Saturday, February 28, 2015

Reflections on What is a Trader

Victor Niederhoffer recently posted on the topic of "What is a Trader?" and then announced a contest for the best short essay on that topic.  The winner will receive $1500 and, if my experience with a Niederhoffer contest many years ago holds true, something much more valuable.  It was my winning of Niederhoffer and Kenner's contest on finding the best stock market indicator that led to a visit to Victor's trading operation and opened the door to a whole new way to view markets.  (That winning indicator was a correlation of the average beats per minute of popular music and the level of the Dow Jones Industrial Average).

As the quote above captures, there is an entrepreneurial and competitive essence to trading.  (Props to Henri and the Best Trading Tweets site for the card.)  Many are drawn to trading because of its independent nature:  you rely on your judgment, you work for yourself, and your rewards are a direct expression of your talents and skills.  It is in that spirit that I offer the following perspective on "What is a Trader":

I would define a trader as "an intellectual entrepreneur: one who generates ideas and manages their risk and reward within a competitive financial marketplace."  This is why the term "speculator" is an accurate one.  The derivation of "speculator" is from the Latin meaning "contemplation, observation" and by the mid 15th century came to mean "pursuit of the truth by means of thinking".  Ayn Rand regarded the trader as an ideal, as one who offers value for value, rather than living off the efforts of others.  The trader also represents Rand's ideal of man as a thinking animal:  one who relies on his/her perception in pursuit of the truth and is willing to accept the risks of that reliance to achieve superior returns.   

At its best, trading is an exercise in what makes us distinctively human:  the ability to perceive reality and plan and execute our actions based upon that perception.  Trading is not about making money, though that is a desired outcome; trading is also not about technical patterns or fundamental relationships.  At its root, trading is entrepreneurship of the mind, one of the purest forms of intellectual competition in some of the most competitive global arenas.

Further Reading:  Trading as Entrepreneurship

Friday, February 27, 2015

Best Practices in Trading: The Power of Elimination

When I first tried my hand at developing quantitative models of markets, I was impressed by the predictive power I could gain by adding more predictors to my equations.  Of course, that worked just fine on an in-sample basis, but completely fell apart when applied out-of-sample and especially in real time.  Why?  Because the complicated equations were custom fit to the historical data and thus not well suited to adapt to new data.  That overfitting created a false sense of security.  The equations with fewer, but powerful predictors were almost always the most robust--most able to provide predictive value going forward.  They were simple in their sophistication.

Today's best practice comes from a long time mentor of traders, Charles Kirk.  He follows markets daily via The Kirk Report and conducts mentorship programs for groups of subscribers.  Charles describes his best practice as "elimination", and his insight fits well with my early quant experience:

"Over 20 years I studied about every possible thing you can imagine about trading and investing.  I accumulated so much knowledge, but eventually realized that the path toward greater profits and success was figuring out what to eliminate so I could focus on the things that really helped me when I was trading at my very best.  All of us go through a period where we add more factors in our strategy.  More things to watch, more indicators to use, more screens to run, more backtesting research to review, more people to listen to, and so on.  The problem with doing that is that once you've been doing it for a while, the complexity itself becomes a huge distraction.  Much of trading well is figuring out what things truly add value and which are actionable and then having the courage to eliminate everything else.  There is a lot of noise and unhelpful factors out there that may be very interesting, but in reality are not helpful and often can present yet another obstacle for you to overcome.

Once you understand the steps you must take and information you need that leads you most often to successful trades, the next step is to eliminate everything you can that isn't absolutely necessary.  In addition, once you have a strategy that works, as a rule you never add anything else into it unless you can at the same time take something away.  That rule will prevent you from making things far more complicated than they need to be and allow you to focus on what truly matters.  The best practice of all, in my view, is one of elimination."

Charles offers a great piece of insight when he points out that it takes courage to eliminate the nonessentials.  In other words, you have to have confidence in the few, essential components of your success to lean on those exclusively.  Too often, when we seek the crutches of things to add to our strategies, it's because we lack confidence in those strategies.  Stripping down our performance to bare essentials forces us to commit--and then to put our money on that commitment.  

The same wisdom holds true for how we present ourselves in public.  If we are comfortable with who we are, we can present ourselves as we are--simply and straightforwardly.  If we are not comfortable with who we are, we will add layers to our social presentation to try to appeal to anyone and everyone.  We might adopt clothing or attitudes that aren't truly ours, or we may try to adapt our presentation to the social setting of the moment.  In each case, adding layers of complexity is a confession of low self-confidence and low self-acceptance.

