Here are some of the common issues that I'm hearing from traders during recent coaching sessions. Most of us can recognize ourselves in one or more of these patterns:
1) Becoming Overly Focused on P/L During Trading - Watching your profits or losses tick up and down during a trade; becoming anxious about P/L and letting P/L, not a trading plan, dictate when you get out of a trade. It's a recipe for performance anxiety. By focusing on process goals rather than P/L, you can stay grounded in good trading practices and minimize performance stresses.
2) Trading Much Larger After a Series of Winning Trades - It is common that traders become overconfident after a series of wins and decide to increase their risk by a factor of two or more. This often leads to large losing trades that wipe out much of the profit, generating frustation and discouragement. Just as it doesn't make sense to plow into a trade after a large move has already occurred, it doesn't make sense to plow into risk after a series of profitable trades.
3) Failing to Learn From Losing Trades - Traders often want to put losses behind them and not dwell on negatives. The downside is that they don't learn from their losses and thus miss opportunities to understand what's happening in markets and what they might be doing wrong. This is especially important following a series of losing trades: either you're not seeing the markets well, or you're not acting well on your perceptions. Both scenarios offer learning opportunities that can help generate profits down the line.
It's common to think of trading as a stressful occupation, but much of the stress is self-generated. By staying focused on "best practices" in trading, we minimize fear and frustration and build confidence in our development.
RELATED POST:
Overcoming Performance Stress
.
Tuesday, March 18, 2008
The Promises and Limits of Coaching: Lessons From College Counseling
In my recent post on how much coaching is enough to produce change, I summarized research from the dose-effect research literature. One problem with this is that the literature is primarily oriented to clinical populations: those with diagnosable disorders. Fortunately, there is one setting for applied psychology that focuses more on normal, developmental problems than clinical ones: college counseling centers.
Having worked at a college counseling center at Cornell University and then directed a student counseling service at SUNY Upstate Medical University, I can attest to the similarities between work with students in higher education and coaching of professionals in trading and other fields. In my work at Syracuse, fully two-thirds of the people seeking assistance were looking for help with such normal concerns as relationship problems, career issues, and performance-related stress. Interestingly, these are also among the most common issues that traders discuss with me. Many of the same cognitive, behavioral, and solution-focused methods that are helpful in work with students are also relevant and useful for traders.
So what can college counseling teach us about the coaching of traders? A very interesting research study conducted in 2000 summarized college counseling work with almost 1700 students across over 40 campuses. This provides a broad cross-section of schools and students. The study found that over 1000 of the students--about 60% of the sample--only attended 3 or fewer counseling visits. This is not unusual: other studies of utilization of helping services have found that the modal number of visits to a psychologist or counselor is one.
The low number of visits does not necessarily mean that the services were not helpful. Rather, the study found that almost 30% of the students reported significant improvement by the end of one session and nearly 40% by the end of the third visit. Among those who attended 10 sessions, 54.5 % reported significant improvement. The study authors suggest that this shows a dose-effect relationship among the college students: more visits produce better results. It also suggests that about half of all people in the college setting--which I believe is the best mirror for coaching settings--can benefit from short-term help. Indeed, they often vote with their feet and only attend several helping meetings.
Still, the data suggest that many people do not benefit from short-term help. On college campuses, this can include people with ongoing problems with anxiety, depression, eating disorders, and substance abuse. Similar problems can be found among traders. Of the people who attended 10 sessions, 9.1% actually deteriorated over time and 36.4% reported no change. This is a finding that is not frequently discussed among psychologists and counselors, and certainly not among coaches: some people get worse, despite best efforts at helping. This may be due to a lack of skill among helpers; a poor personality fit between helper and client; or an unusual problem that is not detected by the counselor.
My experience is that the latter is most often the case. I have met with traders who have received prior coaching (and sometimes therapy), only to find that they have a diagnosable problem that went unrecognized. Sometimes the problem is depression; sometimes it is a form of anxiety; sometimes it is an eating disorder; and sometimes it is a purely medical problem that manifests itself as emotional distress (e.g., a thyroid disorder). It is also sometimes the case that a problem is longstanding and severe and simply needs more than 10 sessions of assistance. One research study, for example, found that individuals with severe emotional disorders continue to show therapeutic responses for 25 sessions of therapy and more.
So what can we conclude from this research? Simple performance problems--especially those that are relatively recent and not severe--often require only short-term assistance. In such cases, coaching can be targeted and brief. Longer-standing problems and those that are affecting multiple areas of life--not just trading--often take more than a brief course of assistance. Generally they require a comprehensive assessment from a trained professional. Coaching holds much promise for many people, but extrapolations from the college counseling research suggest that about half of all people will not benefit from it. That's something you won't hear from helpers eager to collect your fees, but it's important for you to know if you're contemplating help.
RELATED POSTS:
Coaching Yourself for Profitable Trading
What Works in Coaching
.
Having worked at a college counseling center at Cornell University and then directed a student counseling service at SUNY Upstate Medical University, I can attest to the similarities between work with students in higher education and coaching of professionals in trading and other fields. In my work at Syracuse, fully two-thirds of the people seeking assistance were looking for help with such normal concerns as relationship problems, career issues, and performance-related stress. Interestingly, these are also among the most common issues that traders discuss with me. Many of the same cognitive, behavioral, and solution-focused methods that are helpful in work with students are also relevant and useful for traders.
So what can college counseling teach us about the coaching of traders? A very interesting research study conducted in 2000 summarized college counseling work with almost 1700 students across over 40 campuses. This provides a broad cross-section of schools and students. The study found that over 1000 of the students--about 60% of the sample--only attended 3 or fewer counseling visits. This is not unusual: other studies of utilization of helping services have found that the modal number of visits to a psychologist or counselor is one.
The low number of visits does not necessarily mean that the services were not helpful. Rather, the study found that almost 30% of the students reported significant improvement by the end of one session and nearly 40% by the end of the third visit. Among those who attended 10 sessions, 54.5 % reported significant improvement. The study authors suggest that this shows a dose-effect relationship among the college students: more visits produce better results. It also suggests that about half of all people in the college setting--which I believe is the best mirror for coaching settings--can benefit from short-term help. Indeed, they often vote with their feet and only attend several helping meetings.
Still, the data suggest that many people do not benefit from short-term help. On college campuses, this can include people with ongoing problems with anxiety, depression, eating disorders, and substance abuse. Similar problems can be found among traders. Of the people who attended 10 sessions, 9.1% actually deteriorated over time and 36.4% reported no change. This is a finding that is not frequently discussed among psychologists and counselors, and certainly not among coaches: some people get worse, despite best efforts at helping. This may be due to a lack of skill among helpers; a poor personality fit between helper and client; or an unusual problem that is not detected by the counselor.
My experience is that the latter is most often the case. I have met with traders who have received prior coaching (and sometimes therapy), only to find that they have a diagnosable problem that went unrecognized. Sometimes the problem is depression; sometimes it is a form of anxiety; sometimes it is an eating disorder; and sometimes it is a purely medical problem that manifests itself as emotional distress (e.g., a thyroid disorder). It is also sometimes the case that a problem is longstanding and severe and simply needs more than 10 sessions of assistance. One research study, for example, found that individuals with severe emotional disorders continue to show therapeutic responses for 25 sessions of therapy and more.
So what can we conclude from this research? Simple performance problems--especially those that are relatively recent and not severe--often require only short-term assistance. In such cases, coaching can be targeted and brief. Longer-standing problems and those that are affecting multiple areas of life--not just trading--often take more than a brief course of assistance. Generally they require a comprehensive assessment from a trained professional. Coaching holds much promise for many people, but extrapolations from the college counseling research suggest that about half of all people will not benefit from it. That's something you won't hear from helpers eager to collect your fees, but it's important for you to know if you're contemplating help.
