration and turning it into opportunity;

* Thanks to a sharp reader for the link to this article on taking pressure out of trading;

* Hiring boom on the near horizon?

* New home sales still look weak;

* EU uncertainty over Greece weighing on the euro;

* Bank bonds face best of all worlds;

* How the market trades after being down on Fridays;

* Don't take time off when you're trading well!

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NYSE TICK as a Gauge of Intraday Swings

Here we see a four-hour moving average of NYSE TICK (pink line) plotted against SPY (blue line) from March 17th through today's session.

Such a moving average of TICK acts as a short-term overbought-oversold measure. It also highlights when stocks might be making new lows and new highs when selling and buying pressure are waning--nice indications of potential reversals.
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Underperforming Commodities and Commodity Stocks

While the U.S. dollar is on an upward path and Treasury rates have been moving higher, commodities (DBC; top chart) and commodity-related sectors (XLB; middle chart and XLE; bottom chart) have been lagging. Those sectors have also been relative strength laggards during today's session.

I don't think it's a coincidence that emerging market stocks (EEM) have also been lagging during 2010, in the wake of tightening economic conditions in China. Commodities have been, in part, an emerging markets growth story. Lately, traders have been betting on low inflation growth in the U.S., but not raging bull markets overseas.

Will slower growth abroad catch up to the U.S. and lead to a turnaround in U.S. stocks? Or will China seek to avoid a hard landing and resume breakneck growth, spurring commodities and further stock market gains?

I will be watching the relationships among overseas markets, commodities, and U.S. stocks to sort this important issue out.
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Markets Responding to Economic Strength

Just a quick update to yesterday's post, observing important market dynamics, as the dollar (top chart) and 10-year Treasury rates (bottom chart) continue to march higher, as we continue to make fresh bull highs in stocks.

Strong dollar, strong stocks, rising rates: looks like markets are responding to economic strength.

I look forward to the indignant comments of permabears. :-)
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NYXE TICK: Catching Shifts in Intraday Sentiment

Here's a nice illustration of how diminished selling pressure (NYSE TICK, bottom chart) and positive sentiment (Cumulative TICK staying above zero) led to an upside break of the morning range on enhanced volume (top chart). The shift in the distribution of TICK was a nice tell for the coming move.
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Morning Briefing for March 25th: Watching a Breakout

9:58 AM CT - With strength in financial shares, but many sectors trading below their opening prices, we're getting a mixed, range performance thus far in the session. The NYSE TICK has been positive on balance, with only one significant selling reading to this point in the day. Volume is running a bit light relative to recent sessions, contributing to the rangy trade. We would need to see a downshift among financial shares and NYSE TICK to sustain a retreat from the morning breakout highs; I'd need to see greater relative strength among small caps to buy into a continuation move to the upside.

We're seeing breakout highs in the ES and NQ futures going into the opening. Note that the Russell 2000 Index, which had been a leader to the upside, is not poised to open at new highs. We're also a decent distance from fresh peaks in the new high/new low indicator. All of that has me looking closely this morning for signs of a false breakout in the day structure, particularly given a lack of bull peaks among other risk assets. Let's see if the small caps can confirm or contradict the early ES strength. More later this AM.
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Behavioral Finance and Other Interesting Research

* What research tells us about elite performance;

* How common actually is elite trading success?

* Thanks to a savvy portfolio manager for this article on how relaxed minds may learn better;

* Also big thanks to a sharp reader for this post on making training effective with multiple trainers;

* Stress and lack of activity linked to obesity;

* Measuring one's addiction to work!

* The behavioral mistakes made by Chinese investors.

* "We find that investors who think that they are above average in terms of investment skills or past performance (but who did not have above average performance in the past) trade more."

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A Look at the U.S. Dollar and Treasury Rates

Note today's upside break in the U.S. dollar (UUP; top chart) and in 10-year Treasury rates ($TNX; bottom chart).

During the market decline of 2008 and 2009, we generally saw a rising dollar accompany falling stocks and falling interest rates (rising Treasury note prices). The dollar and Treasury debt acted as relative safe havens during the rout of stocks.

Now, however, we have been seeing a stronger dollar since late 2009 along with stronger stocks. Treasury rates have also been on the rise since that time.

Rising rates do not seem to be signaling inflation, as long as we have a firm U.S. dollar. Indeed, commodity prices have stayed relatively tame and were down sharply today. Rather, buying of Treasuries from abroad may be slowing down and traders may be betting that the Fed will tighten credit conditions before inflation becomes a problem.
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Finding Opportunity in Choppy Markets

My experience for much of the past year is that intraday traders, both independent and at proprietary trading firms, have been struggling to make money. This is because of two reasons:

1) The general drop in daily volatility, creating slow market conditions;

2) The increased choppiness of markets, some of which is attributable to algorithmic trading.