When we trade who we are, we reinforce who we are; we don't undercut it.  And, as Kirk wisely observes, that's a great reinforcer of confidence.

Further Reading:  When Traders Lose Confidence

Thursday, February 26, 2015

Volume and Volatility: What They Mean for Our Trading

There is a close relationship between the volume traded in the stock market on a given day and the volatility of price movement during that day.  Since the start of 2014, for example, the volume in the SPY ETF has correlated .87 with the true range for that day.  When we trade more volume, it means that there is more speculative, directional participation in the market--and that tends to move prices.  Savvy day traders realize that and will gravitate to stocks trading on elevated volume for the day, as these provide the greatest profit potential.

The relationship between volume and volatility, however, is not a simple, linear one--and this creates challenges for traders.  Here 's a simple example:  During the last three trading days, SPY has averaged volume of roughly 72 million shares.  The average true range during that period has been less than half a percent or roughly 1 SPY point.  At the end of January, volume over a three day period averaged over 170 million shares.  The average true range during that period was about 1.8 percent or over 3 SPY points.  Volatility picked up by more than you would have expected as a linear function of volume.

The chart above of "pure volatility" represents the amount of volatility we obtain from a given unit of volume in the ES futures.  Note that, at present, the same amount of volume is giving us one quarter of the movement as it did when we made a low in mid January.  Not only do we see volume changing over time; as market cycles mature, the amount of movement provided by volatility changes.  

The bottom line for the current market is that we are seeing less volume *and* each unit of volume is giving us less movement than earlier this year.  That drying up of movement means that we can expect significantly less follow through on market moves than we might normally expect.  That has huge implications for trade management:  the sizing of positions, placement of stops, and establishment of price targets.  It also has meaningful implications for trading psychology, as the lack of movement makes it easy to overtrade the market in the effort to get something going.  

What that means in practice is that it's important to anticipate the amount of participation and movement in the market during your trade and factor that into your planning.  Less volume means that the proportion of directional participants to market makers is reduced.  That makes for a different kind of movement, with reduced momentum/increased choppiness in the short term.  One of the most common trading mistakes I see is that traders do not make proper trading or psychological adjustments to shifts in volatility regimes.

Further Reading:  Why Trading is So Difficult

Wednesday, February 25, 2015

Best Practices in Trading: Elaborating Your Trading Processes

Who are we as traders?  The reality is that we fill many roles and engage in a variety of activities.  It's rare to find traders who work diligently on becoming better traders.  It's even more rare to see traders break down what they do into components and work on bettering themselves in every one of those.

Today's best practice comes from Pier Luigi Pellegrino from Paris, France.  He breaks down trading into four basic areas and then breaks down each of those into two sub domains and each of those into three specific performance elements.  This creates a catalog of 24 performance functions of trading.  Pier explains, "The daily trading routine is focused on a structured and regular implementation of the...24 performance elements."

Here is Pier's breakdown:

1.  Vision (The Fund Manager)

1). Focused Vision - create regularly the images of the financial goal to achieve
2)  Intensity of Purpose - feel with intensity the will to succeed and the expectation to win
3)  Intrinsic Motivation - being driven from within to reach high standards of performance

4)  Self Efficacy - act with self confidence and self efficacy and belief in winning
5)  Rage to Mastery - sustain the conviction of being an elite performer driven to reach mastery
6)  Implicit Action - execute the trading strategy by accessing implicit and intuitive knowledge

2.  Strategy (The Portfolio Manager)

7)  Portfolio Ranking - scan, select, and rank the best trend stocks with the proprietary screening tool
8)  Pattern Monitoring - monitor price action and pattern development among the filtered stocks
9)  Setup Recognition - detect playbook setups through implicit pattern recognition

10)  Risk Analysis - perform due diligence and risk analysis of potential trades
11)  Capital Allocation - determine the capital allocated to the trade (shares and stop level)
12)  Trading Frequency - trade only the best setups with the greatest opportunity

3.  Execution (The Head Trader)

13)  Mental Toughness - develop a strong and competitive mindset
14)  Rituals - replicate consistently a structured and coherent daily routine
15)  Zone State - enter on demand a zone state of focus and concentration during trading