RELATED POSTS:
Coaching Yourself for Profitable Trading
What Works in Coaching
.
Monday, March 17, 2008
Using Trading Ranges to Frame Trade Ideas
Here's an example of a great setup from this morning's trade. It's an example of how I think about morning trading, which may be useful for some readers.
My trade idea usually begins with a "reference range". This can be the overnight range (as in the example above) or the range from the previous day's trade. As the current day unfolds, I look at several indicators to handicap the odds of either breaking out of this range or returning toward the range midpoint when we're near a range extreme:
1) NYSE TICK - I look not only at the raw values of the TICK (which indicate how many stocks are trading at their offer vs. bid price), but how the distribution of these values is shifting over time and how the values are impacting price. What was unusual in today's trade is that we started the day with negative TICK values, but could not make new price lows relative to the overnight range. This told me that selling pressure could not move the market lower and bolstered my expectation that we'd return toward the midpoint of the overnight range. As the early morning progressed, we saw an upward distribution in the NYSE TICK values (rising moving average of TICK), which indicated increased buying interest.
2) ES Volume at Bid/Offer - I read this from a Market Delta screen, and it complements the NYSE TICK quite well. In this case, it showed buyers in size lifting offers in the ES futures, even as the NYSE TICK was still giving negative readings. This suggested to me that large traders in the futures were using the downside opening gap to buy value, again leading to an expectation of a return toward the range midpoint.
3) Leading Sectors - The major leading sector for the recent market has been the financial stocks. When I saw C, GS, and LEH catch a bid in early trade, I expected the broad market to follow suit, against suggesting a return toward the range midpoint.
Because the overnight range was so large, the setup led to a nice move and gain. I was in the trade at 8:40 AM CT (bought SPY) and exited at 9:30 AM CT once we stalled near my price target.
By organizing your perception in terms of ranges and then tracking how stocks are behaving at the edges of those ranges, it's possible to anticipate breakout moves and reversion moves back into the range. A majority of my trades follow this logic.
RELEVANT POSTS:
How I Trade
Using the Opening Minutes of Trading
.
Indicator Review for March 17th
* New Highs/Lows - As of Friday's close, we weren't yet seeing an expansion of fresh 20-day lows relative to last week's readings (top chart). Opening weakness on Monday should test this, and indeed pose an important test. We also still are not seeing an expansion of new lows relative to the January lows. For example, on Friday we had 36 NYSE common stocks make new 52-week highs and only 141 make new lows. Last week, we registered over 220 new annual lows among NYSE common issues, and in January we had over 700 new 52-week lows. The same pattern can be seen among SPX stocks: we had 2 new 52-week highs and 40 new lows. Last week, we saw over 70 new lows among SPX stocks; in January we had over 200 fresh annual lows. The identical pattern of dwindling lows can also be seen among the S&P 600 small cap issues. Interestingly, I don't see any commentary on this; the bearish behavior of the financial issues is getting all the press, while fewer stocks make new lows over time. Clearly these are perilous times for financial markets, and I am not holding long positions until I see stabilization among financial, housing, and other weak sectors. The bulls need to see us hold at these January lows; otherwise we could see quite a capitulation.
* Overbought/Oversold - We continue oversold in my Cumulative Demand/Supply Index (bottom chart), having hit a level last week that has tended to accompany or immediately precede intermediate-term market bottoms. Note, however, that we are tracing a pattern of lower price highs at overbought levels and lower price lows at oversold levels. This is the essence of a bear market. While we could get a rally from current oversold levels, we need to see a pattern of higher price highs at overbought levels to infer a change of trend. Shorter-term, among the 40 stocks in my basket (equally divided among 8 SPX sectors), we have 4 stocks in uptrends, 13 neutral, and 23 in downtrends. The Technical Strength Index is oversold at -1500, but above extreme oversold levels from last week.
* Momentum - We see a pattern with the momentum data very similar to the new highs/lows. Among SPX stocks, we're seeing 20% trading above their 200 day moving averages as of Friday, up from 15% last week and 13% in January. This pattern of rising % of stocks above 200-day MAs is even more noticeable among NYSE issues. Demand was 37 on Friday; Supply was 92, so short-term momentum remains bearish. Thus far we are remaining above last week's advance-decline line among NYSE common stocks (as well as NASDAQ 100 stocks and S&P 600 small caps), but that could change with weakness early this week.
All in all, we can see from the indicators that we're in a bear market mode; that we're testing the January lows; that weakness among financial stocks has been leading recent market weakness; but that there are early signs of waning new lows and waning downside momentum across the broad market. Taking day-to-day market cues from the financials has been a winning strategy, and I plan to stick with that. I am reluctant to chase new price lows, however, in the face of non-confirming new lows and momentum--particularly if we see stabilization among the financials (which would have me nibbling on the long side).
RELATED POST:
Last Week's Indicator Update
.
Sunday, March 16, 2008
Stock Market Fears Grounded in a Stark Reality
Last week it was a $70 stock; today it was purchased by JPM for $2 a share. That is how quickly things unraveled for Bear Stearns (BSC). In the face of such utter annihilation of wealth, it's understandable that markets are fearful and volatile to start the week. Note that the VIX is once again above 30, on track to spike higher should the overnight weakness spill over to tomorrow's trading session.
Plunging Stocks, Plunging Dollar: Updates Via Twitter
I pulled the bottom chart off my screen a few minutes ago to show you how things are shaping up in an unusual start to the trading week. We've already declined over 30 ES points from the highs following the Fed's announcement of a discount rate cut, with volatility very unusual for overnight trade. Japan is down over 3%, and the dollar is absolutely plunging versus the yen (top chart) and euro (middle chart). Meanwhile, we are not only breaking below Friday's stock market lows, but also challenging the important lows from January. This is a very dangerous market, given the dynamics of plunging rates (2 year Treasuries at 1.35%; 10 year @ 3.37%) and plunging dollar. I will update market observations via Twitter. The last five Twitter "tweets" appear on the blog home page; the full set are on my Twitter page. Interested traders can subscribe (no cost, of course) via RSS; see my Twitter page.
Global Returns Year-to-Date: The Emerging Markets Decoupled
Here we see year-to-date returns for a number of global markets, including the U.S. (SPY); Australia (EWA); Canada (EWC); Germany (EWG); Hong Kong (EWH); Japan (EWJ); Brazil (EWZ); South Africa (EZA); and China (FXI).
Note that returns have been negative across the board, with resource rich Brazil, Canada, South Africa, and Russia (not shown) faring far better than resource consumers in Asia.
Note also that the strongest emerging markets (China, Hong Kong) are now leading the downside, nearly doubling the losses in the U.S.
Perhaps most notably, we now see that the once seemingly monolithic "emerging markets" have decoupled, with Brazil and Russia outperforming the world and China dramatically underperforming.
Weekend Perspectives and Ideas
* More Weak Dollar - Remember when the yen was the world's weak currency? It's been on a recent tear vs. the U.S. dollar (above). Indeed, just about every major currency has fared well vs. the dollar, as the Bernanke Fed pursues quantitative rate easing in the face of bank and credit market challenges. The two-year yield on U.S. Treasury debt is 1.48%. Compare that with 6.31% in Australia; 13.06% in Brazil; 3.08% in Germany; and 3.82% in the U.K. and you can see why global investors may not be attracted to the USD. Even the yen, yielding a paltry .57% for its 2 year government debt, is relatively attractive, given perceptions of the U.S. economy and continued difficulties within the U.S. financial system.
