Well, we'll have the Fed announcement the day before and then Initial Claims and Leading Indicators at 8:30 AM and 10:00 AM CT respectively, so it could be an interesting day. I've had some good questions and feedback re: the post on trading breakouts, so Thursday let's track the market in real time during the early morning and see if we can focus on sentiment as a tool for developing trade ideas. Here's some background reading for the session:
1) Basic principles of short-term trading;
2) Using NYSE TICK to identify the trend of sentiment;
3) Using volume to determine if we're likely to trend;
4) Price targets for short-term trades;
5) Using TICK to help us handicap the odds of hitting pivot targets.
See you then!
Brett
Monday, March 19, 2007
Trading Short-Term Range Breakouts With The NYSE TICK
When stocks trade in a relatively narrow range for 30 minutes or more, we have the opportunity for a meaningful breakout move. The general rule is that the longer the range, the greater the magnitude--and often the duration--of the subsequent breakout move. The challenge for the short-term trader, of course, is determining the ultimate direction of the breakout.
The mistake many traders make is trying to crystal ball the breakout direction, committing their capital before the market shows its hand. Rather than try to pick tops or bottoms within a range, we can let sentiment be our guide. Let's take a look.
Above we have a chart of Friday's morning market. This is taken from my RealTick screen and shows Eastern time. The red candlesticks represent the June ES futures; the blue lines are the NYSE TICK. Both are one-minute values. Note that we have a trading range in the futures from roughly 9:55 AM to 10:30 AM.
Now recall that the TICK is showing us sentiment: the number of stocks that are being traded at their offer price minus those traded at their bids. (For more background on the NYSE TICK, go to Technorati, click on "advanced search" in their search box, enter "NYSE TICK" for the search words, and limit your search to the TraderFeed URL. You'll get a listing of every post that deals with the TICK). The question I ask during the range is: What is the level of sentiment (i.e., the level of TICK) needed to keep this market in a range?
We can see from the chart above that the average TICK level during the range is a bit over 400 (it's actually 433). I also know from my research going into the day that the average TICK level over the past 20 trading sessions was 250.
What is that telling us?
It is taking above average bullish sentiment just to keep the market moving in place. This is the very embodiment of inefficiency: the inability of sentiment to move price. As a rule, uptrends lose efficiency before they turn into downtrends.
Here is where context matters. The trading range is also occurring just above the previous day's high price. If this were a valid breakout move (note that we're viewing the prior day as a trading range in itself), we should be gaining efficiency as we move higher. The loss of efficiency is a nice tell that we're going to at least move back to the middle of the prior day's trading range (its value area). For that reason, I did not have a problem selling the futures with an initial position while we were still in the range. (One of my primary stop-loss exits was a breakout high in TICK. That probably would have invalidated my thesis of inefficiency and waning bullish sentiment).
The second, and more secure, point to enter the trade idea is on the first bounce following a breakout low in the TICK. When the TICK makes a new low relative to the trading range (as we see a little after 10:35 AM) and then bounces back to positive territory, that becomes a high probability entry. It's showing us that sentiment is waning, and--as long as price on the bounce stays below price prior to the TICK breakout--it shows us that we're making lower price highs and lower lows. You won't catch the exact top of the market with this entry, but by letting the market show its hand, you can ride a move already in progress.
As long as the TICK bounces occur at successively lower price highs and your average TICK level is falling, you can stay in the trade. That's telling you that sentiment is becoming more bearish and the market is maintaining or even increasing efficiency to the downside. If your initial profit target was the midpoint from the prior day and you are *still* seeing a bearish tilt to sentiment and downside price efficiency, then you want to leave at least a piece of your position on to hit your further targets: either the low from the prior day or the S1 pivot level, whichever comes first. It's helpful to have those targets written in front of you; that's why I post ES targets to the Trading Psychology Weblog each day. This is especially true if volume is expanding on the decline, given the volume-volatility relationship.
Notice how much information you are integrating over time to make this trade and stay in it. I will have more to say about conceptual integration in an upcoming post. Suffice it to say here that you are integrating patterns of range and value with patterns of efficiency with real-time patterns of shifts in price and sentiment (TICK). It takes a fair amount of experience with these patterns to recognize the trade, make the proper entry, and ride it toward a high probability target.
Perhaps now you understand why I say that the notion that trading is mostly mental/psychological is complete rubbish. A negative frame of mind can interfere with the best of skills and experience, but a positive frame of mind won't provide you with the pattern recognition skills and the conceptual integration to make the above trade. The way you learn short-term trading is by seeing one example of a pattern, after another, after another, after another. Eventually those patterns jump out at you and you can make the proper identifications in real time. A blog like this can jump-start your learning process by showing you some of the patterns to look for. But, ultimately, it's your screen time and your degree of immersion in market patterns that will enable you to truly see markets and make the right trades.
Sunday, March 18, 2007
Mad Props To Jason Goepfert At SentimenTrader.com
Maybe it's a case of great minds thinking alike or perhaps it's mass hysteria, but it looks as though Jason Goepfert and I have tackled the same topic today: the very high put-call ratios. My recent post focused on equity-only ratios; Jason goes well beyond those data to look at who is buying and selling options and how that compares with historical norms. His special report on the topic is absolutely first rate. If you're not a subscriber, consider a free trial.
I'm not commercially affiliated with SentimenTrader; nor does Jason even know I'm posting this. But, hey, when I see a solid, original, and thoughtful piece of research on a topic relevant to traders *and* investors, it's worth a shout out.
I'm not commercially affiliated with SentimenTrader; nor does Jason even know I'm posting this. But, hey, when I see a solid, original, and thoughtful piece of research on a topic relevant to traders *and* investors, it's worth a shout out.
The Bearish Equity Put-Call Ratio: What To Make Of Extreme Options Sentiment
In the wake of the sharp market drop on 2/27, the bearishness is so thick you can cut it with a knife. When markets are making orderly new highs--as was happening for months prior to the drop--I rarely get emails asking my opinion about market direction. As soon as the market plunged, however, I started getting requests from readers as well as media. Posts showed up in my inbox from True Believers heralding the end of the market as we know it. That got my attention. There are no foolproof strategies in trading, but fading market idiots comes pretty close.
But all of that is subjective, as a certain barefoot speculator would chide. What do the data tell us?
The equity put-call option data tell us that bearish sentiment is off the chart. Literally.
My data show that we have seen 12 of the last 15 trading sessions in which the volume in equity put options has exceeded the volume in equity calls. To put that into perspective, from January, 2001 through mid-February, 2007, we only had a total of 44 days (out of 1527!) in which put volume exceeded call volume among equities.
Moreover, we've had several days recently (February 27 and March 13 stand out) which have seen higher put-call ratios than *any* day during the 2001-2003 bear market. Indeed, during that bear market, we *never* saw a 20-day put-call ratio exceed 1.0, as it does at present.
What makes this surprising from my perspective is that all of this bearishness is occurring without us being down so much as 10% on the major averages. In my recent video, I review the price and money flow for eight major S&P sectors. From the vantage points of both price and flow, the recent drop so far has been no greater than any other correction during the past several years. But it certainly has engendered greater fear among options participants.
Going back to 2001, such fear has had bullish implications. When we've had a single put/call reading above 1.0 (N = 44), the next 20 days in the S&P 500 Index (SPY) have averaged a gain of 2.09% (33 up, 11 down). That is quite a bit stronger than the average 20-day gain of .16% (899 up, 628 down) for the entire sample.
If we just go back to 2004, we find 30 instances of equity put/call readings above 1.0. Twenty days later, SPY has been up by an average of 1.48% (23 up, 7 down). In Vegas, I'd take those odds.
I've seen a few historical comparisons between the current market period and past ones. Most of those comparisons look for similarities between this market and past market tops. In some ways, however, from a sentiment vantage point, this market reminds me of 1987 *after* the huge drop. It was such an anomalous event and major decline that it turned sentiment on a dime. In the Investors' Intelligence survey, for example, the percentage of bears to bulls shifted from 17:60 in August to 45:28 in October. It also led to further selling in the near term and restrained performance for much of 1988. Ultimately, however, we look back on that period as a time when extreme bearishness had it wrong.
Perhaps, however, the better analogue would be the market of the mid 1990s. Then, as recently, we had record low volatility. We then climbed to new highs in 1995, just as we made new highs in 2007, but occasional market drops took their toll on sentiment. For instance, we saw bears outnumber bulls in the Investors' Intelligence survey after market corrections in November, 1995; August, 1996; and April, 1997. This tendency for even relatively mild corrections to engender strong bearish sentiment was a major part of what kept that bull market going.