16)  Trade Implementation - execute the trade flawlessly with clarity and intuition
17)  Order Management - utilize adaptive exit tactic with trailing stops and profit targets
18)  Performance Niche - focus relentlessly on your strategy and discard other methods

4.  Feedback (The Performance Coach)

19)  Performance Training - train key performance skills with structured deliberate practice
20)  Mental Rehearsal - isolate, rehearse, and integrate critical skills and optimal behaviors
21)  Laboring Instinct - develop a mindset of continuous improvement and skill refinement

22)  Continuous Debriefing - Debrief, monitor, and measure performance
23)  Performance Diagnosis - Detect factors limiting performance and enhancing success
24)  Feedback Implementation - Correct weaknesses and repeat winning actions

Now your breakdown of trading process might look different from Pier's (mine would be heavier on research processes and--ironically--less geared toward sustaining positive mindset), but the principle still holds:  dividing trading into component actions enables you to look under the performance hood and observe what you're doing well and what could stand improvement.

Indeed, a breakdown such as Pier's 24 performance functions could anchor an effective end of day or end of week report card that could anchor goal setting the next day or week.  That would be a best practice that embraces best practices!

Further Reading:  The Rage to Master

Tuesday, February 24, 2015

Best Practices in Trading: Developing a Framework for Good Trading

Too many traders justify poor trading and overtrading by appealing to "intuition".  There's no question that intuition and implicit learning are cornerstones of pattern recognition.  That doesn't mean, however, that any trade one feels like putting on is a good trade!  Intuition is the result of extensive exposure to a field.  Without prolonged immersion and study, there is no building of pattern recognition skills.

An effective way of ensuring that your trading truly represents sound trading is to construct a framework for your good trades that captures their essential elements.  Today's best practice comes from reader Awais Bokhari, the co-founder and CEO of the OpenTrader training program and the eminiplayer trading site.  Awais has been involved in training over 1000 traders, so he has worthwhile insights into the building of trading skills.  He describes the trading framework he employs to aid execution and screen for valid trade ideas:

"After working with numerous traders, one common challenge I've noticed is that even after they have developed a solid understanding of the market and its mechanics, they still struggle with trade execution, and can't objectively determine the quality of a trade setup in real time.  So, even after they've developed a good trade plan, they're unable to execute that plan in real time.

To improve execution, I provide our students with an Execution Framework and teach them The Anatomy of a Valid Trade Idea.  The concept here is to break down the trading methodology/strategy and determine the common components that are at the base of every good setup.  We then track those components in a trade journal/spreadsheet with simple Yes/No values.  It's important that we're able to measure and track each component objectively.  This means we can't include or track anything that relies on intuition.

For our discretionary trading methodology, we follow four key components that make up a valid trade idea:

1.  Good Trade Location:  For a majority of trade setups, trade location is going to be important.  In many situations, trade location alone can be enough of a reason to enter a trade.  To make this an objective determination, you simply answer whether you took the trade at a predetermined support/resistance zone.

2.  Intraday Control/Bias (short term directional bias):  We can assess which side is in control on the day time frame by seeing where the market is trading in relation to the first hour high/low, midpoint, VWAP, VPOC (volume point of control), overnight high/low, and previous day's high/low.  Trades in the direction of the intraday control have a higher probability of reaching their profit targets.  When entering a trade that is counter to the intraday control, you should be more conservative with your trade location.

3.  Momentum:  We gauge momentum by monitoring the NYSE TICK in conjunction with price action.  Trades in the direction of momentum have a higher probability of reaching their profit targets.  When entering a trade that is counter to momentum, you should generally be more conservative with your trade location.

4.  Larger Time Frame Control/Bias (trend):  For the purpose of day trading, we assess the larger time frame control based on the 30-minute and daily charts.  Trades in the direction of the larger time frame have a higher probability of reaching their profit targets.  And, again, trades that are counter to the larger time frame/trend should usually be taken at more conservative trade location.

Confluence:  These four key components make up a valid trade idea.  The more of these you stack in your favor, the higher the odds of the setup working out.  As a rule, at least two of these components should be in your favor on every trade.

Reward-to-Risk:  R/R is used as a filter and is a prerequisite to entering any trade.  Because R/R is subjective and every single trade must meet our minimum R/R criterion of 2:1, R/R can never be used as the only reason to enter a trade.  It is necessary, but not sufficient on its own.