* Bursting Bubbles - Flight delays from Florida to Chicago gave me an opportunity to read "Greenspan's Bubbles" by Bill Fleckenstein (McGraw Hill, 2008). The book questions Greenspan as an economic forecaster and then takes readers on a review of Fed policy and consequences from 1995 through the present. An interesting subtext to the author's argument is the misplaced optimism (exuberance) placed on progress, whether it's the productivity/technology revolution ("the New Economy") or financial engineering. It's an easy, short read and an illuminating context for the current unwinding of the housing market and related debt instruments.
* Bears Out in Force - Excellent, excellent summary of sentiment data from Trader's Narrative. We are seeing historic levels of bearishness from a variety of indicators. See also the post from A Dash of Insight: No one is bullish.
* Tracking Your Performance - I see that Trader DNA has developed some new tools for futures traders to track and analyze their performance, including a Web-based service. They've also compiled a number of performance-related articles, including several of mine.
* Hot Industry - Brain fitness is seen as a hot industry going forward, with applications for both clinical and normal populations. I believe we'll see greater application of these tools in trading environments going forward.
* Excellent Quote - Trader Mike offers an excellent observation from Art Cashin. So many traders have come of age in the last few years when we've had lower volatility and a bullish trend. That includes many prop and fund traders. As a result, we seem to swing from unbridled optimism to the depths of fear and despair and back again.
* Falsified Data - Barry Ritholtz offers a hard-hitting critique of the CPI numbers.
* Bearish Stearns - Here's a nice mashup of perspectives on the BSC situation from Research Recap.
* Emerging Strategies - Richard Wilson offers his views of up-and-coming hedge fund strategies. Here's his listing of hedge fund website resources.
.
Saturday, March 15, 2008
Formatting Your Trading Journal for Success
My recent posts have focused on using journals to improve trading. Everyone has a journal format that (one hopes) works best for them. Here I'll suggest a format that I find particularly useful.
The reason I'm offering the suggestion is that I continue to find that traders use journals in ways that are less than constructive. The greatest mistakes in journaling, I find, are:
1) Lack of Specifics - The journal contains vague, general intentions such as, "I need to trade less aggressively", without any indication of how the trader will accomplish this. If the intent is to trade less aggressively, then the journal should create a specific goal. An example from my own trading would be: "I'll enter positions with one unit and scale in with a second unit on the first pullback in NYSE TICK when my position is profitable." Notice how this makes the general intention so much more concrete. Now I have something constructive to implement and can grade myself on the implementation. If I only say, "I need to trade less aggressively", that's not goal-setting. That's Monday-morning quarterbacking, or me just wagging my finger at myself. Self-criticism by itself never improved anyone: it's self-criticism followed by constructive problem solving that does the trick.
2) Focus on Negatives - The worst journals are the ones that simply vent fear or frustration. They recite every bad or missed trade, everything that went wrong during the day. Not only is there an absence of constructive suggestions for improvement, but there is also an absence of ideas re: what the trader has done right. The idea is to learn from what you do right, not just what you do wrong. Indeed, focusing on strengths will enhance motivation and the sense of competence and efficacy. By staying exclusively problem-focused, it's all too easy to drain motivation and optimism.
So, how can we improve the above in a format for a trading journal?
My suggestion is starting the journal with a listing of your specific goal(s) for that trading day.
Those goals should be: a) chosen from your previous day's or week's trading; and b) taken from your trading rules. The goal should be either to improve a mistake you made, or to build upon something you did right. The goal should state specifically what you expect yourself to do during the coming day, so that you can rehearse the goal in your mind before the market opens and so that you can evaluate how you performed on the goal at the end of the day.
Notice that, before creating the journal, it's important to write out your trading rules in advance: everything that you want to follow to trade well. You can't hold yourself accountable for a rule that you don't create; that's perfectionism, and it's not helpful either. Rules should clearly state how you want to size positions, enter them, exit them, set stops, set exits, scale in and out of trades, etc. Your journal will track how well you follow these rules, not just whether you make money or not.
So you start with rules, notice when you do a particularly good or poor job following the rules, and then set goals for the next day based on the good or poor performance. The journal entry then gives yourself a grade at the end of the day for how well you performed on your goals and why you earned that grade. Include your daily P/L with your grade, so that you can quickly see how your performance rises and falls with your grades.
The journal keeps you constructive, keeps you learning, and keeps you working on the things that are most important. It is not a tool for simply rehashing the day or voicing your feelings; it is your tool for self-development: your means for coaching yourself.
RELEVANT POST:
When Coaching Works and Doesn't Work
.
The reason I'm offering the suggestion is that I continue to find that traders use journals in ways that are less than constructive. The greatest mistakes in journaling, I find, are:
1) Lack of Specifics - The journal contains vague, general intentions such as, "I need to trade less aggressively", without any indication of how the trader will accomplish this. If the intent is to trade less aggressively, then the journal should create a specific goal. An example from my own trading would be: "I'll enter positions with one unit and scale in with a second unit on the first pullback in NYSE TICK when my position is profitable." Notice how this makes the general intention so much more concrete. Now I have something constructive to implement and can grade myself on the implementation. If I only say, "I need to trade less aggressively", that's not goal-setting. That's Monday-morning quarterbacking, or me just wagging my finger at myself. Self-criticism by itself never improved anyone: it's self-criticism followed by constructive problem solving that does the trick.
2) Focus on Negatives - The worst journals are the ones that simply vent fear or frustration. They recite every bad or missed trade, everything that went wrong during the day. Not only is there an absence of constructive suggestions for improvement, but there is also an absence of ideas re: what the trader has done right. The idea is to learn from what you do right, not just what you do wrong. Indeed, focusing on strengths will enhance motivation and the sense of competence and efficacy. By staying exclusively problem-focused, it's all too easy to drain motivation and optimism.
So, how can we improve the above in a format for a trading journal?
My suggestion is starting the journal with a listing of your specific goal(s) for that trading day.
Those goals should be: a) chosen from your previous day's or week's trading; and b) taken from your trading rules. The goal should be either to improve a mistake you made, or to build upon something you did right. The goal should state specifically what you expect yourself to do during the coming day, so that you can rehearse the goal in your mind before the market opens and so that you can evaluate how you performed on the goal at the end of the day.
Notice that, before creating the journal, it's important to write out your trading rules in advance: everything that you want to follow to trade well. You can't hold yourself accountable for a rule that you don't create; that's perfectionism, and it's not helpful either. Rules should clearly state how you want to size positions, enter them, exit them, set stops, set exits, scale in and out of trades, etc. Your journal will track how well you follow these rules, not just whether you make money or not.
So you start with rules, notice when you do a particularly good or poor job following the rules, and then set goals for the next day based on the good or poor performance. The journal entry then gives yourself a grade at the end of the day for how well you performed on your goals and why you earned that grade. Include your daily P/L with your grade, so that you can quickly see how your performance rises and falls with your grades.
The journal keeps you constructive, keeps you learning, and keeps you working on the things that are most important. It is not a tool for simply rehashing the day or voicing your feelings; it is your tool for self-development: your means for coaching yourself.
RELEVANT POST:
When Coaching Works and Doesn't Work
.
Friday, March 14, 2008
Using Trading Journals to Identify and Change Your Patterns
In my last post, we took a look at trading journals and how those can be used to improve performance. The report card format for journaling is particularly helpful for goal-setting, tracking progress, and recognizing patterns in our own trading. In this post, I'll review some of the patterns that most often appear across journal entries--and that are important to work on.