In the recent market we see a significant pickup in bearish sentiment in the AAII poll--from 27% bears and 58% bulls in January to 45% bears and 33% bulls most recently--but not so far in the Investors' Intelligence survey. If we look at weekly data for all listed options, we have to go back to July, 2004 to find an equivalent, elevated ratio of put volume to call volume. Before that, we saw similar elevated levels in February, March, May, and November, 2003--all good buying opportunities for investors.
One last observation. The VIX bottomed at 8.89 intraday on December 27, 1993. The market correction drove the VIX higher to 28 in early April, 1994 and a later correction late in 1994 took us back toward 20. From that point forward, we continued with sub-20 VIX levels throughout 1995 and into early 1996 as the market moved steadily higher. When we did finally break out to consistently higher VIX levels in March, 1996, it was in an environment of upside volatility, not market weakness. Moral of the story? A bottom in VIX does not at all necessarily imply a major market top. It hasn't taken much price weakness to get the bears growling. This time may be different and--as I recently stressed--I need to see dollar volume flows and solid price action show me that we can put in a bottom here. Still, I don't think market history is on the bears' side.
But all of that is subjective, as a certain barefoot speculator would chide. What do the data tell us?
The equity put-call option data tell us that bearish sentiment is off the chart. Literally.
My data show that we have seen 12 of the last 15 trading sessions in which the volume in equity put options has exceeded the volume in equity calls. To put that into perspective, from January, 2001 through mid-February, 2007, we only had a total of 44 days (out of 1527!) in which put volume exceeded call volume among equities.
Moreover, we've had several days recently (February 27 and March 13 stand out) which have seen higher put-call ratios than *any* day during the 2001-2003 bear market. Indeed, during that bear market, we *never* saw a 20-day put-call ratio exceed 1.0, as it does at present.
What makes this surprising from my perspective is that all of this bearishness is occurring without us being down so much as 10% on the major averages. In my recent video, I review the price and money flow for eight major S&P sectors. From the vantage points of both price and flow, the recent drop so far has been no greater than any other correction during the past several years. But it certainly has engendered greater fear among options participants.
Going back to 2001, such fear has had bullish implications. When we've had a single put/call reading above 1.0 (N = 44), the next 20 days in the S&P 500 Index (SPY) have averaged a gain of 2.09% (33 up, 11 down). That is quite a bit stronger than the average 20-day gain of .16% (899 up, 628 down) for the entire sample.
If we just go back to 2004, we find 30 instances of equity put/call readings above 1.0. Twenty days later, SPY has been up by an average of 1.48% (23 up, 7 down). In Vegas, I'd take those odds.
I've seen a few historical comparisons between the current market period and past ones. Most of those comparisons look for similarities between this market and past market tops. In some ways, however, from a sentiment vantage point, this market reminds me of 1987 *after* the huge drop. It was such an anomalous event and major decline that it turned sentiment on a dime. In the Investors' Intelligence survey, for example, the percentage of bears to bulls shifted from 17:60 in August to 45:28 in October. It also led to further selling in the near term and restrained performance for much of 1988. Ultimately, however, we look back on that period as a time when extreme bearishness had it wrong.
Perhaps, however, the better analogue would be the market of the mid 1990s. Then, as recently, we had record low volatility. We then climbed to new highs in 1995, just as we made new highs in 2007, but occasional market drops took their toll on sentiment. For instance, we saw bears outnumber bulls in the Investors' Intelligence survey after market corrections in November, 1995; August, 1996; and April, 1997. This tendency for even relatively mild corrections to engender strong bearish sentiment was a major part of what kept that bull market going.
In the recent market we see a significant pickup in bearish sentiment in the AAII poll--from 27% bears and 58% bulls in January to 45% bears and 33% bulls most recently--but not so far in the Investors' Intelligence survey. If we look at weekly data for all listed options, we have to go back to July, 2004 to find an equivalent, elevated ratio of put volume to call volume. Before that, we saw similar elevated levels in February, March, May, and November, 2003--all good buying opportunities for investors.
One last observation. The VIX bottomed at 8.89 intraday on December 27, 1993. The market correction drove the VIX higher to 28 in early April, 1994 and a later correction late in 1994 took us back toward 20. From that point forward, we continued with sub-20 VIX levels throughout 1995 and into early 1996 as the market moved steadily higher. When we did finally break out to consistently higher VIX levels in March, 1996, it was in an environment of upside volatility, not market weakness. Moral of the story? A bottom in VIX does not at all necessarily imply a major market top. It hasn't taken much price weakness to get the bears growling. This time may be different and--as I recently stressed--I need to see dollar volume flows and solid price action show me that we can put in a bottom here. Still, I don't think market history is on the bears' side.
Saturday, March 17, 2007
TraderFeed Video: March Dollar Flows
Well, it's my first video effort, so be gentle! Need to work on the graphics quality in .wmv mode and could be smoother, but after crashing the computer and losing my files more times than I care to count, it's nice to see some fruits of an afternoon's labor.
The basic idea here is a bottoms-up notion: By tracking the dollars flowing into and out of sectors within the S&P 500 universe, we can detect if large institutions are accumulating or distributing stocks. That, in turn, will help us determine whether we're putting in a market bottom after the recent decline or whether further weakness may be in store. This was very helpful in my decision to not jump in and buy following the large market decline on the 27th, and it continues to guide my intermediate-term perspective.
Hope the video provides some guidance for your trading this coming week.
The basic idea here is a bottoms-up notion: By tracking the dollars flowing into and out of sectors within the S&P 500 universe, we can detect if large institutions are accumulating or distributing stocks. That, in turn, will help us determine whether we're putting in a market bottom after the recent decline or whether further weakness may be in store. This was very helpful in my decision to not jump in and buy following the large market decline on the 27th, and it continues to guide my intermediate-term perspective.
Hope the video provides some guidance for your trading this coming week.
Oversold Stock Market, Or First Leg Of A Bear?
A question I'm hearing again and again from traders is whether we're starting a bear market or completing a normal bull market correction. Few current questions are more relevant for traders and investors alike.Let's take a look at what the data are telling us.
Suppose we describe each day's price change in the S&P 500 Index (SPY) as a function of its average daily price range over the past 200 days. We thus adjust price changes for the volatility occurring at that time and measure change in terms of "range units". A market that goes up .50 range units thus rises by an amount equivalent to half the average daily price range over the prior 200 days. A market that goes down by -.50 range has fallen by an equivalent amount.
Such a measure enables us to more directly compare price changes from historically volatile market periods to those from markets, like the present one, that have been non-volatile.
Now we will construct a very simple overbought-oversold (OB-OS) indicator by summing the daily range unit changes over the past 20 trading sessions. The result, plotted from 2004 to the present, can be seen in the chart above.
Several patterns are evident in the chart. First, we have seen important market bottoms when the OB-OS measure has dipped below -3.0. Second, we've seen sharp rises off the market lows confirm that we, indeed, have seen lows. Those sharp rises indicate that buyers are jumping into the market to obtain bargain prices. Third, we see that upside momentum in the OB-OS tends to peak ahead of price, as indicated by the blue arrows. That tells us that we tend to see smaller upside thrusts as bull swings age.
At an OB-OS reading of -6.0 recently, we touched oversold levels not seen since the important June/July 2006 market lows. Note that each oversold reading in OB-OS has occurred at higher price lows. That, by definition, occurs in bull markets. Nothing thus far in the current market decline has violated that pattern.
Indeed, going back to the start of 2004 (N = 785), we find 84 occasions in which OB-OS has been below -3.0. Twenty days later, SPY averages a healthy gain of 1.88% (64 up, 20 down). That is much stronger than the average 20 day gain of .44% (442 up, 259 down) for the remainder of the sample. If the bull market is intact, we should see higher prices shortly.
Ah, but here's the rub: If we examine the data going back to 1998 rather than back to 2004, we see that 20-day returns following OB-OS readings of -3.0 or lower are actually negative. What gives?
The answer lies in the difference between bull and bear markets. What makes a bull market is that relatively mild downturns in the OB-OS are taken as buying opportunities by investors. During bear periods such as late 1998 and the 2001-2002 period, those same downturns in the OB-OS become much deeper. To give just a few examples, OB-OS reached -14.0 in July, 2002; -10.0 in September, 2001; and -11 in late August, 1998.
Notice that we can't attribute the difference between those periods and the recent ones simply to market volatility. Each decline is measured in units derived from the volatility of the market as it traded then. No, what makes bear markets--even adjusted for volatility--is that what had been a normal, corrective buying opportunity in the bull market now no longer attracts the same buying. This lack of demand, in turn, stimulates further sales and deeper OB-OS lows.
So what does this mean for the current market?
It is the quality of the next market rise--not anything we can crystal ball at this moment--that will probably tell us whether or not the bull market is alive. If this is a normal correction in an ongoing bull market, we should see investors jump into bargains and drive prices sharply higher. If we get only a tepid bounce from these lows that cannot make new price highs, that will embolden the bears for another round of selling.