But can traders turn these challenges into opportunity?

David Aferiat of Trade Ideas has recently posted on the topic of finding opportunity in the market's traps. He offers a strategy that relies on mean reversion as a trading opportunity and shows the recent backtested results for the strategy. The post is worth a thoughtful read, because it illustrates the kind of thinking that can succeed in current market conditions.

The general idea is to find points in the market in which bulls or bears are trapped: they have committed to positions, but can no longer move the market their way. It's when they have to scurry out of their positions that the market reversals provide a trading opportunity. Note that this is the foundation for the transition pattern that I recently posted.
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Midday Briefing for March 24th: Pulling Back

As you can see, we've been oscillating around the day session's opening price of 1165 in the ES futures, with about 882 more declining stocks than advancing. In my basket of 40 stocks that is evenly divided among eight S&P 500 sectors, 15 stocks are up from their open, 25 down. This weakness is also reflected in continued pressure on risk assets, including oil, gold, and euro and Aussie dollar vs. USD. Interestingly, small caps are not relatively weak from their open, which is one reason we're not seeing a more lopsided ratio of declining stocks to advancers.
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The Challenge of Mean Reversion Reversals in the Stock Market

Note how often price in the ES futures has popped to a new high or low, only to return to the prior trading range (blue arrows above).

I explained a major reason why this "mean reversion" occurs in my recent post on algorithmic trading.

This has proven to be a major challenge for short-term traders, who find themselves faked out on seeming moves that reverse.

The first step toward adapting is recognizing that a jump to a new high or low may be a trap. We then need criteria that help us differentiate the traps from the genuine directional moves.

More on that topic of criteria soon to come.
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Morning Briefing for March 24th: Facing Pressure

9:28 AM CT - I've added the top chart to show how we're trading both within the overnight trading range and within the range defined by yesterday's highs and lows. While we've seen pressure on risk assets, the ability of stocks to hold up above yesterday's value area has been impressive. The distribution of NYSE TICK is relatively mixed, contributing to the range trade picture.

We're seeing pressure among risk assets going into today's open, with a weak euro, strong USD, and weak commodity prices. That has weighed on stocks, as we've retraced much of yesterday afternoon's breakout move. Recall that we were in a range market with VWAP around 1162. Selling pressure could not take us below VWAP and we got the breakout move late in the day, taking us to new bull highs across most major indexes. Despite that, we saw fewer stocks register 20-day new highs than last week. Now we're looking to see if stocks can sustain their breakout move or will return to yesterday's value area. Should we see additional pressure on risk assets and relative weakness among small caps and NASDAQ issues, I'd expect the retracement to yesterday's value area and a setting of a fresh trading range.

More later this AM.
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The Most Common Problem I See Among Active Traders

The recent post on listening to market communications highlights one of the most common problems I see among active traders, particularly those that trade on a day time frame.

We've all known people who seem to talk at you rather than with you. It seems as if they're uninterested in anything you have to say. They just want to get things off their minds. Indeed, even as you're talking, you can see that they can't wait to blurt out whatever is in their heads.

Can you imagine a psychologist who interacted like that? You're trying to describe your problems, and the shrink is talking right over you with whatever psychobabble he happens to be espousing at the time. That would be quite frustrating.

Well, that is how many traders approach markets. They don't listen to what the market has to say. Instead, they're looking for the next setup, the next trade to put on.

When you sit in front of the screen, the goal should be similar to the psychologist's: to understand what is going on before you take action. If you're approaching markets with your own opinions and your own need to put on trades, you'll miss the market's communications--its evolving patterns--and any hope of getting a gut feel for the action will be gone.

I often wondered why I tended to trade well after taking a break from markets. The reason, I discovered, was that I was following markets during the break, but not trying to put on trades. That freed me up to simply hear what the markets had to say.

If you have a *need* to talk, chances are you'll be a poor conversationalist because you'll be a poor listener.

And if you have a *need* to trade, odds are you'll be tone deaf with respect to what markets are actually telling you.

More:

Why Controlling Emotions is Not the Goal

Listening and Trading

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Learning to Listen to Market Communications

My recent post on gaining access to our inner expertise stressed that what we know is, in part, a function of our state of consciousness.

If all knowledge was explicit and continuously available to us, then we would be able to make excellent trading decisions regardless of our mind frames. It is because much of our knowing is encoded implicitly, as a function of "gut feel", that access to that intuition is important.

No one knows this better than psychologists.