1) Patterns of Negative Self-Talk: These occur during frustrated moments in markets. We miss a trade, a trade blows through our stop, we give back our money on the day: all of these create frustration. This frustration then triggers an anger response that we direct toward ourselves. For example, we might find ourself saying, "Here it goes again! Other people are killing these markets, and I can't get it going." At that point, your frustration is no longer about the specific trade or market event, but is directed to *you as a person*. Trading should be about trading; not about you. After all, you wouldn't be boasting and crowing in the journal if the trade went your way. If you wouldn't like to hear your message coming from someone else (imagine your buddy at the workstation next to yours saying, "Whoa, dude, other people are killing these markets, and you can't get it going!") and if you wouldn't be speaking that way to your trading buddy, then you shouldn't be speaking that way to yourself. Interrupting that negative self-talk and turning your frustration toward a constructive kick in the pants ("C'mon, Brett, you know you shouldn't be trading so large in the chopfest. Let's stick with the rules!") can be very helpful in preventing frustration from snowballing.
2) Patterns of Impulsivity - Out of excitement, boredom, desire to regain profits, or overconfidence, you find yourself trading too frequently or with too much size. This, in turn, leads to uneven performance and outsized trading losses, which then produce discouragement. Many traders keep their goals--and their trading rules--taped to their screens; this helps keep them in the forebrain as a check on impulsivity. One trader I worked with actually had a brief checklist that he had to check off before placing any trade. This prevented him from acting hastily. If you can figure out the triggers that make you impulsive (sometimes these are winning trades, where you start playing with "house money"), you have a good chance to put on the brakes before you act on impulse.
3) Patterns of Fear - Particularly after losses, but sometimes after making money and being afraid of losing it, traders fail to act on good signals or do not size their trades adequately. The result is missed opportunity. Often this occurs if the trader is engaging in "catastrophizing": making a normal potential loss into something much larger. Worry, physical tension, and feelings of nervousness are great clues to track in a journal. Once you recognize your fear patterns, you can take some deep breaths, calm yourself, and focus on assessing opportunity (and focus on those trading rules). One way of breaking overwhelming fear after large losses is just to put on some small trades when your signals are good and get your rhythm and confidence back. Then you ramp back up to normal size in a gradual, but steady manner. Playing defense is not giving into fear: having rules about risk control and hanging onto a day's profits can help you distinguish the two.
Once you notice your patterns, it's easier to construct specific goals for the next day's and week's trade. The overarching goal is changing your patterns: controlling how you think and feel rather than having them control you. It's difficult to imagine changing your patterns if you're not aware of them in the first place!
RELEVANT POSTS:
Using Emotion to Change Emotion
Some 2007 Posts on Trading and Emotions
.
1) Patterns of Negative Self-Talk: These occur during frustrated moments in markets. We miss a trade, a trade blows through our stop, we give back our money on the day: all of these create frustration. This frustration then triggers an anger response that we direct toward ourselves. For example, we might find ourself saying, "Here it goes again! Other people are killing these markets, and I can't get it going." At that point, your frustration is no longer about the specific trade or market event, but is directed to *you as a person*. Trading should be about trading; not about you. After all, you wouldn't be boasting and crowing in the journal if the trade went your way. If you wouldn't like to hear your message coming from someone else (imagine your buddy at the workstation next to yours saying, "Whoa, dude, other people are killing these markets, and you can't get it going!") and if you wouldn't be speaking that way to your trading buddy, then you shouldn't be speaking that way to yourself. Interrupting that negative self-talk and turning your frustration toward a constructive kick in the pants ("C'mon, Brett, you know you shouldn't be trading so large in the chopfest. Let's stick with the rules!") can be very helpful in preventing frustration from snowballing.
2) Patterns of Impulsivity - Out of excitement, boredom, desire to regain profits, or overconfidence, you find yourself trading too frequently or with too much size. This, in turn, leads to uneven performance and outsized trading losses, which then produce discouragement. Many traders keep their goals--and their trading rules--taped to their screens; this helps keep them in the forebrain as a check on impulsivity. One trader I worked with actually had a brief checklist that he had to check off before placing any trade. This prevented him from acting hastily. If you can figure out the triggers that make you impulsive (sometimes these are winning trades, where you start playing with "house money"), you have a good chance to put on the brakes before you act on impulse.
3) Patterns of Fear - Particularly after losses, but sometimes after making money and being afraid of losing it, traders fail to act on good signals or do not size their trades adequately. The result is missed opportunity. Often this occurs if the trader is engaging in "catastrophizing": making a normal potential loss into something much larger. Worry, physical tension, and feelings of nervousness are great clues to track in a journal. Once you recognize your fear patterns, you can take some deep breaths, calm yourself, and focus on assessing opportunity (and focus on those trading rules). One way of breaking overwhelming fear after large losses is just to put on some small trades when your signals are good and get your rhythm and confidence back. Then you ramp back up to normal size in a gradual, but steady manner. Playing defense is not giving into fear: having rules about risk control and hanging onto a day's profits can help you distinguish the two.
Once you notice your patterns, it's easier to construct specific goals for the next day's and week's trade. The overarching goal is changing your patterns: controlling how you think and feel rather than having them control you. It's difficult to imagine changing your patterns if you're not aware of them in the first place!
RELEVANT POSTS:
Using Emotion to Change Emotion
Some 2007 Posts on Trading and Emotions
.
Thursday, March 13, 2008
Using Trading Journals to Improve Trading Performance
I've begun working with a small group of individual traders at proprietary trading firms using daily online journals as a foundation for our work. In this post, I'll describe one useful format for such journals and how they can useful for self-improvement as well.
We know from research in psychology that goal-settting is an effective tool for performance development. Goals should be:
1) Challenging, but attainable;
2) Limited in number
3) Accompanied by regular feedback to cement learning and tailor new goals.
A journal format that I like translates each goal into a "subject" in a "report card". For frequent traders (i.e., those who trade intraday and/or every day), a single grade at the end of the day (A, B, C, D, F) indicates the degree to which the goal was met that day. Beside each grade go comments and observations that explain why the grade was given. Ideally, these comments should include what was happening in markets (and trading) at the time; what was going on in terms of the trader's thoughts and feelings; and what the trading outcomes were.
An advantage of this format is that it places equal emphasis upon the identification and assessment of strengths (the "A" grades) as weaknesses (the "F" grades). It focuses traders on the most relevant areas for improvement and easily leads to new goal setting for the following day when a poor grade is received in a particular area.
Traders I work with email me the journal/report cards daily and I provide daily email feedback. We then "meet" weekly by phone to review the week, learn from recent efforts, and set overarching goals for the next week. By utilizing the online medium for coaching, we minimize time and expense and achieve much of the advantages of having a full-time personal coach.
This regularity of contact is especially useful in ensuring that problem patterns are identified quickly and do not snowball. The money saved in drawdowns as a result is significant. The report cards are also helpful in focusing traders on their strengths, so that they can take maximum advantage of what they're doing right.
I use a variation of this report card format myself and have found it helpful for my own development as a trader. The key to using it for oneself is setting regular time aside to review the card, identify specific goals and actions for improvement, and then tracking those efforts at change the next day--repeating this process through the week. My experience is that one can achieve a compounding of learning with such active review.
It's also possible to connect with peers for mutual mentoring by sharing online journals/report cards. This is one of the advantages of such social networking platforms for traders as Stocktickr. Like going to the gym with a buddy to keep each other focused and motivated, collaborating on journals can be a great way to build advantages of a trading group even when trading independently.
RELEVANT POSTS:
Trader Perspectives on Keeping a Journal
Turning Setbacks Into Goals
.
We know from research in psychology that goal-settting is an effective tool for performance development. Goals should be:
1) Challenging, but attainable;
2) Limited in number
3) Accompanied by regular feedback to cement learning and tailor new goals.
A journal format that I like translates each goal into a "subject" in a "report card". For frequent traders (i.e., those who trade intraday and/or every day), a single grade at the end of the day (A, B, C, D, F) indicates the degree to which the goal was met that day. Beside each grade go comments and observations that explain why the grade was given. Ideally, these comments should include what was happening in markets (and trading) at the time; what was going on in terms of the trader's thoughts and feelings; and what the trading outcomes were.