We've found that this execution framework allows our traders to be more objective and quickly determine the quality of a trade setup in real time.  Another benefit is that it allows the trader to objective assess trades at the the end of the day."

Awais has created a guide to trade selection that can assist traders in real time decision making and also facilitate review of winning and losing trades.  By applying these criteria to all trades all the time, the trader internalizes the basics of good decision making and turns excellence in execution into a positive habit pattern.

Further Reading:  How Many Daytraders Actually Make Money Consistently?

Monday, February 23, 2015

Starting the Week With New Perspectives

*  Note the persistent buying in stocks in recent months, as there has been considerably more lifting of offers than hitting of bids across the broad range of NYSE stocks.  Although breadth has waned over that time, we have not seen a significant influx of selling pressure whatsoever.

One of the most important psychological changes a trader can make:  transforming a negative focus on loss to a positive attitude toward learning;

Great weekly overview from Jeff Miller;

*  Valuable tools for market research and much more from Abnormal Returns

*  Perspectives from Ed Seykota and other worthwhile readings from Steve Burns

The psychology of pulling the trigger on trades from Finance Trends;

Very interesting site for crowdsourcing financial predictions;

An unusual amount of valuable data on technical indicators from Paststat. 

Sunday, February 22, 2015

Best Practices in Trading: Organizing Your Trading Business

If you run your trading as a business, then it's clear you are both the worker and the manager.  You are the researcher developing trade ideas; you are manager of your positions and risk; and you are also a self-manager.  Many times trading does not succeed because the business is not well run.  Traders jump from one role and function to another, without grounding each of these in productive routines and best practices.  A solo shop owner has distinct processes for selecting and ordering merchandise, displaying the products, serving customers, and managing the finances.  The success of the shop hinges upon executing each of those functions efficiently and effectively.

Today's best practice is offered by Bryan Lee, a full-time futures trader from Malaysia.  He describes how he divides his work into three components:

"I trade several futures markets in the U.S. and Asia, which includes crude oil, gold, bonds, mini Dow futures, soybean, wheat, corn, palm oil, soybean oil, etc.  My trading approaches are long term trend following and swing trading.  My trading is system-based, meaning all trading decisions are based on signals generated by my trading systems.  I integrate my own risk management algorithms in all the products in my portfolio.

I divide my trading into three parts:

1.  Research and Development - This includes study of trading methodologies and  research, development, and backtesting of new trading strategies.  Risk management for the entire portfolio is also included in this section.

2.  Trade Execution - I wake up at 5 AM (Malaysia time) to run my trading system.  Since my systems use end of day data, they will only generate trading signals before the market open each day.  Then my job is to place the signals as trade orders in the trading platform.  When a trade order is triggered, I am informed by the platform.  I will then jot down the time, price, lots, and other trade information in my trading log book.

3.  Auditor - The job of an auditor is to verify and audit all trades done for the day.  This is typically done at the end of each trading day.  I trade on a GLOBEX platform, where many futures markets are open for almost 24 hours.  I wake up at 5 AM and check for all the trades done for the day.  I will verify the record in the trading log with the statement sent by the broker.

I perform three roles, a researcher, a trade executor, and an auditor, all by myself, but I only perform one role at a time.  I can't be a researcher and a trade executor at the same time.  This will create conflicts and affect my trading."

The key idea that Bryan highlights is that he clearly delineates the major functions of his trading and has a distinct time--and processes--for each.  Although Bryan is a systematic trader, his best practice applies to discretionary traders as well.  Time needed for research and market observation must be separate from time spent actually trading and managing positions--and both must be separate from time spent working on oneself and improving one's performance.  It's not that successful traders follow a process.  Rather, they divide and conquer, creating separate processes for each part of their business.

What makes you a successful idea generator?  A successful risk manager?  A successful self-manager?  If you don't have distinct time devoted to each, it is unlikely that you can perform and grow in each of those functions.  Trading well ultimately means running your trading business well.  