In practical terms, that means I take the Missouri approach to the bull market: show me that something has changed since 2004. Until I see distinct evidence of change in actual market patterns--not just fears of mortgage lender bankruptcies, inflation, or a runaway Yen--I will assume that the current regime (trend) is intact. The market will have to show me that something has changed before I alter my investment strategy. It can do that in one of two ways: by producing a subnormal bounce from these lows or by resuming a decline to distinctively more negative OB-OS levels.
At the June/July, 2006 lows, we saw over 50 S&P 500 stocks make fresh 52-week lows. After the recent market tumble, we've seen 8 S&P stocks make annual lows. This time may indeed be different, but the current market will need to show me more before I come to that conclusion.
In an upcoming post, I will update my assessment of Dollar Volume Flows into the large cap stocks to see if institutions are using these lower market prices to pick up bargains. After the initial large market drop, if you recall, Dollar Volume Flows told us that we were *not* seeing bargain hunting. That turned out to be a helpful indication that further weakness was ahead. If we continue to see weak money flows into stocks, even at continued oversold levels, that would trigger my Missouri skepticism about the bull.
Friday, March 16, 2007
CNBC Appearance Tonight At 7 PM ET
A word of appreciation to everyone who forwarded questions for tonight's CNBC appearance at 7 PM ET/6 PM CT. I'll be part of a special program that will feature a large panel of commentators. My particular subpanel will consist of Doug Hirschhorn, Ari Kiev, and myself with observations about trading and market psychology. I'll be up to bat for a few minutes very early in the program and then again later on in the hour. I submitted the questions to the producer of the show, so hopefully we'll get a few perspectives from panelists about those issues. I believe there will be questions from viewers as well. If there's a question I don't get to, by all means follow up with it in the comments section to this post. Thanks--
Brett
Brett
Learning How To React To Changing Markets
Back in the late 1990s, I decided to take trading very seriously. I began to archive market data in Excel, starting a collection of one-minute price and indicator data that I have maintained faithfully since 1998. I also printed out charts such as the one above, in which I viewed each major indicator vs. stock index price and identified patterns that occurred at important turning points. To this day, I have a stack of printed charts that fills quite a few filing cabinets.
When you notice a pattern and then notice it again, and again, and again in different variations, eventually you become sensitive to what is pattern and what is noise. The process is very similar to the training of a radiologist, who learns to read X-rays or scans by seeing very many normal and abnormal ones, or a pathologist, who--after seeing many normal and abnormal tissue samples--becomes very sensitive to what is disease and what is expectable variation in health.
Most important, seeing patterns again and again enables a trader to recognize those in real time as they are forming. As I stress in my book, I have found simulated trading--particularly simulators that enable you to play and replay market days--to be especially powerful as learning devices. Seeing patterns unfold again and again significantly reduces one's learning curve. Once you've seen a trading pattern unfold dozens and dozens of times, you develop a feel for its future unfolding. That's the process of implicit learning I've described in past posts.
And that is how you learn to react to changing markets: By experiencing many, many market changes.
Wednesday was a particularly valuable day for observing patterns, because so many of them occurred within the span of a single trading session. I have labeled the above chart with four letters to indicate some of the more noteworthy patterns:
Point A) Notice how, in the opening minutes of trade, the market is much more reactive to the drops in the NYSE TICK than to the bounces at the very start of the session. When we jumped to positive TICK readings, these were followed by immediate selling that took us back into negative TICK territory. By the time we saw buying at point A, even the strong TICK of +1000 couldn't vault us above the opening highs in the S&P index futures. I refer to this pattern as inefficiency: Quite simply, if we measure the amount of upward price movement we are getting per unit of NYSE TICK, it is quite low. It's like a runner who is huffing and puffing, but getting nowhere. Such inefficiency is common at market turning points: sentiment is no longer able to sustain a short-term trend. Before we see a surplus of selling, we'll see buying sentiment (positive TICK) that no longer can move price higher. I generally sell those inefficient TICK bounces, particularly when they're occurring near tops of ranges.
Point B) Commencing at point B, we see that we get a pattern of lower highs and lower lows in the NYSE TICK. That is the classic pattern of a short-term market decline. As long as that pattern holds, you keep selling the TICK bounces. The thrusts to negative TICK, especially on elevated volume, are opportunities for the active trader to take some short-term profits off the table, even as he or she might ride a core position toward a designated target (such as the pivots mentioned in the Weblog). Recall that the NYSE TICK is telling us the relative balance of stocks trading at their offer price (upticks) vs. bid price (downticks). When we see a distribution of TICK values that is tilting downward (lower highs, lower lows), it means that bearish sentiment is trending. Those are markets we can ride lower.
Market Low) The market low for the day occurred on a very negative thrust in the TICK. A pattern that doesn't show up on the above chart, but that I had mentioned in my blog post that day was that, while the ES contract was making new lows for the correction, other stock indices (such as NQ and ER2) were not. If a majority of issues are not participating in a move, there's an enhanced likelihood that the move will not be sustained. Notice, however, that someone *only* looking at intraday data (such as the above chart) would have missed this vital longer-timeframe pattern. The important point here is that patterns are generally nested within larger patterns, and it's those larger patterns that create trends. Even very active traders need to train themselves to see patterns present in daily and even weekly data. Someone with their nose in the one-minute data on Wednesday would have been completely run over at the market low if they were short, oblivious to why the market had suddenly turned.
Point C) Notice the shift that occurs following the market low. We quickly go from a downthrust toward -1000 TICK to an upthrust above +1000 TICK. This creates a breakout in TICK, revealing a sudden surge in bullish sentiment. Even more important, we're no longer seeing the inefficiency associated with Point A. Rather, price is quite responsive to the broad upticking among stocks. By the time you get another thrust down below -500 TICK, price is well off its lows. What that tells us is that, unlike early in the day, high TICK readings are being followed by further high TICK readings: the bullish sentiment is sustained from minute to minute. This tells us that longer time frame participants have identified the market lows as value and are jumping into the market, lifting offer, to take advantage of bargain prices. This transitional pattern--from TICK extreme to opposite TICK extreme, with price responsive--does not occur very often, but can be seen at major market turns and at times when the market is roiled by unexpected news and economic reports.
Point D) At Point D we have the pattern from Point B, but in reverse. Now we're seeing higher TICK highs and higher TICK lows. Bullish sentiment is now uptrending. That is a great indication that we can afford to ride long positions and even add to them on TICK pullbacks. In an uptrend, successive TICK lows will occur at higher price lows; in a downtrend, successive TICK highs will occur at lower price highs. By the time we hit Point D, bouts of selling can no longer move the market lower. They merely serve as further encouragement for the bargain hunters.
Seeing patterns on a chart is only the first step in learning how to react to changing markets. The chart review tells you what to look for. The hard part, then, is to make the transition from chart review after the fact to recognition of patterns in real time. That's a frustrating time in the learning process, as you'll first make progress by recognizing patterns a bit too late to truly profit from them. But it is better late than never. Eventually the patterns become such second nature that you can see them well in advance, just as I noted the emerging divergences minutes before the market low.
No amount of positive thinking or empty-headed glorification of "you are what you believe" can substitute for knowing what patterns to look for and then immersing yourself in those patterns so thoroughly that they become part of your perceptual apparatus. That is true whether you're a scalper noting patterns in a depth-of-market screen; an active trader trading off the one-minute NYSE TICK; or a swing trader playing off Woodie's CCI patterns: learning to react to changing markets means that you shift your perception before the market makes its shift.
Thursday, March 15, 2007
How You Can Repay Bloggers For Their Work
Brian Shannon, who offers excellent video-based technical analysis through his Alpha Trends blog, recently drew upon the negative comment of a reader to reflect upon what blogs are all about. Brian makes no bones about being a businessman, but he also observes that more goes into producing a blog than sheer business interest. These "warm and fuzzy reasons" for blogging include the opportunity to meet other, talented traders and the joys of being part of the learning process for up-and-coming market participants.
When you think about it, those warm and fuzzy reasons have to loom large as motivations for the best bloggers. Think about the time and effort it takes Brian to produce a video each day; the resources that go into the massive link collections of Charles Kirk or Barry Ritholtz; or the writing and research that are required to produce Mish's analytical posts. The links I carry daily on my Weblog are my attempt to recognize the worthy contributions of these and so many other dedicated bloggers. Taken together, the blogosphere truly has become an alternative media outlet, with content that just can't be found elsewhere.
One of the highest forms of praise I receive from readers is a simple acknowledgment of the value of my posts and a request: "Is there any way I can repay you for all you've given me?" That is warm and fuzzy to the Nth power.