An advantage of this format is that it places equal emphasis upon the identification and assessment of strengths (the "A" grades) as weaknesses (the "F" grades). It focuses traders on the most relevant areas for improvement and easily leads to new goal setting for the following day when a poor grade is received in a particular area.
Traders I work with email me the journal/report cards daily and I provide daily email feedback. We then "meet" weekly by phone to review the week, learn from recent efforts, and set overarching goals for the next week. By utilizing the online medium for coaching, we minimize time and expense and achieve much of the advantages of having a full-time personal coach.
This regularity of contact is especially useful in ensuring that problem patterns are identified quickly and do not snowball. The money saved in drawdowns as a result is significant. The report cards are also helpful in focusing traders on their strengths, so that they can take maximum advantage of what they're doing right.
I use a variation of this report card format myself and have found it helpful for my own development as a trader. The key to using it for oneself is setting regular time aside to review the card, identify specific goals and actions for improvement, and then tracking those efforts at change the next day--repeating this process through the week. My experience is that one can achieve a compounding of learning with such active review.
It's also possible to connect with peers for mutual mentoring by sharing online journals/report cards. This is one of the advantages of such social networking platforms for traders as Stocktickr. Like going to the gym with a buddy to keep each other focused and motivated, collaborating on journals can be a great way to build advantages of a trading group even when trading independently.
RELEVANT POSTS:
Trader Perspectives on Keeping a Journal
Turning Setbacks Into Goals
.
Wednesday, March 12, 2008
Tracking the NYSE TICK and Other Wednesday Thoughts
Tracking the TICK: Several traders have emailed and asked about easy ways to track the distribution of the NYSE TICK, which (as I mentioned yesterday) caught the afternoon rally quite nicely. One simple method (top chart) is to create a moving average of the TICK (mine is a ten-period average of five-minute bars) and then track: a) whether the average is dominantly above or below the zero (black) line; and b) whether the average is upwardly, downwardly, or non-sloping. We can see how the blue TICK MA line stayed positive (and upward sloping) for most the afternoon.
Double Bottom?: The Banking Index ($BKX; bottom chart), for all the woes of the financial sector, could not make new lows during the recent market weakness, creating a nice double bottom pattern. We're now rallying very sharply off that bottom. Headlines feature scary bank news, but markets are forward-looking and may be indicating a degree of stabilization. The key will be the ability of some of these troubled investment banks and broker/dealers to hold their recent lows.
The Next Bubble? - Check out links from Abnormal Returns, especially re: how the next bubble has to be large enough to rescue us from this one. Also note the post on generating superior returns by pursuing hot anomalies in markets.
Brief Observation - When people heatedly challenge your views on markets, but offer no evidence or analytical reasoning to back their arguments, you know that theirs is a defensive reaction. At some level they know they're wrong, and they're feeling threatened. It's one of the best market tells I've found, which is why I never discourage nasty emails and blog comments.
.
How Much Coaching is Enough: A Look at the Dose-Effect Relationship in Counseling and Psychotherapy
Those who engage in "coaching"--whether it be "life coaching", "executive coaching", or the coaching of traders in financial markets--are quick to point out that they do not engage in counseling or psychotherapy. This is understandable, as most coaches lack training in these fields. (How they can adequately distinguish those who need clinical vs. coaching services without such training is a question we'll leave to another day). Still, it is not clear that the interpersonal helping processes that are part of effective coaching are any different from those that typify effective counseling. Both are verbal, interpersonal vehicles for effecting targeted changes in thought, feeling, and behavior. Both begin with an initial assessment and progress through the development of a plan and the introduction of helping methods. Structurally, coaching and counseling are identical.
This similarity suggests that issues that have long interested counselors and psychotherapists are relevant to coaches. One of these is the dose-effect relationship: how much coaching is needed on average to achieve a particular change? Fortunately there is a rich research literature in this area that is relevant to coaches and those who purchase their services. In this and subsequent posts, I will explore the implications of this research.
My review of this literature back in 1994 found that the dose-effect relationship in the helping fields is a function of many different factors, including the following:
* Severity, Duration, and Complexity of Presenting Problems - On average, it takes longer to achieve a given level of benefit for people with severe problems (those that greatly impair functioning), chronic problems (those with longstanding concerns), and complex problems (those that manifest themselves in multiple, interacting ways).
* Nature of the Changes Sought - On average, changes in mood and attitude are achieved earlier than changes in actual functioning. With good coaching, for instance, a trader will start to feel better about his work before he actually starts to trade and perform better.
* Motivation and Involvement of the Person Being Helped - On average, those who are more motivated for change and who are more highly involved in the helping process achieve gains more quickly than those who are ambivalent about change or who are less engaged in change efforts.
* Readiness for Change - On average, those who clearly identify specific changes they wish to make and are ready to take action on those benefit from assistance more rapidly than those who need time to explore their thoughts, feelings, and behaviors and come to greater self-understanding prior to formulating targeted goals.
* Duration of Changes Sought - On average, changes can be initiated in a relatively brief time span, but it takes a greater dose of helping to achieve changes that will be longstanding. This is because of the phenomenon of relapse: if helping is too brief, changes aren't truly internalized and the risk of relapse increases significantly.
Research by Kenneth Howard and colleagues conducted in the mid-1980s--and later replicated by a variety of investigators--found that about half of all people seeking assistance in therapy achieve their gains within eight sessions. Once again, these favorable short-term outcomes were more common among those with less severe and less chronic problems than among those with pervasive and longstanding concerns. Indeed, when we look just at people with relatively mild and recent presenting complaints, the number achieving significant change within eight sessions soars to 75%. It is precisely for this reason that we should expect coaching to be an ideal medium for brief change, as coaching is explicitly aimed at non-clinical populations.
What this research suggests is that, if coaching is truly appropriate for an individual, it should be able to proceed in a relatively brief manner to achieve targeted changes. Long-term coaching may be as much an indication of practitioner shortcomings (or client dependency) as practical necessity.
One variable not commonly addressed in this research is the competence of the person providing helping services. An interesting recent study conducted at a training clinic (and therefore utilizing less experienced helpers) found an attenuated dose-effect curve overall: it took more sessions to achieve a given level of average benefit. An earlier investigation at a training clinic found that only 22% of clients achieved significant gains after 8 sessions, compared to the 50% reported in the literature. The first study also found reliable differences among helpers: some just seemed to yield better outcomes than others. It may well be that training and experience (as well as helping skill) enable helpers to more quickly establish good working relationships with others; target problem areas; and introduce methods for addressing these areas.
This is an important research finding, given the lack of substantive credentialing and experience among many who hold themselves out as coaches. With coaches as with traders, skill and experience appear to make a significant difference in generating outcomes.
RELATED POST:
Coaching the Professional Trader
.
This similarity suggests that issues that have long interested counselors and psychotherapists are relevant to coaches. One of these is the dose-effect relationship: how much coaching is needed on average to achieve a particular change? Fortunately there is a rich research literature in this area that is relevant to coaches and those who purchase their services. In this and subsequent posts, I will explore the implications of this research.
My review of this literature back in 1994 found that the dose-effect relationship in the helping fields is a function of many different factors, including the following:
* Severity, Duration, and Complexity of Presenting Problems - On average, it takes longer to achieve a given level of benefit for people with severe problems (those that greatly impair functioning), chronic problems (those with longstanding concerns), and complex problems (those that manifest themselves in multiple, interacting ways).