Further Reading:  What Makes Good Traders Great Entrepreneurs

Saturday, February 21, 2015

Best Practices in Trading: Making Trading Fit Into Your Life

A common, but poorly recognized, cause of trading failure occurs when traders attempt to engage markets in ways that do not engage their greatest strengths and resources.  Daytrading and investment are two ways of participating in markets that are quite different in their demands.  The talented daytrader--one who can make decisions quickly based upon pattern recognition--can be very different from the talented investor, who often is one who possesses strong research and analytical skills.  The daytraders I have worked with have managed individual positions with a high degree of leverage.  The portfolio managers I have worked with have managed a large number of positions with a high degree of diversification.  It's like sprinting and distance running:  both are track events, but they require quite different skills.

Today's best practice comes from reader Saul Matos from Portugal (@TridionTrader).  He emphasizes the importance of finding an approach to markets that works for your lifestyle as well as your skill sets:

"When I started trading, I tried to be a trend follower because it was the method that suited me the most.  This way, I thought, I would be able to reconcile trading with my professional and family life.

Nevertheless, trading started consuming more time than I initially imagined.  With the pressure of everyday life, I became more anxious when I needed to make decisions, resulting in really poor decisions.  That resulted in losing 10% of my total capital.

In the next few years, I feel my life will not get easier, as I am the father of two small kids.  So I was compelled to adapt my trading method to fit my life and not the other way around.  Therefore I started a long-term investment in a diversified asset allocation portfolio.  Adapting the way I trade instead of the way I live and knowing that time will heal some of my mistakes has been really reassuring.  I'm making decisions fear-free and my results are becoming better and better."

Note that Saul made two key adjustments to his trading:

1)  He extended his time frame, becoming more of an investor than a trader;

2)  He diversified his holdings, so that any single holding moving against him could not unduly damage his capital base.

The combination of these adjustments enable him to engage markets constructively without interfering with his other commitments.  

I know traders who have developed effective methods for trading intraday and several day swings in markets, allowing them to make use of pattern recognition skills but also allowing them significant time away from screens.  Two traders I know limit themselves to trading patterns that set up at specific times of day, which again enables them to exploit their pattern recognition, but keeps them from becoming too caught up in market activity.

It's necessary that your trading have an edge in your favor, but having an edge won't help you if that edge is not one you can trade sustainably.  Saul's insight is that trading has to fit into your life and not the reverse.

Further Reading:  Embracing Stress and Minimizing Distress

Friday, February 20, 2015

Best Practices in Trading: Self-Control Routines During Trading Hours

During market hours, it can become easy to so focus on trading that we neglect the person who is doing the trading!  Once we lose self-awareness, we can make decisions that we would never make if we were calm and focused.  Self-control is easy when we are not facing stressful situations and dealing with fight-or-flight responses.  During periods of emotional, cognitive, and physiological arousal, however, our state shifts can take us very far from our initial planning.  That is why self-control strategies that can be employed during trading hours are a best practice.

Today's self-control methods are illustrated by reader Gus Joury, a short-term trader of crude oil futures.  Here are some of the daily practices that aid his trading:

"1.  I start my day with 15-20 minutes of meditation/mindfulness.  I practice breathing meditation and or TM to clear my mind and keep me focused and aware of my emotions before I start trading.  During this time, I use the inner balance app with a heart rate variability monitor to measure my performance for that session and I record my score.

2.  I go over my checklist to make sure I had a good night's sleep, protein breakfast, and workout.  I also rate my physical condition, distraction level, and overall emotional and mental state for trading.  

3.  Before I start trading, I look at market conditions and rhythms at different time frames to try to evaluate whether the market is tradable, whether it is trending or choppy, etc.  This helps me decide which tools and setups to use and whether it is worth trading or not.

4.  I start my first trade with small size (1-2 contracts) to test the waters and see if I am in tune with the market and to get a feel for the overall market environment.

5.  Once I start with a winning trade, I start increasing my size in the following trade by adding to the winners.  I like to start small and if the market goes in my direction, I add to my position using buy/sell stops and then scale out at the first target and second target and then trail my last position with one tick below/above the previous bar low/high to maximize my profits in the trade after having pocketed earlier profits.  This strategy makes me less anxious to take profits and helps me hold my position longer with a trailing stop.  It gives me good risk management and allows my winners to be much larger than losers.

6.  During my trade, if I experience any anxiety or discomfort, I take deep breaths in and out in order to maintain my focus and stick to my plan.  

7.  After closing my trade, if I feel any anxiety, regret, or discomfort, I take a breathing session break for 5-15 minutes until I clear my mind and refocus.  I also do some EFT tapping (emotional freedom techniques) with breathing to release negative energy.  I sometimes take a break by walking out of the trading office.