In the past, I have declined repayment. I have never sought commercial or personal gain from blogging, other than some visibility for the books I've written and the work I perform with trading firms. But now I'll take up the question directly on behalf of bloggers generally and outline two specific ways grateful readers can repay excellent content.
1) Be An Active Participant - The best blogs are not mere assemblages of posts. Rather, they are conversations with readers. As a blogger myself, I gain greatly from feedback and the willingness of readers to share their ideas with me. Many times I'll engage in an email exchange with a reader about trading ideas that leaves both of us more informed. The comments sections of blogs are perfect places for such conversations. Very often, readers add perspectives to my posts that I hadn't thought of. When you actively and thoughtfully engage in a blog-based conversation, you elevate all participants: the blogger included.
2) Download the Alexa Toolbar and Let Your Visits Be Registered - I'm very aware of Alexa's limitations as a way of monitoring web traffic, just as Amazon's sales rankings have their shortcomings. No matter: Alexa, like Arbitron in radio and Nielsen in television broadcasting, has become a standard for measuring the popularity of websites. When you download the Alexa toolbar, your visits to blogs are registered and counted in the traffic data. I have the toolbar installed in my browser and have never encountered problems with it. But it does provide Bloggers with a measure of repayment. Some bloggers sell advertising on their sites. High traffic ratings help them attract ad dollars and support their work. Other bloggers are hoping to use their blogs to land book contracts, speaking engagements, or consultations. High ratings in Alexa help their marketability. Note that I'm not advocating stuffing the Alexa ballot box--American Idol style--to pad the votes for your favorites. I merely suggest that each blog visit is a vote, and that you let your votes be counted.
Most of my blogging friends, I suspect, are too modest to write a post about repayment. For them, as for me, warm and fuzzy reasons will always rank at the top of contributing to the education and empowerment of others. But good work deserves recognition. By actively participating in blogs and letting your visits register in the traffic data, you offer a measure of recognition--some warm fuzzies of your own--to those who contribute to your trading success.
Thanks for all your support--
Brett
When you think about it, those warm and fuzzy reasons have to loom large as motivations for the best bloggers. Think about the time and effort it takes Brian to produce a video each day; the resources that go into the massive link collections of Charles Kirk or Barry Ritholtz; or the writing and research that are required to produce Mish's analytical posts. The links I carry daily on my Weblog are my attempt to recognize the worthy contributions of these and so many other dedicated bloggers. Taken together, the blogosphere truly has become an alternative media outlet, with content that just can't be found elsewhere.
One of the highest forms of praise I receive from readers is a simple acknowledgment of the value of my posts and a request: "Is there any way I can repay you for all you've given me?" That is warm and fuzzy to the Nth power.
In the past, I have declined repayment. I have never sought commercial or personal gain from blogging, other than some visibility for the books I've written and the work I perform with trading firms. But now I'll take up the question directly on behalf of bloggers generally and outline two specific ways grateful readers can repay excellent content.
1) Be An Active Participant - The best blogs are not mere assemblages of posts. Rather, they are conversations with readers. As a blogger myself, I gain greatly from feedback and the willingness of readers to share their ideas with me. Many times I'll engage in an email exchange with a reader about trading ideas that leaves both of us more informed. The comments sections of blogs are perfect places for such conversations. Very often, readers add perspectives to my posts that I hadn't thought of. When you actively and thoughtfully engage in a blog-based conversation, you elevate all participants: the blogger included.
2) Download the Alexa Toolbar and Let Your Visits Be Registered - I'm very aware of Alexa's limitations as a way of monitoring web traffic, just as Amazon's sales rankings have their shortcomings. No matter: Alexa, like Arbitron in radio and Nielsen in television broadcasting, has become a standard for measuring the popularity of websites. When you download the Alexa toolbar, your visits to blogs are registered and counted in the traffic data. I have the toolbar installed in my browser and have never encountered problems with it. But it does provide Bloggers with a measure of repayment. Some bloggers sell advertising on their sites. High traffic ratings help them attract ad dollars and support their work. Other bloggers are hoping to use their blogs to land book contracts, speaking engagements, or consultations. High ratings in Alexa help their marketability. Note that I'm not advocating stuffing the Alexa ballot box--American Idol style--to pad the votes for your favorites. I merely suggest that each blog visit is a vote, and that you let your votes be counted.
Most of my blogging friends, I suspect, are too modest to write a post about repayment. For them, as for me, warm and fuzzy reasons will always rank at the top of contributing to the education and empowerment of others. But good work deserves recognition. By actively participating in blogs and letting your visits register in the traffic data, you offer a measure of recognition--some warm fuzzies of your own--to those who contribute to your trading success.
Thanks for all your support--
Brett
Melinda Doolittle and the Mark of Greatness
My greatest interest as a psychologist--going all the way back to the days when I was a sophomore at Duke University sitting on a beach in Florida reading Ayn Rand's The Fountainhead--has been the phenomenon of greatness. By greatness I mean exemplary, elite levels of performance that stand head and shoulders above mere competence. When I wrote my most recent book, Enhancing Trader Performance, it wasn't simply to describe the ways of becoming more successful in the financial markets. Rather, I tried to capture the essence of what it means to be great at what you do.
The good performer performs well. Great performances, however, flow through the performer. It is as if a different self is at work. I've had those moments as a writer when I'll sit in front of a blank sheet of paper with a blank mind and suddenly begin writing...and writing...and writing. A few minutes later I'll look at what I've written in complete and total surprise, as if someone else has written it. "That's really good!" I'll think. But it's not like praising my own work. It's acknowledging the work that has just flowed through me.
Ed Seykota recognized this of the best traders. The good ones have talent, but for the great ones, the talent has them. It's the same with great artists and athletes. The talent takes over and the person becomes a vessel for the performance. The ability to channel performances through oneself: that is the mark of greatness.
All of which brings us to current American Idol participant Melinda Doolittle. For those of you who don't follow Idol closely, please take a look at Melinda's initial audition. She is quite nervous, and she is clearly uncomfortable taking center stage. (Her prior work has been as a backup singer). Every week since then, she absorbs the praise of judges with a look of disbelief. You can see that she doesn't quite buy it herself; she would be the last one to think of herself as great. When Simon gives her the positive feedback following her audition, you can see her normal personality: somewhat effacing, modest, and shyly engaging.
Then watch her on stage as she sings. It's as if a different person emerges. As the performance progresses, it completely takes over the normal Melinda. Then, shortly after the song is finished and she faces the judges, she returns to her usual self. This past week, Paula Abdul asked her what she was thinking when she was singing and, somewhat mystified, Melinda responded that she couldn't remember anything. It was, Paula suggested jokingly, an "out of body experience".
But Paula was right. Greatness is out of body, it is out of the normal self. It occurs when skills have become so developed that they are automatized. Think of the speed and reflexes of the young Muhammad Ali; the many times Michael Jordan would take over a basketball court; or--as I described in my book--the ballerina who, when photographed, performed the same leap precisely the same way each time.
When I come up with a trade idea, it may work and it may not. But when I've been watching the market for quite a while and an idea presents itself to me, it is almost always a winner. It is like Melinda's singing: so out of body that the ancient Greeks attributed the inspiration to divine forces: the Muses.
You may or may not like American Idol. But watch Melinda. It's not often that you see the mark of greatness in such bold relief. When you see what is possible, nothing less will suffice: the important thing in life is to find that arena of performance in which your talents and skills have you. Then you're not merely working a job or even a career: you're doing what you're meant to be doing.
Like Melinda.
Wednesday, March 14, 2007
Two Deadly Sins In Trading
Earlier this morning, I put on a nice trade: shorted ES at 1394 and covered at 1389. Let's take a look at what made it a good trade, and then we'll examine two deadly sins in this current market that make it difficult to make good trades.
The first--and perhaps most positive--aspect of the trade was that it was my first of the day. I sold ES a little after 10 AM CT, which means I sat there for a full 90 minutes watching the market move around not making a single trade. Instead I waited for what I considered to be a perfect setup. There was enough volatility that I felt I didn't need many winning trades to have a good day.
The second positive aspect of the trade was that I was sure of the market trend (down) and waited for a nice bounce before selling. I then waited for the bounce to lose steam before entering. Instead of trying to pick a top, I waited for the market to become unable to make new highs (see chart above) when buyers came in before committing my capital. That enabled me to take a minimum of heat on the trade and ride the market trend down.
The third positive aspect of the trade was that I had a lower peak in ES around 9:45 AM CT to lean on as a reference point for a catastrophic stop. My trade was predicated on the notion that ES was unable to make new highs on fresh buying, as indicated by the NYSE TICK readings. I also saw that fewer stocks were making fresh short-term (30 min) highs. If those conditions had been violated, I had a stop loss in mind to limit the amount of capital at risk.