* Nature of the Changes Sought - On average, changes in mood and attitude are achieved earlier than changes in actual functioning. With good coaching, for instance, a trader will start to feel better about his work before he actually starts to trade and perform better.
* Motivation and Involvement of the Person Being Helped - On average, those who are more motivated for change and who are more highly involved in the helping process achieve gains more quickly than those who are ambivalent about change or who are less engaged in change efforts.
* Readiness for Change - On average, those who clearly identify specific changes they wish to make and are ready to take action on those benefit from assistance more rapidly than those who need time to explore their thoughts, feelings, and behaviors and come to greater self-understanding prior to formulating targeted goals.
* Duration of Changes Sought - On average, changes can be initiated in a relatively brief time span, but it takes a greater dose of helping to achieve changes that will be longstanding. This is because of the phenomenon of relapse: if helping is too brief, changes aren't truly internalized and the risk of relapse increases significantly.
Research by Kenneth Howard and colleagues conducted in the mid-1980s--and later replicated by a variety of investigators--found that about half of all people seeking assistance in therapy achieve their gains within eight sessions. Once again, these favorable short-term outcomes were more common among those with less severe and less chronic problems than among those with pervasive and longstanding concerns. Indeed, when we look just at people with relatively mild and recent presenting complaints, the number achieving significant change within eight sessions soars to 75%. It is precisely for this reason that we should expect coaching to be an ideal medium for brief change, as coaching is explicitly aimed at non-clinical populations.
What this research suggests is that, if coaching is truly appropriate for an individual, it should be able to proceed in a relatively brief manner to achieve targeted changes. Long-term coaching may be as much an indication of practitioner shortcomings (or client dependency) as practical necessity.
One variable not commonly addressed in this research is the competence of the person providing helping services. An interesting recent study conducted at a training clinic (and therefore utilizing less experienced helpers) found an attenuated dose-effect curve overall: it took more sessions to achieve a given level of average benefit. An earlier investigation at a training clinic found that only 22% of clients achieved significant gains after 8 sessions, compared to the 50% reported in the literature. The first study also found reliable differences among helpers: some just seemed to yield better outcomes than others. It may well be that training and experience (as well as helping skill) enable helpers to more quickly establish good working relationships with others; target problem areas; and introduce methods for addressing these areas.
This is an important research finding, given the lack of substantive credentialing and experience among many who hold themselves out as coaches. With coaches as with traders, skill and experience appear to make a significant difference in generating outcomes.
RELATED POST:
Coaching the Professional Trader
.
Tuesday, March 11, 2008
Stock Market Divergences and Other Pattern Recognition Themes for Tuesday
* Catching Divergences - I've recently been posting on the topic of market themes and divergence patterns. Today's trade provided a great example. Note the double bottom in the ES futures (top chart, blue arrow), as the index made a marginal new price low for the regular trading session. The NYSE TICK (bottom chart, blue arrow), however, showed distinctly less selling at the fresh price low. Indeed, that second low in ES was not confirmed by price lows in the Russell futures, the banking stocks ($BKX), or the Dow Industrials (DIA). Once the market rebounded from the divergence, the TICK began a positive shift in distribution (note the rising blue moving average line in the second chart), which helped keep traders on the right side of the market, participating in the major bear *pwnage. (Note: it's really the same pattern--just at a larger time scale--that I noted in the recent post on the bear market).
* Preparing for the Rally - Check out this great post from Charles Kirk, particularly the good questions to ask about the positions you're holding.
* Rally or Just Short Covering? - Trader Mike notes the Fed catalyst and asks the important question as to whether the initial short covering could attract the participation of bulls. The ability of the market to catch a second wind after the initial rally led to profit taking was a positive sign for bulls.
* Identifying Your Own Patterns - When you know your own patterns as a trader, you're more able to catch and modify them. Check out this excellent post from Ray Barros on "the power of questions" to identify our patterns.
* More Pattern Recognition - Check out the chart-based pattern recognition post on the Afraid to Trade blog that captured the day's action. And, for a different pattern that has worked exceedingly well, check out Kevin's post on the yen's relationship to the stock market.
* Questioning a Pattern - The Quantifiable Edges blog takes a historical look at divergence patterns in the new high/low data.
* An Online Newspaper - The Newsflashr site that I linked in a recent post was just featured in an article in the Boston Globe. Very useful service, IMO, for catching patterns in global news.
.
An Oversold Stock Market Amidst a Crisis of Confidence
We've hit oversold levels (below -30) in my Adjusted Demand/Supply Index; as mentioned earlier, these levels have been associated with favorable returns 20 days out and overbought readings (above +20) have provided a nice heads-up for subnormal returns over that span. I generally act on these readings when we see a pattern of waning new highs in an overbought market and dwindling new lows in an oversold one. The new high/new low picture was mixed on Monday, with 20-day new lows across the NYSE, NASDAQ, and ASE exceeding the Friday level (223 new highs and 3318 new lows on Monday vs. 224 highs and 3150 lows on Friday), but 52-week new lows among NYSE common stocks, SPX stocks, and NDX stocks dropping from Friday to Monday.
Meanwhile, the crisis of confidence among financial issues continued unabated on Monday, which is one of those themes I've been tracking for overall market direction. The Cumulative NYSE TICK, which has been dreadfully weak of late, continued so on Monday--another useful gauge of daily market direction--no doubt reflecting sentiment among traders, who are seeing daily new lows among such stocks as GS, FNM, C, BSC, and MER. A look at the longer-term charts of these issues is truly harrowing: FNM has gone from about 70 in August, 2007 to under 20 on Monday; MER has been cut in half since June; and C has gone from 54 to under 20 in that same time period. Moreover, the rate of damage has been accelerating: C has moved from 26 to under 20 within the last two weeks; FNM has gone from about 30 to under 20; and MER has moved from 55 to 43 in that same span.
Nor has weakness been limited to financial shares. Among the 40 stocks in my basket (equally divided among 8 sectors from the S&P 500 Index), my measure of Technical Strength (short-term trending) is also at highly oversold levels that have typified recent intermediate-term market lows. Two of the stocks qualify as trading in uptrends, five are neutral, and 33 are in downtrends. The overall Technical Strength Index, at -2160, is near levels reached at the January market lows.
As the recent post emphasized, the selling extremes we've been seeing (such as those 3318 new 20-day lows) are consistent with a momentum low in the stock market (which tends to precede price lows), but to enjoy more than a bullish bout of short covering, we need to see confidence enter the financial sector and buying sentiment return to stocks overall (an upward sloping Cumulative NYSE TICK). I'll continue to watch those two tells for day-to-day market direction, even as I stay alert for evidence of dwindling new lows at these oversold levels and a potential market rebound.
.
Monday, March 10, 2008
Why Financial Crises Are Inevitable
Thanks to a reader for passing along this hard-hitting and insightful post from Paul Wilmott. He makes the argument that we will have periods of wild market volatility for no fundamental economic reasons. He explains:
"Banks and hedge funds are in control of a ridiculous amount of the world’s wealth. They also trade irresponsibly large quantities of complex derivatives. They slavishly and unimaginatively copy each other, all holding similar positions. These contracts are then dynamically hedged by buying and selling shares according to mathematical formulae. This can and does exacerbate the volatility of the underlying."
He also points out that too much money will always chase too few products because large, undiversified bets with other people's money will always provide the most tempting returns for money managers.
In this vein, I highly recommend Richard Bookstaber's text "A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation" (Wiley, 2007). In his concluding chapter, entitled "Built to Crash?", he observes:
"...the positive effects of innovation come a a price. Innovation increases complexity. Many innovative instruments are in the form of derivatives with conditional and nonlinear payoffs. When a market dislocation arises, it is difficult to know how the prices of these instruments will react. Innovation and mechanical efficiency have also increased complexity by pushing markets to become more interconnected...The combination of tight coupling and complexity is a formula for normal accidents--accidents that are all but inevitable as a result of the structure of the system." (p. 255-256).