8.  Once I hit my daily stop loss, I stop trading.  I also stop trading if I lose 50-75% of intraday profits." 

Notice how Gus combines methods for physical and emotional control, such as the breathing, with methods of money management.  He attempts to stay in winning trades, exit losing trades with smallest size, and regulate the losses he can incur on any given trading day.  All of these are methods of self-control, and all of them help him stay focused on markets rather than focused on P/L.  

Money management is an essential part of self management in trading.  As I've mentioned in my books, I never want to lose so much money in a day that I cannot have a profitable week; I never want to lose so much in a week that I cannot come back for the month; and I never want a losing month to ensure a losing year.  A major aid to optimism and positivity is ensuring that you always have enough dry powder to mount a comeback after a loss.

Further Reading:  Self Control and Working Memory

Thursday, February 19, 2015

Revisiting Buying and Selling Pressure and What It Means for Stocks

As readers know, the NYSE TICK is one of my favorite market measures, as it gauges upticking versus downticking on a moment-to-moment basis across all NYSE stocks.  A while ago, I decided to treat upticks and downticks as separate time series and create distinct measures of buying and selling pressure.  What I found was eye-opening:  as intermediate-term market cycles top out, we see a distinct withdrawal of buying pressure from the market, as well as diminished selling pressure.  As the market tops out, selling pressure exceeds buying pressure, eventually resulting in significant selling extremes at or near cycle lows.  Interestingly, buying pressure picks up into and following those lows, as value-oriented, longer-timeframe participants are attracted to the lower share prices.  (All raw data from e-Signal).

What we're seeing at present is a significant reduction of buying pressure in recent sessions (top chart) and also diminished selling pressure (second chart), but selling pressure beginning to overtake buying (third chart).  As volume and realized volatility have been collapsing, buyers have withdrawn from the market relative to sellers.  This is occurring even as many broad market averages are at new highs, but the number of shares registering fresh new highs has been well below late 2014 levels (bottom chart; raw data from the Barchart site.)

All of this looks more like a topping market rather than one gaining buying interest and expanding its breadth.  We need to see a resurgence of buying pressure to sustain the breakout from the late 2014 trading range.

Further Reading:  Who Has the Upper Hand in the Market?

Wednesday, February 18, 2015

Positive Psychology, Building Strengths, and the New Forbes Blog

A major development in psychology has been the systematic study of positive aspects of human development:  happiness, love, creativity, resilience, health, etc.  This has given rise to a positive psychology movement that seeks to help people, not by eliminating their weaknesses, but by cultivating their strengths.  This positive psychology has the potential to make us better people, as well as more productive and successful traders.

In my new Forbes blog, I am writing a practical book on positive psychology one blog post at a time.  In that blog book, I plan to highlight important research and practice in positive psychology and how we can make use of those discoveries.  I think you'll find, in the first three posts listed below, a view on the application of psychology that is both unique and uniquely promising.

I look forward to seeing the book evolve.  One great aspect of writing a book via a blog is that the comments, interests, and suggestions of readers can help guide the writing.  In that sense, the book becomes self-organizing, reflecting the insights of many--not just the author.

Thanks as always for your interest and support.  Most of us have an inkling that we are but a fraction of what we are capable of becoming.  My hope is that the new blog will be a resource for developing your deepest dreams and highest ideals.


Tuesday, February 17, 2015

Best Practices in Trading: Scenario-Based Preparation

In trading, as in sports, the game is often won or lost before the competition formally begins.  It's the preparation for winning that leads to winning and the failure to prepare that prepares for failure.  Coach Bob Knight famously observed that many have the will to win, but not many have the will to prepare to win.  Elite performers love the preparation, not just the performance--and that's what enables them to move to ever higher levels of performance.

Reader Paul Landry contributes today's best practice:  a scenario-based preparation routine.  By anticipating a variety of possible market scenarios and how he'd respond to each, Paul helps ensure that he will not be surprised by market developments.  It is very difficult to emotionally overreact to situations that we have anticipated and prepared for.  In that sense, mental preparation is one of our best tools for emotional self-control.  Here's how Paul explains his routine:

"I come from a military background.  Before an operation, rehearsals are crucial to getting things right before we face decisions in the heat of battle.  I find I also need to conduct rehearsals before the trading day.  I rehearse seven possible scenarios with four parts for each one.