The fourth positive aspect of the trade was that I waited for longs to capitulate, as indicated by increased volume (and increased hitting of bids), to make my exit. That allowed me to take my profits without being exposed to short-covering. It also enabled me to wait for the next bounce, gauge its strength, and re-enter with yet other selling positions.
What I'm hearing from quite a few traders is that they're making a deadly mistake: They are confusing market movement with market opportunity. That is leading them to overtrade the market and get whipsawed by the considerable volatility. Movement is only opportunity if it coincides with your own, well-grounded setups. If you don't wait for the right entry conditions, movement offers more risk than reward. A volatile market allows you to be patient: You'll get your move eventually.
The second deadly mistake traders make is that, after a trade such as the one above, they'll keep trading, rather than return to their patience. Why? Sometimes it's out of excitement and greed, but often it's because they're trading small. Even a relatively modest prop trader might be trading 50 contracts. This means that the five point winner has just put them up $12,500 on the session. That's a respectable day in itself; there's no need to put on another trade unless it sets up sweetly.
But what if, instead of trading 50 contracts, you're trading 5? Now your five-point winner has paid you out $1250. Not bad at all, but also not a killing if you're hoping to support a family on your earnings. So, instead of trading large, the small trader trades often--and commits the deadly sin of getting away from opportunity.
Going with the overall trend, waiting for the right opportunity, letting markets show they're strengthening or weakening before you make your move, keeping stop losses close relative to potential reward, taking profits aggressively when you get an extreme move your way, trading large enough to make an acceptable income from one good trade per day: these are part of the mental model I've created for my own trading.
Staying grounded in that mental model means avoiding overtrading. Volatility is not necessarily opportunity and trading small positions more often won't provide the returns of trading larger size with the proper, selective setups.
By the way, as a parenthetical note, observe that we've made fresh bear lows in the S&P 500 Index, but not in NQ, ER2, or semiconductors. I'll be watching that.
How To Utilize The Trading Psychology Weblog
A reader recently asked me for guidance regarding the indicators and ideas tracked in the Trading Psychology Weblog. This post will summarize the content of the Weblog and how it can best be utilized.I generally post to the Trading Psychology Weblog daily. Exceptions are when I'm on the road, working with traders, or on vacation.
It's best to think of the entries as preparation for the trading day ahead. The posts are generally divided into three sections:
* Blog Links: These track blogs and websites for interesting perspectives. The links are grouped according to theme. Some are "Ideas" regarding markets and the economy; others are collections of "Links" gathered by bloggers; and some are specifically related to "Trading". I try to focus on the blogs that provide fresh, high-quality educational content, and I also try to highlight the work of new bloggers. A read through the entries will provide an idea of what's on the minds of experienced analysts and traders.
* Market Perspective: This is a section in which I take an indicator and update it for the current market. I try to focus on indicators that are out of the ordinary, and that offer a compelling message. The goal is to look at the market from a fresh angle.
* Market Synthesis: This is the section that will require the greatest explanation. It is my attempt to synthesize a number of indicators, some of them proprietary, into a trading outlook for the coming day. The synthesis generally assesses the short-term trend of the market, whether the recent market is strengthening or weakening, and how I plan to approach the coming day's trade.
Here is an explanation of each of the measures referenced in the Market Synthesis and how they are used:
1) Pivot Points - I've posted to TraderFeed on the topic of pivot points; an advanced search in Technorati will provide a full list of relevant posts. These pivots, derived from the previous day's prices in the ES (S&P futures) market, were first used by floor traders and since have gained wide currency. The daily pivot level is simply the average of the previous day's high, low, and closing prices (day session data only). It is closely related to another Weblog measure, the Volume Weighted Average Price (VWAP). Whereas the daily pivot is a simple price average, VWAP weights each minute's average price by the volume traded that minute to show where most trade has occurred. In a range bound market, if you fail to break out of the upper or lower edges of the range, the daily pivot and the VWAP will be your high-probability price targets. In my own trading, I generally take some profits at these levels. If trade is slow, I'll probably take my entire position off at that profit target. Recall that volume is correlated with volatility: in a slow market, a move back to the average price may be all the directional movement you get on a short-term trade.
Along with the daily pivot, I provide the S1, S2, and R1 and R2 price targets. These are calculated as a function of the daily pivot and the price movement from the previous day away from the pivot. The specific formulas are in my article. When volume is normal and you have a trending day or a breakout from a price range, your high-probability price target will be R1 in a rising market and S1 in a falling market. Generally, I will take profits at or near these levels. In a high volume trending market, where we can expect greater volatility, I will leave at least a piece of my position to hit the R2 (in a rising market) or S2 (in a falling market) targets. The other price targets to keep in mind are the high and low from the previous trading session (Since 85% of all trading days are not inside days, we're likely to hit one or another of those extremes) and the high and low from the overnight futures market (a good first target for an early morning trade). Monitoring where we are trading in the day relative to these levels provides a good set of reference points for the market's overall action.
2) Short-Term Trend - I refer to a bullish short-term trend as one in which we see higher/lower prices day-over-day and at least one of the two following: a rising number of stocks making fresh 20-day new highs/new lows and/or a rising/falling balance between Demand and Supply (see below). In other words, price alone won't define a trend. We have to see rising participation in the market move. When we don't have these criteria met, I refer to a neutral trending mode, which generally signifies a range bound environment. In a short-term uptrend, think about the previous day's high and R1 as initial price targets; in a short-term downtrend, think about the previous day's low and S1 and initial targets. In a neutral trending mode, think about fading range extremes toward the daily pivot and VWAP levels.
3) Adjusted NYSE TICK - This has also been the subject of a number of TraderFeed posts. The NYSE TICK measures the number of stocks trading at their offer price minus those trading at their bids. The Adjusted TICK is an index that subtracts the 20-day average TICK reading from each one-minute reading and then cumulates the one-minute readings into a single daily total. When the Adjusted TICK is greater than zero, it means that there is an above average tendency of traders to lift offers among the broad list of stocks. Readings below zero indicate an above average tendency of traders to hit bids among stocks. In range bound markets, we typically find Adjusted TICK readings relatively close to the zero level--generally between -200 and +200. Extreme positive or negative readings--generally greater than +500 or less than -500--are typical of trending markets. Monitoring TICK during the day is a major way of establishing the kind of day you're in--especially if you compare the current day's readings with those of the previous day. This will tell you if buying or selling interest are increasing over time. In general, if I see that the previous day's Adjusted TICK was quite positive/negative, I'll look for some upside/downside follow through the next day and establish pivot targets accordingly. I'm more likely to look for range bound markets and returns to the day's pivot and VWAP following relatively neutral Adjusted TICK readings.
4) Institutional Composite - Pretty much the same thing as the Adjusted TICK, except the TICK data are derived from the Dow 30 stocks and not from the broad NYSE universe. That makes the Institutional Composite sensitive to buying and selling among large caps, but it also makes it sensitive to program trading activity. The best trending days will have distinctly positive or negative readings in *both* Adjusted TICK and Institutional Composite. Following those days, I tend to look for follow through the next trading day. When Adjusted TICK is strong and Institutional Composite weak or vice versa, I use this as an indication of which sector is gaining the most interest: small/midcaps or large caps.
5) Demand and Supply - This is my main measure of stock momentum. It, too, has been the subject of several TraderFeed posts. Both are proprietary indexes that track the number of stocks across all major exchanges that close above (Demand) or below (Supply) the volatility envelopes surrounding their short- and medium-term moving averages. A high level of Demand thus indicates many stocks have very strong upside momentum; a high level of Supply suggests very strong downside momentum. Low levels of both and relatively balanced readings between Demand and Supply are typical of range bound markets. Once again, this is very useful information in setting pivot-based price targets for trades. Very strong Demand and Supply markets tend to follow through to the upside and downside in the near term. Rises and declines on weak Demand and Supply are more likely to reverse. The combination of Adjusted TICK and Demand/Supply will tell you quite a bit about the trending strength of the recent market.
6) New 20 Day Highs and Lows - This measure also tracks all stocks trading on the major exchanges (NYSE, NASDAQ, ASE). It is an index of the number of issues making fresh 20-day highs on the day vs. the number of issues making fresh 20-day lows. If we get a market rise, but do not meaningfully expand the number of stocks making fresh 20-day highs (and vice versa for declines), I tend to look for reversals of that move the next day. Conversely, expanding new highs or lows suggests a trending tendency. At the end of a trading day, I'll ask myself: What did the market try to do today (price action) and how successful was it (expansion of NYSE TICK/Institutional Composite, Demand/Supply, New Highs/Lows)? Seeing how the most recent values for the indicators compare with the prior days' levels will give you an idea of whether the market is gaining or losing trendiness.