This line of reasoning has powerful implications for risk management. We tend to think of risk in terms of standard deviations and normal distributions. Financial systems, however, possess fat tails of returns--and increasing complexity may only increase this "fatness". We can calculate the historical odds of a market crash, but will such models accurately capture risk in systems of increasingly tight coupling?
Paul Wilmott concludes:
"Banks and hedge funds are in control of a ridiculous amount of the world’s wealth. They also trade irresponsibly large quantities of complex derivatives. They slavishly and unimaginatively copy each other, all holding similar positions. These contracts are then dynamically hedged by buying and selling shares according to mathematical formulae. This can and does exacerbate the volatility of the underlying."
He also points out that too much money will always chase too few products because large, undiversified bets with other people's money will always provide the most tempting returns for money managers.
In this vein, I highly recommend Richard Bookstaber's text "A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation" (Wiley, 2007). In his concluding chapter, entitled "Built to Crash?", he observes:
"...the positive effects of innovation come a a price. Innovation increases complexity. Many innovative instruments are in the form of derivatives with conditional and nonlinear payoffs. When a market dislocation arises, it is difficult to know how the prices of these instruments will react. Innovation and mechanical efficiency have also increased complexity by pushing markets to become more interconnected...The combination of tight coupling and complexity is a formula for normal accidents--accidents that are all but inevitable as a result of the structure of the system." (p. 255-256).
This line of reasoning has powerful implications for risk management. We tend to think of risk in terms of standard deviations and normal distributions. Financial systems, however, possess fat tails of returns--and increasing complexity may only increase this "fatness". We can calculate the historical odds of a market crash, but will such models accurately capture risk in systems of increasingly tight coupling?
Paul Wilmott concludes:
Banks and hedge funds employ mathematicians with no financial-market experience to build models that no one is testing scientifically for use in situations where they were not intended by traders who don’t understand them. And people are surprised by the losses!
If sophisticated mathematical models can't capture risk and complexity, can we expect the gut hunches of discretionary traders to do better? There's a lesson in all this, and it seems to be: The odds of catastrophic financial outcomes are greater than we estimate. Even when we think we're diversified, the tight coupling of complex, interwoven financial systems ensures that, at times of stress, correlations will tend toward one or minus-one.
Looking for more reading on complexity and how we are "fooled by randomness"? Check out Nassim Taleb's website and this excellent summary of his ideas. They provide a sobering perspective on how we don't really know what we don't know.
Indicator Update for March 10th
This will update my recent post on the market indicators and some of the conclusions from that review. Blogger is not allowing me to post charts, so please excuse their absence.
* New Highs/Lows - Friday we saw levels of new lows consistent with recent momentum lows in markets. There were 224 new 20-day highs against 3150 new lows. We also saw 97 new 65-day highs across the NYSE, NASDAQ, and ASE, against 1225 new lows. This represents significant weakness, but so far remains below the level of new lows registered in January. Similarly, if we just look at the common stocks traded on the NYSE, we had 7 new 52-week highs, but 246 new lows. Note that 52-week new lows in January swelled to over 700. Among S&P 600 small caps, Friday had 2 new 52-week highs and 80 new lows. (January's new lows exceeded 200). And finally, among the S&P 500 large caps, we had no new highs and 73 fresh annual lows. (January's new lows also exceeded 200). Long story short, there are divergences in the high/low data that make me question the downside from here.
* Sentiment - As my recent post indicated, sentiment is quite bearish and is beginning to hit levels associated with recent market bottoms. Shorter-term, we continue to see weakness in the NYSE TICK, with the cumulative line in a clear downtrend. I need to see evidence of buying interest in the TICK before aggressively pursuing the upside in this market. Seven of the last eight trading sessions have seen net selling in the Cumulative Adjusted TICK; my breakdown of buying vs. selling interest shows overwhelmingly above average selling pressure during that time. The coast is not clear for bulls unless and until this selling pressure abates and we see evidence of above-average buying (which has occurred only once in the past eight sessions).
* Overbought/Oversold - My Cumulative Demand/Supply indicator is a hair breadth away from the -30 level that has typified recent bottoms in the stock market. Supply has exceeded demand for six of the past seven trading sessions, which shows unusual sustained selling activity. (Recall that Supply and Demand are indexes of the number of stocks closing below vs. above the volatility envelopes surrounding their moving averages). Longer-term, we have 18% of SPX stocks trading above their 200-day moving averages and 14% trading above their 50-day moving averages--quite oversold, but still above the very low levels registered in January(14% and 8%, respectively).
* Advance-Decline Lines - We're seeing new lows in the AD Lines for NYSE common stocks and for NASDAQ 100 stocks, S&P 500 stocks, and S&P 600 stocks. It is clearly premature to be aggressively buying the market while this indicator remains in a downtrend across the board.
In sum, we're seeing levels in the indicators consistent with momentum market lows. Price lows can occur beneath such momentum lows, so it is not at all inconceivable that we could see more downside in the days to come. Indeed, recent activity has been skewed solidly to the downside, making bottom-fishing dangerous. Still, for the first time in this bear market, we're seeing divergences in the data even amidst the selling pressure and bearish sentiment. That has me questioning the longer-term viability of the downside.
.
* New Highs/Lows - Friday we saw levels of new lows consistent with recent momentum lows in markets. There were 224 new 20-day highs against 3150 new lows. We also saw 97 new 65-day highs across the NYSE, NASDAQ, and ASE, against 1225 new lows. This represents significant weakness, but so far remains below the level of new lows registered in January. Similarly, if we just look at the common stocks traded on the NYSE, we had 7 new 52-week highs, but 246 new lows. Note that 52-week new lows in January swelled to over 700. Among S&P 600 small caps, Friday had 2 new 52-week highs and 80 new lows. (January's new lows exceeded 200). And finally, among the S&P 500 large caps, we had no new highs and 73 fresh annual lows. (January's new lows also exceeded 200). Long story short, there are divergences in the high/low data that make me question the downside from here.
* Sentiment - As my recent post indicated, sentiment is quite bearish and is beginning to hit levels associated with recent market bottoms. Shorter-term, we continue to see weakness in the NYSE TICK, with the cumulative line in a clear downtrend. I need to see evidence of buying interest in the TICK before aggressively pursuing the upside in this market. Seven of the last eight trading sessions have seen net selling in the Cumulative Adjusted TICK; my breakdown of buying vs. selling interest shows overwhelmingly above average selling pressure during that time. The coast is not clear for bulls unless and until this selling pressure abates and we see evidence of above-average buying (which has occurred only once in the past eight sessions).
* Overbought/Oversold - My Cumulative Demand/Supply indicator is a hair breadth away from the -30 level that has typified recent bottoms in the stock market. Supply has exceeded demand for six of the past seven trading sessions, which shows unusual sustained selling activity. (Recall that Supply and Demand are indexes of the number of stocks closing below vs. above the volatility envelopes surrounding their moving averages). Longer-term, we have 18% of SPX stocks trading above their 200-day moving averages and 14% trading above their 50-day moving averages--quite oversold, but still above the very low levels registered in January(14% and 8%, respectively).
* Advance-Decline Lines - We're seeing new lows in the AD Lines for NYSE common stocks and for NASDAQ 100 stocks, S&P 500 stocks, and S&P 600 stocks. It is clearly premature to be aggressively buying the market while this indicator remains in a downtrend across the board.