The seven scenarios are:  a bullish move that turns into a long trend upward; a bullish move that turns into a short trend upward; a bearish move that turns into a long trend downward; a bearish move that turns into a short trend downward; a return to the mean move where the market reverses; the most likely move that I could experience; and the most dangerous move I could experience. 

The four parts are:  the likelihood of each scenario; what the charts and indicators will show to identify each scenario; what is the likely near term direction for each scenario; and what my reaction should be when faced with each scenario.

The rehearsals help me in two ways.  First, the decision making is faster and of higher quality because I have been in the situation before.  Also, the second-guessing during and after the trade is minimized because the decisions were rehearsed beforehand, when trading stress was minimal."

Notice that Paul's preparation routine is really an exercise in open-mindedness.  He does not start the market day locked into any one particular scenario.  Rather, he rehearses and prepares for all likely situations, staying flexible as markets unfold.  During the day's session, certain scenarios will come to the fore and others will not play out, enabling Paul to focus on his preparation for the day's most likely outcomes.  

My experience with this kind of preparation is that detail is important.  It's not just visualizing a situation that is important, but concretely rehearsing the specific steps you would take in that situation.  Preparing through multiple modalities is more effective than through a single channel.  For example, visualizing a scenario and desired responses; talking out the scenario and responses; and writing them both out are different ways of processing trading plans.  Spending more time on the exercise--and drawing upon multiple ways of processing the plans--results in a deeper and more effective preparation.

"What if" planning is essential not only in military actions but in most competitive games and sports, from chess to football.  As Paul emphasizes, one cannot count on accurately and thoroughly processing a situation in the heat of battle.  Thoroughly planning actions before things heat up is a great way to make sure we trade well, regardless of curve balls the market may toss our way.

Further Reading:  Priming and Preparing Your Brain

Monday, February 16, 2015

Best Practices in Trading: Developing Trading Rituals

A ritual is something we do that has special meaning and that we perform the same way at the same time.  A family might have its Thanksgiving meal rituals; most religious services are anchored by rituals; we have rituals for such special events as births, weddings, and funerals.  Rituals are more than mere habits--they set time apart to focus us on what is meaningful.  When we enter a ritual, we change modes to participate in the significance of the occasion.

Today's best practice in trading is developing trading rituals.  These are activities that focus us on what is most important in trading.  Reader Yvan Byeajee, an active, full-time trader, has written a book called Paradigm Shift that stresses the importance of organization and preparation for trading success.  Yvan explains that "The book is essentially a statement of the work ethic that is required to make it in this business.  Without it, even the most robust system is doomed to failure.  I strongly believe that this applies to almost anything in life."

Here is the daily work schedule and rituals laid out by Yvan (all times Pacific):

Monday to Friday:

5:30 AM - 5:50 AM:  Read my list of positive affirmations.  (Positive Expectancy Mind + Positive Expectancy Model = Success)

5:50 AM - 6:30 AM:  Breakfast while glancing over market related news

6:30 AM:  Market opens.  Watch how price action unfolds

8:00 AM:  By that time I'm usually done watching the markets.  I am out of any daytrades I took for the day.  I also placed my orders to open any new swing trading ideas and placed my orders to close any existing ones

8:00 AM - 8:30 AM:  I read trading blogs.

8:30 AM - 9:00 AM:  I listen to a trading-related podcast.

9:00 AM - 12:00 N:  I'm usually out during that time period for a run, followed by a 1-hour yoga session.

12:00 N - 1:00 PM:  At that time, I'm back in front of my screen to watch the final hour prior to the market close and I look to close or initiate new positions if there are any.

1:00 PM - 2:00 PM:  I update my trading journal and trading log.  I also save the charts of the setups I took or exited for later review.

2:00 PM - 3:30 PM:  Research and homework for the next trading day (scanning through hundreds of charts, noting possible entries, exits, position sizing, and risk management parameters to minimize decisions during market hours)

9:30 PM - 10:00 PM:  Book:  Trading related lectures.  I will typically read one chapter per day.

10:00 PM - 10:20 PM:  Meditation


9:30 PM - 10:00 PM:  Book:  Trading related lectures.  One chapter as usual.