7) Institutional Momentum - This also is a proprietary measure that tracks the momentum of a group of 17 large cap stocks over medium to longer time frames. Accordingly, it functions as a kind of overbought-oversold measure for a longer time frame. Very positive numbers--greater than +500--suggest solid upside momentum. Very negative numbers--less than -500--indicate solid downside momentum. We especially want to see how today's readings compare to those of recent days, to see if the market is gaining or losing momentum. Along with Institutional Momentum, I track the number of stocks in the basket that are trading in intermediate-term uptrends vs. downtrends. This, too, acts as a kind of intermediate-term overbought-oversold measure.
All in all, these are measures that tell you what's happening beneath price action. I find they are useful in helping me frame ideas of whether markets are gaining vs. losing strength and whether I want to plan trades that ride a trend vs. look for reversal. Of course, it is crucial to observe how the market is trading in real time before setting up a trade; none of the Weblog indicators are designed as mechanical tools. Still, I find them valuable in understanding what's happening in the market and in providing context for intraday trading ideas.
Tuesday, March 13, 2007
What Individual Stocks Tell Us About Index Movement
It really looked as though we were going to fall out of bed in the stock index futures markets this morning before the open. The Yen once again strengthened against the dollar and you could see selling hit the ES, NQ, and ER2 contracts. Early after the open, we dipped to 1409.25 in the ES futures, breaking the lows from the prior two days. Then we got some buying in ES, returning us to the prior trading range before another selling wave hit shortly after 9:00 AM CT.
So what do you do? Sell the market in anticipation of further weakness or decide that selling has exhausted itself? That's when an analysis of what individual stocks are doing can be helpful.
It turns out that, although the ES contract made a 3-day low on the early down move, only 11 Dow stocks broke their lows from the prior two days. In general, I've found that, whenever fewer than half of stocks participate in a move, that move is more likely to reverse than if there is broad participation. Moreover, despite the selling in the futures, my TICK Volume measure--while negative--was holding well above the prior day's lows.
From the vantage point of individual stock action, the subsequent rally in the futures was not so surprising. As popular as they are, the index futures *are* derivative of the broader stock market. If a majority of large cap stocks are refusing to participate in a move, it is difficult to sustain a trend. Knowing how individual stocks are moving provides important clues as to directional shifts in the futures.
So what do you do? Sell the market in anticipation of further weakness or decide that selling has exhausted itself? That's when an analysis of what individual stocks are doing can be helpful.
It turns out that, although the ES contract made a 3-day low on the early down move, only 11 Dow stocks broke their lows from the prior two days. In general, I've found that, whenever fewer than half of stocks participate in a move, that move is more likely to reverse than if there is broad participation. Moreover, despite the selling in the futures, my TICK Volume measure--while negative--was holding well above the prior day's lows.
From the vantage point of individual stock action, the subsequent rally in the futures was not so surprising. As popular as they are, the index futures *are* derivative of the broader stock market. If a majority of large cap stocks are refusing to participate in a move, it is difficult to sustain a trend. Knowing how individual stocks are moving provides important clues as to directional shifts in the futures.
NYSE TICK Volume: Tracking The Sentiment Of Large Traders
My past posts have dealt with the NYSE TICK as a measure of sentiment and the tracking of large traders as a way of assessing market direction. In response to a reader question as to dollar volume flow in the market overall, let's see if we can integrate these ideas.
The integration is with an indicator we can call TICK Volume. Here is how it is derived: Each minute of the trading day, I take the reading of the NYSE TICK by averaging the high, low, and close for that minute. I then subtract from that reading the average one minute NYSE TICK reading from the past 20 trading sessions. That gives me the Adjusted TICK, which is cumulated on a daily basis and summarized as an index in the Trading Psychology Weblog.
Notice that the Adjusted TICK tells us whether we have above or below average tendencies of traders to transact at the market offer (positive readings) or at the market bid (negative readings). This makes the TICK a valuable sentiment measure, as it captures how eager buyers are to enter the market (lift offers) and how eager sellers are to exit (hit bids).
The TICK Volume measure, depicted above from the period December, 2006 to the present, takes the Adjusted TICK one step further by multiplying each one-minute reading by the ES volume for that minute. I cumulate the 1 minute readings into a single end-of-day measure that is positive if there is net tendency to lift offers and negative if there is net tendency to hit bids. We know from research linked above that ES volume is dominated by the largest market participants. By multiplying Adjusted TICK by volume, we weight the sentiment data to reflect what the institutions and large locals are doing.
We can see that, from December through February, the S&P 500 Index (SPY) ratcheted higher, but we saw lower highs in TICK Volume. These divergences were also evident in the data regarding stocks making new highs and in my Adjusted Dollar Volume Flow data. There is a concept in statistics called convergent validity: A measure should overlap other, known measures of that particular construct. The converging findings from TICK Volume, new high/low data, and Dollar Volume Flow suggest that they are capturing a similar construct, which I believe is related to the behavioral tendencies of institutional traders.
Clearly TICK Volume highlights the very negative sentiment during the recent market drop. Note, however, that the bounce in sentiment since that time has been relatively tepid. We have not seen large traders pile into the market, seeking bargains, and lifting offers to anywhere near the degree to which they were exiting the market during the downdraft. That has led me to question the sustainability of the bounce.
Over the past three sessions, we've been in a trading range, oscillating around an average price of about 1416-1417 in the June ES futures. Traders will be watching carefully for breakout moves from this range to determine whether we will see a fresh upleg off the recent lows or a test of those lows. One of the strengths of TICK Volume as a measure is that it captures short-term breakouts in sentiment quite nicely, as it updates each minute. I will be watching TICK Volume carefully to handicap the odds of an eventual breakout move.
Soliciting Questions For CNBC Special Program Interview
As part of CNBC's Million Dollar Challenge, I'll be appearing on a special program Friday evening between 7 and 8 PM EST that will deal with trader/investor psychology.
It's always difficult in a matter of a few minutes to convey ideas properly, but the first priority is to convey the proper ideas.
That's where you come in!
If you have any questions about trading and trading psychology that you'd like me to forward to the producer of the show, either leave them as a comment to this blog entry or email me at the address at the end of the "About Me" section of the TraderFeed home page.
I'll select the themes/questions that are of greatest interest and pass them along for inclusion in the show. I don't know any better way to make financial television relevant than to poll real life traders and address the real challenges that we all face day in and day out.
Thanks!
Brett
It's always difficult in a matter of a few minutes to convey ideas properly, but the first priority is to convey the proper ideas.
That's where you come in!
If you have any questions about trading and trading psychology that you'd like me to forward to the producer of the show, either leave them as a comment to this blog entry or email me at the address at the end of the "About Me" section of the TraderFeed home page.
I'll select the themes/questions that are of greatest interest and pass them along for inclusion in the show. I don't know any better way to make financial television relevant than to poll real life traders and address the real challenges that we all face day in and day out.
Thanks!
Brett
Monday, March 12, 2007
The Paradox Of Trading Rules: What Attracts People To Trading Is What Makes Them Fail
I've asked many traders what attracts them to the field and responses of varied. Many cite the challenge of figuring out complex markets, the lure of a large income, and the inherent competitive nature of trading. The most common theme that emerges, however, is that of autonomy. Many traders are attracted to the markets because trading enables them to set their own (reasonable) hours and work for themselves. It is not at all uncommon in my experience for a struggling trader to voice his or her worst fear: not losing money, but losing the autonomy of self-employment. The idea of working a 9-to-5 job for a straight salary rubs many traders the wrong way, despite the seeming lure of security and benefits conferred by such jobs.
In recent posts, I mentioned that autonomy is an important component of personal well-being. For that reason, I included it as a dimension in my brief personality questionnaire for traders. Research suggests that daily fluctuations in our perceived ability to control our outcomes contribute to shifts in our moods and that people in societies that offer greater personal freedom report higher levels of positive mood than those in countries with restricted options.
As Daniel Nettle reports in his book Happiness, people with professional jobs report higher levels of well-being than people in unskilled positions. This is partly a function of income, but also represents a response to the higher autonomy present in most professions. In fact, on a ten-point scale of personal happiness, poor individuals who report a high level of autonomy average a score of 7.85. Wealthy persons who perceive a low level of autonomy average only 5.82. The conclusion? "Being at the top of the social heap only makes you happy in as much as it gives you the opportunity to control your life" (p. 74).
This helps to explain why traders will stick with trading even after it is clear they are not making a solid living from their efforts. Perhaps, paraphrasing Milton, it is psychologically better to rule in financial Hell than serve in heavenly wealth.