If I am focused on the person I'm meeting with, I can pick up subtle nuances in their use of language, the tone of their voice, the sequencing of their topics, the changes in their posture and rate of speaking, etc. That level of being attuned to people not only helps me understand them; it also helps them feel understood.

If, however, I go into a meeting preoccupied with my own concerns, I become emotionally tone deaf. The subtle cues of conversation and interaction become lost and I miss the communications behind the communications.

The same thing happens in intimate relationships: how attuned we are to our partners affects how well we interact with them. If I'm busy talking and not listening, I become tone deaf as a spouse.

The markets are continuously communicating with us; the challenge, like in social interactions, is reading the communications behind the communications. These manifest themselves in patterns, not dissimilar from the patterns of tone of voice and gesture than we see in social conversation.

This is why listening is a core trading skill.

And it's why sustaining a frame of mind that is conducive to listening is paramount for active traders.

More:

Emotionally Intelligent Trading (also see links to first two posts in the series)

Following the Market Like a Psychologist

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Midday Briefing for March 23rd: Tracking a Range Market

We've remained in a range all day long, but if we can hold the VWAP level on selling, we should be able to mount a decent test of the day's highs, particularly if small caps can outperform and if we can sustain firmness among other risk assets. As a rule, I'll play potential range breakouts in the direction of the larger time-frame trend.

Note that I have an oscillator at the bottom of the chart. In a range environment, these can give relative orientation to potential buy and sell levels; in anything other than a range environment, I don't find traditional oscillators to be of much use.
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Gaining Access to Inner Expertise

As I emphasized in this important post, traders know more than they know they know. This is the result of internalizing patterns in markets over time. The resulting "gut feel" for markets provides an intuitive level of recognizing when those patterns are occurring in real time.

A key challenge for traders is that they are often in frames of mind that deny them access to this intuitive, implicit level of knowing. Among the states of mind that interfere with one's gut feel for markets are:

* Fear and anxiety;
* Anger and frustration;
* Boredom;
* Overconfidence;
* Pessimism and depression;
* Excitement and thrill-seeking.

As a rule, the more we are focused on profits, losses, and self-related thoughts, the less focused we are on the patterns playing themselves out in markets. It's that focus, in part, that provides us with access to the gut.

Biofeedback is a useful tool for training ourselves to enter and stay in the state needed to access our implicit knowledge. (See this post for a summary). By sustaining a state of calm focus, we can recognize hunches and insights as they materialize.

This may be one reason why we can trade like pros on certain occasions and like rookies on others: the state we're in may provide or deny us access to the pattern recognition skills underlying most active trading. We cannot access our internal expert if our attention is drawn elsewhere and our thoughts and emotions are drowning out our intuitions.

More on this topic soon to come
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Thinking Like the Computers

One thing I've learned from observing the actual trading of prop traders--those who are trading actively in and out of the market through the day--is that, as a rule, they are drawn to movement and momentum. They like to trade breakouts from ranges, and they like to see clear signs of strength or weakness before they buy or sell.

Many algorithmic (automated) programs that trade actively take advantage of these tendencies by selling strength and buying weakness. If you imagine hundreds of computers, each programmed to work offers at X period highs and work bids at X period lows--and if you imagine X as scalable across time frames--you get a sense for what drives markets on the short time frame when directional, institutional traders are not active.

Traders can benefit from thinking like the computers.

This morning we broke the overnight lows in the ES futures, but small caps were not making morning lows; nor were other risk assets.

If you were looking only at the S&P index, you wanted to be a seller and catch the downside breakout.

If you were thinking like the computer, you were working a bid and profiting from the move back to the average price in a range environment.

Much short-term trading success comes from doing what doesn't come naturally.

More: Why Traders Lose Money in Slow Markets

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Morning Briefing for March 23rd: Forming a Range

9:56 AM CT - I've added the top chart to show the continued range trade in the ES futures. We have moved below the overnight range and ticked above it, each time returning back into the range. Getting day structure right and fading those moves away from value is how intraday traders can mint some coin during otherwise slow, trendless markets.

We can see that the market is setting up in a trading range during the overnight session, oscillating around the volume-weighted average price around 1162. As I alluded yesterday, I like to look at the overnight range as an "opening range" and play for a breakout of that range as an early trade idea. Very often, the early distribution of NYSE TICK readings will give a clue as to that breakout move--and also to whether the break can be sustained. I also like to look at the Cumulative Delta (volume transacted at offer minus volume transacted at market bid) to provide a gauge as to whether we're likely to sustain a breakout or stay rangebound.

Thus far, we're not seeing decisive moves among the majority of risk assets, which keeps me in range trading mode to start the day. I'll update later this AM.
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