In sum, we're seeing levels in the indicators consistent with momentum market lows. Price lows can occur beneath such momentum lows, so it is not at all inconceivable that we could see more downside in the days to come. Indeed, recent activity has been skewed solidly to the downside, making bottom-fishing dangerous. Still, for the first time in this bear market, we're seeing divergences in the data even amidst the selling pressure and bearish sentiment. That has me questioning the longer-term viability of the downside.
.
Sunday, March 09, 2008
Stock Market Sentiment: What the Relative Equity Put/Call Ratio is Telling Us
As the chart above indicates, rises in the relative equity put/call ratio (which I operationalize as the 10-day equity put/call volume ratio divided by the 200-day ratio) have been reliably associated with market bottoms since 2004. On Friday, we saw the 10-day ratio exceed the 200-day ratio by over 20%.
Since 2004 (N = 1033 trading days), we've had 129 occasions in which the relative put/call ratio has met or exceeded the 20% threshold. Twenty days later, the S&P 500 Index (SPY) has been up by an average of 2.22% (103 up, 26 down), much stronger than the average 20-day gain of .11% (537 up, 367 down) for the remainder of the sample.
More broadly, when the relative equity put/call ratio has been above 1.0 (meaning that we're seeing more puts traded relative to calls over the past 10 days compared to the past 200 days), the next 20 trading days in SPY have averaged a gain of .84%. When the relative ratio has been below 1.0, the next 20 days in SPY have averaged a loss of -.31%.
While it is certainly possible for the market to get weaker in the short run even when the ratio has exceeded 1.20 (50 of the 129 occasions were down after five trading days), it's generally paid to fade extremes in the relative equity put/call ratio.
RELATED POSTS:
What We Can Learn From the Equity Put/Call Ratio
What to Expect When Equity Options Traders are Bearish
.
More Insight Into How to Lose at Trading
In my August post on how to lose at trading the stock market, I examined what happened if a trader bought strength in a technical indicator and sold weakness. The result was consistent losing. Doing what seems obvious in the stock market, to paraphrase Joseph Granville, is obviously wrong.
Let's take a different approach to the issue. Suppose I want to make sure that a rising market is truly in an uptrend and not just making a random bounce. Similarly, I want to ensure that a downtrend is significant before I jump on board. So I construct an indicator that will tell me when a move is significant vs. random.
Specifically, I take a 20-day moving average of the S&P 500 Index (SPY) and calculate Bollinger Bands (a volatility envelope) above and below the average. The bands are set for two standard deviations of price movement. Thus, if the market closes above the upper band, that means that it has made a statistically significant move above its average. If it closes below the band, that means that the market has moved significantly below its average.
The strategy is to not assume a trend is in place until the market has moved significantly--not just randomly--in a directional fashion.
So how does such a strategy fare? Let's update a post from last May.
Over the last three years, buying closes above the 20-day bands and selling closes below the bands has given us 14 winning trades and 29 losers in SPY for a net loss of 20 points (the equivalent of 200 S&P cash or futures points). The average gain for winning trades was .48 point in SPY. The average size of losers was .31 point. The setup captures larger winners than losers on average, but cannot make money because there are so many more losing trades than winners.
Of the 43 trades, 25 were long and 18 were short. Among the long trades, there were 11 winners and 14 losers. Of the 18 short trades, only 3 were winners and 15 were losers.
The superior performance on long trades suggests that, when this setup works, it captures the longer-term trend in the market. Interestingly in this regard, all three winning short trades have occurred since July of 2007, which is when the current bear market began. When the setup trades against the market's longer-term trend, the results are abysmal.
So what does this tell us? If we wait for a trend to become "significant" and obvious, it is too late. There is no systematic edge chasing a move that has already closed outside a volatility envelope. Indeed, to repeat a conclusion from my earlier post, pursuing a countertrend move outside the envelope has such a poor track record that it is promising.
The best way to lose at trading is to go with the obvious. I've argued in the past that the market is rigged against human nature: it is easy to lose money buying in an uptrend, and it is easy to lose money buying strength and selling weakness. Success comes to traders only when they overcome normal human biases.
.
Let's take a different approach to the issue. Suppose I want to make sure that a rising market is truly in an uptrend and not just making a random bounce. Similarly, I want to ensure that a downtrend is significant before I jump on board. So I construct an indicator that will tell me when a move is significant vs. random.
Specifically, I take a 20-day moving average of the S&P 500 Index (SPY) and calculate Bollinger Bands (a volatility envelope) above and below the average. The bands are set for two standard deviations of price movement. Thus, if the market closes above the upper band, that means that it has made a statistically significant move above its average. If it closes below the band, that means that the market has moved significantly below its average.
The strategy is to not assume a trend is in place until the market has moved significantly--not just randomly--in a directional fashion.
So how does such a strategy fare? Let's update a post from last May.
Over the last three years, buying closes above the 20-day bands and selling closes below the bands has given us 14 winning trades and 29 losers in SPY for a net loss of 20 points (the equivalent of 200 S&P cash or futures points). The average gain for winning trades was .48 point in SPY. The average size of losers was .31 point. The setup captures larger winners than losers on average, but cannot make money because there are so many more losing trades than winners.
Of the 43 trades, 25 were long and 18 were short. Among the long trades, there were 11 winners and 14 losers. Of the 18 short trades, only 3 were winners and 15 were losers.
The superior performance on long trades suggests that, when this setup works, it captures the longer-term trend in the market. Interestingly in this regard, all three winning short trades have occurred since July of 2007, which is when the current bear market began. When the setup trades against the market's longer-term trend, the results are abysmal.
So what does this tell us? If we wait for a trend to become "significant" and obvious, it is too late. There is no systematic edge chasing a move that has already closed outside a volatility envelope. Indeed, to repeat a conclusion from my earlier post, pursuing a countertrend move outside the envelope has such a poor track record that it is promising.
The best way to lose at trading is to go with the obvious. I've argued in the past that the market is rigged against human nature: it is easy to lose money buying in an uptrend, and it is easy to lose money buying strength and selling weakness. Success comes to traders only when they overcome normal human biases.
.
Saturday, March 08, 2008
Weekend Links: Volume Two
* A Dash of Credit Market Insight - A Dash of Insight takes a look at the divergence between earnings expectations for stocks and messages from the credit markets. See also the ETFs currently recommended by their model.
* A Test of Technical Analysis - CXO Advisory reports on a study of over 7800 technical analysis rules applied to long-term Dow Jones Industrial Average data and finds room for skepticism.
* Where Jobs Are Being Lost - Calculated Risk looks at the data and the toll being taken by the housing slowdown.
* What If the Fed *Doesn't* Go 75 bps? - Econobrowser looks at implications for commodities.
* Finding Yield - Retail investors are jumping into municipal bonds, attracted by yields favorable compared with taxables, according to Accrued Interest.
* It's Who You Know That Counts - Research Recap reports on a very surprising predictor of analyst accuracy with stock recommendations.
* Next We'll Get Rid of Bars on Charts - StockTickr finds an unusual aid to trading that makes a good amount of psychological sense.
.
* A Test of Technical Analysis - CXO Advisory reports on a study of over 7800 technical analysis rules applied to long-term Dow Jones Industrial Average data and finds room for skepticism.
* Where Jobs Are Being Lost - Calculated Risk looks at the data and the toll being taken by the housing slowdown.
* What If the Fed *Doesn't* Go 75 bps? - Econobrowser looks at implications for commodities.
* Finding Yield - Retail investors are jumping into municipal bonds, attracted by yields favorable compared with taxables, according to Accrued Interest.
* It's Who You Know That Counts - Research Recap reports on a very surprising predictor of analyst accuracy with stock recommendations.
* Next We'll Get Rid of Bars on Charts - StockTickr finds an unusual aid to trading that makes a good amount of psychological sense.
.
Subscribe to:
Posts (Atom)
Posts