But therein lies the rub. What if trading success requires a high level of rule-following and self-restraint? No one would point to Army boot camp as a source of high autonomy for a recruit, but trading arguably requires just as much attention to detail and discipline. Ironically, what most attracts people to trading is what frequently does them in: they subconsciously--and sometimes overtly--view rule-governance as a form of unwanted restraint. Their violation of trading rules and plans represents an assertion of autonomy, not a deeply hidden motivation to court failure.
The key to succeeding with trading rules is to truly make them your own. Frame them your way out of your own experience. Having rules imposed by your trading firm or trying to borrow rules from another trader won't provide the autonomy of self-defined rules that you actively choose. Autonomy doesn't mean living without rules or limits. It means actively selecting the guidelines for your own behavior. If no one followed the rules of the highway, everyone's freedom to travel would be impaired. We willingly accept rules because these sometimes get us where we want to go in life.
If your trading rules are right for you, they should feel natural, like driving on the proper side of the highway. If your rules feel like strait-jackets, you know there will be a battle between the need for autonomy and the need for profits. And, if you're like most people, autonomy will win out.
In recent posts, I mentioned that autonomy is an important component of personal well-being. For that reason, I included it as a dimension in my brief personality questionnaire for traders. Research suggests that daily fluctuations in our perceived ability to control our outcomes contribute to shifts in our moods and that people in societies that offer greater personal freedom report higher levels of positive mood than those in countries with restricted options.
As Daniel Nettle reports in his book Happiness, people with professional jobs report higher levels of well-being than people in unskilled positions. This is partly a function of income, but also represents a response to the higher autonomy present in most professions. In fact, on a ten-point scale of personal happiness, poor individuals who report a high level of autonomy average a score of 7.85. Wealthy persons who perceive a low level of autonomy average only 5.82. The conclusion? "Being at the top of the social heap only makes you happy in as much as it gives you the opportunity to control your life" (p. 74).
This helps to explain why traders will stick with trading even after it is clear they are not making a solid living from their efforts. Perhaps, paraphrasing Milton, it is psychologically better to rule in financial Hell than serve in heavenly wealth.
But therein lies the rub. What if trading success requires a high level of rule-following and self-restraint? No one would point to Army boot camp as a source of high autonomy for a recruit, but trading arguably requires just as much attention to detail and discipline. Ironically, what most attracts people to trading is what frequently does them in: they subconsciously--and sometimes overtly--view rule-governance as a form of unwanted restraint. Their violation of trading rules and plans represents an assertion of autonomy, not a deeply hidden motivation to court failure.
The key to succeeding with trading rules is to truly make them your own. Frame them your way out of your own experience. Having rules imposed by your trading firm or trying to borrow rules from another trader won't provide the autonomy of self-defined rules that you actively choose. Autonomy doesn't mean living without rules or limits. It means actively selecting the guidelines for your own behavior. If no one followed the rules of the highway, everyone's freedom to travel would be impaired. We willingly accept rules because these sometimes get us where we want to go in life.
If your trading rules are right for you, they should feel natural, like driving on the proper side of the highway. If your rules feel like strait-jackets, you know there will be a battle between the need for autonomy and the need for profits. And, if you're like most people, autonomy will win out.
Sunday, March 11, 2007
Disgust Yourself: A Framework For Rapid Behavior Change
A while back, I posted on the topic of "brief therapy for the mentally well". Brief therapies are collections of methods designed to promote rapid changes in patterns of thinking, feeling, and acting. Much of what I do as a psychologist is help traders become their own trading coaches by applying brief techniques to their own situations. Some resources for learning brief change techniques can be found in this post and in my two trading books.
People who write about psychology (but who aren't psychologists) often assert that behaviors change through positive thinking, goal setting, and the like. One would think that the annual experience of broken New Years' resolutions would put an end to such fantasies, but apparently not. The idea that we can shape ourselves by willing self-improvement seems unusually impervious to lack of research evidence and much personal experience to the contrary.
So how do people control their behavior and sustain the motivation to change themselves?
Let's look at a very unusual example: the anorexic patient. Anorexic people greatly restrict their food intake, sometimes to the point of death. They frequently have a distorted body image and believe themselves to be overweight, even as they are literally wasting away.
Clearly anorexia is a serious psychiatric disorder, but it is an interesting motivational phenomenon. Here is an inborn, hard-wired behavior pattern--eating--that is overridden by a social motivation: the desire to not be fat. So all-encompassing is this motivation that it often proves to be resistant to efforts at treatment, medical as well as psychological.
What is the basis for the anorexic person's motivation? Not positive self-statements and goal-setting, that's for sure! Rather, the anorexic individual is motivated by disgust. Quite literally, the patient is disgusted by anything that feels or looks overweight--and that disgust is so strong that it keeps food at bay.
Daniel Nettle's recent book Happiness: The Science Behind Your Smile makes the important point that disgust is a much stronger emotion than happiness. We tend to habituate to happiness: what makes us happy (a new car, seeing an old friend), after a while loses its ability to bring overt joy. Disgust, however, such as the sensation of eating food that has gone bad, stays with us for quite a while. What disgusts us now--for instance, sitting on a bus next to a person who hasn't bathed in weeks--will most likely produce equal disgust should it happen in the future. Indeed, like the anorexic, we might even avoid buses altogether just to prevent a repeat experience of disgust.
There are solid evolutionary reasons for this, Nettle notes. The things that would disgust primitive man--tainted food, unsanitary conditions--are directly related to his survival. If it took many learning trials to become averse to such situations, humans might not have survived their learning curves. By hard-wiring disgust, learning, and motivation, nature provided the opportunity for one-trial learning: the briefest of all therapies.
When we examine many of the most dramatic examples of personal change, we find disgust as a common element. What gets a person to finally stick with a diet is reaching the point of disgust with his or her appearance, energy level, etc. Similarly, smokers and alcoholics reach the point where the consequences of their behaviors disgust them, whether those consequences are smelling bad, becoming short of breath, or losing jobs or driver's licenses. "I can't stand living this way," is a frequent refrain among therapy clients who are ready for change.
I personally reached the point of sticking with my stop loss levels when I became disgusted by large losses that ate into days' and weeks' worth of profits. Similarly, I became better at defining and acting upon my profit targets when I became disgusted with situations in which I had a nice profit in hand and let it completely reverse to breakeven. And letting winners turn into losers? That became *so* disgusting for me that I set my exits to ensure it won't happen again.
Want a reliable behavioral method for ensuring that you follow your trading plans? Simple! Hook up your trade station to an IV drip going into your arm. Whenever you violate your plans, the drip would release a small amount of ipecac extract to induce violent nausea. Very quickly, the association between the trading behavior and the nausea would lead you to anticipate negative consequences any time you broke your rules. An anticipatory disgust response, like that of primitive man and tainted meat, would keep you from doing the wrong thing. Permanently.
There actually is a treatment similar to the imaginary example above, and it's called aversion therapy. Taking a drug that makes an alcoholic person sick whenever they drink ends up being one of the most effective ways of dealing with the addiction. Positive intentions and self-help exercises don't nearly possess the force of gut physical disgust.
If disgust can turn eating into a behavior to be avoided and an alcoholic's drinking into a thing of the past, perhaps it can be leveraged into a brief treatment for trading problems. The key is turning common wisdom on its head. Instead of trying to *make* yourself do the right things, fill your mind with thoughts and images of how disgusting you are when you do the wrong things. Just as anorexics spend hours in front of mirrors berating themselves for their looks, you can create your own metaphorical mirrors and become emotionally connected to the wasted effort and lost money from poor trading practices.
We are most apt to change a pattern once we become truly disgusted by it. Would you continue to do business with someone who violated your contract with him and took your money? No, you'd become so disgusted with such a dishonest individual that you'd shun him altogether.
Well, that person is you when your own patterns violate your contract with yourself and cause you to lose money. Once you become truly disgusted with your own patterns, you'll shun them altogether. And that's the briefest--and most effective--of therapies.
People who write about psychology (but who aren't psychologists) often assert that behaviors change through positive thinking, goal setting, and the like. One would think that the annual experience of broken New Years' resolutions would put an end to such fantasies, but apparently not. The idea that we can shape ourselves by willing self-improvement seems unusually impervious to lack of research evidence and much personal experience to the contrary.
So how do people control their behavior and sustain the motivation to change themselves?
Let's look at a very unusual example: the anorexic patient. Anorexic people greatly restrict their food intake, sometimes to the point of death. They frequently have a distorted body image and believe themselves to be overweight, even as they are literally wasting away.
Clearly anorexia is a serious psychiatric disorder, but it is an interesting motivational phenomenon. Here is an inborn, hard-wired behavior pattern--eating--that is overridden by a social motivation: the desire to not be fat. So all-encompassing is this motivation that it often proves to be resistant to efforts at treatment, medical as well as psychological.
What is the basis for the anorexic person's motivation? Not positive self-statements and goal-setting, that's for sure! Rather, the anorexic individual is motivated by disgust. Quite literally, the patient is disgusted by anything that feels or looks overweight--and that disgust is so strong that it keeps food at bay.
Daniel Nettle's recent book Happiness: The Science Behind Your Smile makes the important point that disgust is a much stronger emotion than happiness. We tend to habituate to happiness: what makes us happy (a new car, seeing an old friend), after a while loses its ability to bring overt joy. Disgust, however, such as the sensation of eating food that has gone bad, stays with us for quite a while. What disgusts us now--for instance, sitting on a bus next to a person who hasn't bathed in weeks--will most likely produce equal disgust should it happen in the future. Indeed, like the anorexic, we might even avoid buses altogether just to prevent a repeat experience of disgust.
There are solid evolutionary reasons for this, Nettle notes. The things that would disgust primitive man--tainted food, unsanitary conditions--are directly related to his survival. If it took many learning trials to become averse to such situations, humans might not have survived their learning curves. By hard-wiring disgust, learning, and motivation, nature provided the opportunity for one-trial learning: the briefest of all therapies.
When we examine many of the most dramatic examples of personal change, we find disgust as a common element. What gets a person to finally stick with a diet is reaching the point of disgust with his or her appearance, energy level, etc. Similarly, smokers and alcoholics reach the point where the consequences of their behaviors disgust them, whether those consequences are smelling bad, becoming short of breath, or losing jobs or driver's licenses. "I can't stand living this way," is a frequent refrain among therapy clients who are ready for change.
I personally reached the point of sticking with my stop loss levels when I became disgusted by large losses that ate into days' and weeks' worth of profits. Similarly, I became better at defining and acting upon my profit targets when I became disgusted with situations in which I had a nice profit in hand and let it completely reverse to breakeven. And letting winners turn into losers? That became *so* disgusting for me that I set my exits to ensure it won't happen again.
Want a reliable behavioral method for ensuring that you follow your trading plans? Simple! Hook up your trade station to an IV drip going into your arm. Whenever you violate your plans, the drip would release a small amount of ipecac extract to induce violent nausea. Very quickly, the association between the trading behavior and the nausea would lead you to anticipate negative consequences any time you broke your rules. An anticipatory disgust response, like that of primitive man and tainted meat, would keep you from doing the wrong thing. Permanently.
There actually is a treatment similar to the imaginary example above, and it's called aversion therapy. Taking a drug that makes an alcoholic person sick whenever they drink ends up being one of the most effective ways of dealing with the addiction. Positive intentions and self-help exercises don't nearly possess the force of gut physical disgust.
If disgust can turn eating into a behavior to be avoided and an alcoholic's drinking into a thing of the past, perhaps it can be leveraged into a brief treatment for trading problems. The key is turning common wisdom on its head. Instead of trying to *make* yourself do the right things, fill your mind with thoughts and images of how disgusting you are when you do the wrong things. Just as anorexics spend hours in front of mirrors berating themselves for their looks, you can create your own metaphorical mirrors and become emotionally connected to the wasted effort and lost money from poor trading practices.
We are most apt to change a pattern once we become truly disgusted by it. Would you continue to do business with someone who violated your contract with him and took your money? No, you'd become so disgusted with such a dishonest individual that you'd shun him altogether.
Well, that person is you when your own patterns violate your contract with yourself and cause you to lose money. Once you become truly disgusted with your own patterns, you'll shun them altogether. And that's the briefest--and most effective--of therapies.
Where's The Flow? XLV And Health Care Stocks
This will be the last of the eight S&P 500 large cap sectors that we evaluate for Adjusted Relative Dollar Volume Flow. I will be posting future updates for the sectors, as well as for the Dow and S&P 500 indices, to the Trading Psychology Weblog. Recall that, to this point, we've looked at materials, financial, energy, technology, consumer discretionary, consumer staples, and industrial stocks. We've also taken a look at dollar volume flows for the S&P 500 Index as a whole. Now we'll ask the WTF question about health care stocks, as represented by the XLV sector Spyder ETF. As with the prior analyses, I selected five stocks that dominate XLV to assess dollar volume flows: PFE, JNJ, MRK, LLY, and AMGN.
The chart above, going back to January, 2004, shows price for XLV (blue line) against the ten-day average Adjusted Relative Dollar Volume Flow for the health care stocks (pink line). As before, when the flow line is above the zero level (horizontal red line), it tells us that above average dollar volume flows are entering the sector. Conversely, when the flow line dips below the zero level, it signifies subnormal dollar volume flows into the health care stocks.
Our familiar pattern once again appears in the recent data: we saw a steady decline in the dollar volume peaks leading up to the February, 2007 price peak in XLV. This pattern has also shown up during prior topping processes in the sector. We can also see that, in the wake of the recent market decline, Adjusted Dollar Flows have been subnormal in the health care shares, but only modestly so. Out of the last eight trading sessions, four have shown below average dollar flows and four have shown above average flows.
What we might conclude from these data is that buyers have not yet jumped in at lower prices to embrace the health care stocks, but neither have they sold them aggressively. This is in keeping with the hypothesis that, during the decline, investors have been relatively risk-averse, preferring defensive market sectors over growth-oriented and more volatile ones. Until we see evidence of above-average flows returning to the health care issues, however, it is premature to call a market bottom in the sector.
Where's The Flow? XLI And The Industrial Stocks
Thus far we've looked at Adjusted Relative Dollar Volume Flows for several sectors within the S&P 500 large cap universe, including materials, financial, technology, energy, consumer discretionary, and consumer staples stocks. We've also tracked volume flows for the S&P 500 Index as a whole. Now we ask the WTF question about industrial stocks, as represented by the XLI Spyder sector ETF. As with the other sectors, I've chosen five stocks that dominate the ETF to gauge dollar flows. These include GE, UPS, BA, UTX, and MMM.
The above chart, going back to January, 2004, shows us the price of XLI (blue line) vs. the ten-day average Adjusted Dollar Flows for the group of industrial stocks (pink line). When the pink line is above the zero level (horizontal red line), it means that dollar volume flows into the industrial sector are above average (relative to their 200-day average). When the pink line falls below the zero level, it means that we have below average dollar flows into the sector.
Patterns that we've seen among the other sectors are also evident among the industrial shares. We can see a surge of dollar flow into the sector in September, 2006 followed by higher prices. We also see waning peaks in dollar volume flow leading to the price peak in February, 2006, by now a familiar pattern.
Notice how the recent market decline has led to persistent subnormal dollar volume flows into the industrial sector. Indeed, only 2 out of the last 20 trading sessions have shown above-average flows. What that tells us is that, even with the recent drop in prices, large market participants are not putting money to work among the industrial shares. Until we see evidence of such interest, it is premature to call a bottom in this sector.
Saturday, March 10, 2007
Where's The Flow? XLP And Consumer Staples Stocks
Well, we're doing a pretty good job of winding our way through the major market sectors within the S&P 500 Index universe. To this point we've looked at Adjusted Relative Dollar Volume Flow among the materials, energy, technology, financial, and consumer discretionary sectors, as well as the S&P index overall. Now we ask the WTF question about consumer staples stocks. That sector is represented by the XLP Spyder sector ETF. As with the other sectors, I've chosen five stocks that dominate the ETF to assess dollar flows: PG, MO, WMT, KO, and WAG.
As with the other sectors, the blue line represents the price of the XLP ETF going back to January, 2004. The pink line captures the 10-day average of dollar flows among the five stocks. When that line is above the horizontal red line at the zero level, it tells us that flows are above average compared with their 200 day average. When the pink line is below the zero level, it tells us that dollar flows into the consumer staples issues are subnormal.
We can see that a surge of dollar volume flowed into the consumer staples stocks in September, 2006--a pattern similar to what we saw among the consumer discretionary issues. We can also see the lower peaks in dollar flows leading to the price high in February, 2007--a pattern noted among the other sectors. Also as with those other sectors, we can see that negative values for the Adjusted Relative Dollar Volume Flows have represented intermediate-term buying opportunities among the consumer staples shares.
Observe, however, that--even in the wake of the recent market decline--we have yet to see subnormal flows into the sector. In other words, large market participants are not bailing out of this sector, even during the significant market drop. Although 7 of the last 10 trading sessions have shown subnormal dollar flows, these have been only very modestly below average--and the positive days have been well above average. We don't yet see significant dollar flows going into the staples, but--on a relative basis--they, along with the materials and consumer discretionary stocks, have weathered the decline well. A reasonable hypothesis is that investors have been less aggressive in selling defensive market sectors during the recent period of risk aversion.
Subscribe to:
Posts (Atom)
Posts