10:00 PM - 10:20 PM:  Meditation


1:00 PM - 2:30 PM - Read journal, logs, and saved charts.  The goal is not only to learn something about the market's behavior, but also mine:  What I did right, what I did wrong, and where I could have done better.

2:30 PM - 4:00 PM - Backtesting (statistical analysis of previous chart patterns and their occurrences, updating of my positive expectancy model and possible new models.)

9:30 PM - 10:00 PM:  Book:  Trading related lectures.  One chapter.

10:00 PM - 10:20 PM:  Meditation

Yvan explains, "My best practices have evolved over time to fit my needs at the moment, so new traders should expect theirs to do the same.  They should test, modify, and ultimately find something that suits them the best.  Once they have set up a task to perform as part of their routine, they should try their best to stick to it and be done with it within the set time frame.  Every time we participate in a ritual, we are expressing our beliefs, either verbally or implicitly, so we should be focused on the process, one small step at a time, and the results will take care of themselves."

Yvan offers a great example of how he has turned best practices into robust processes.  What strikes me most in his schedule is how much time he *doesn't* spend in front of trading screens.  I think this is very important.  He prepares his trades the night before and conducts extensive homework in the evenings and during weekend hours.  That allows him to use active trading hours to simply execute his plans.  Such planning and time away from screens prevents overtrading and also enables Yvan to work on himself.  Note how he uses reading, affirmations, meditation, and yoga to keep his mind and body in shape.

Your schedule and rituals may differ from Yvan's but the important takeaway--as he points out--is the consistency of your activities.  It is that consistency that turns a valuable practice into a ritual.  I strongly suspect that Yvan's edge in markets comes both from the work he performs daily and weekly and also his ability to turn best practices into daily and weekly rituals.

Further Reading:  Cultivating Winning Habits

Sunday, February 15, 2015

Assessing the Recent Stock Market Strength

Stocks moved smartly to new highs in the major averages this past week.  Sector rotation was particularly noteworthy, with former leaders utilities and consumer staples--defensive and yield plays--falling behind and more growth-oriented sectors--consumer discretionary and raw materials--showing particular strength.  This reflects strength in U.S. economic data and an increased pricing of odds that the Fed will begin to normalize interest rates later this year.

The top chart tracks the number of stocks across all exchanges making fresh three-month new highs vs. new lows. (Raw data from the Barchart site).  Note that new highs have been growing in recent sessions, but remain below peak levels seen in 2014.  This reflects the fact that many sectors, such as financials, energy, consumer staples, and healthcare, have not registered recent new highs.  Still, I note that relatively few shares are registering fresh new lows, an indication that buying has been broad-based.  Indeed, the bottom chart tracks the Cumulative NYSE TICK--the cumulative upticks vs. downticks for all NYSE stocks--and shows consistent buying interest from institutional players.  (Raw data from e-Signal). 

The second chart from the top is my measure of intermediate term market strength.  It is a 10-day moving average of SPX stocks making 5, 20, and 100-day highs vs. lows.  (Raw data from Index Indicators).  It has risen sharply in recent sessions and is near a momentum peak.  Note that it is not at all unusual for this strength measure to top out ahead of price during intermediate-term market cycles, which means that we could see further upside drift even if breadth moderates from here.

The second chart from the bottom shows the number of NYSE stocks closing above their upper Bollinger Bands vs. those closing below their lower Bands.  (Raw data from Stock Charts).  It is very common for this measure to peak ahead of price during intermediate-term market cycles and that's what has happened so far.  Note, however, that the Bollinger Balance--the number of stocks closing above vs. below their Bands--has remained consistently positive in recent sessions, reflecting the buying pressure noted above.

So where does that leave us?  Here are a few observations:

*  We made a momentum low in mid-January, with the lows in very early February drying up.  From that point, we have embarked on a new intermediate-term upward cycle, which is approaching a momentum peak;

*  Buying pressure has been significant during this most recent upward cycle and should continue to propel prices higher, even after we have made a momentum (breadth) peak for this cycle.  We need to see selling pressure from institutions begin to exceed buying pressure before the current cycle is imperiled;

*  Despite fresh price highs, many sectors are not making new highs thus far and stocks making new highs are below 2014 levels.  I believe the current upswing is part of a broad topping formation in stocks and not a fresh bull market leg; a significant expansion of new highs beyond 2014 levels would contradict that view;

*  In my current base case scenario, we continue to drift higher on upward buying momentum, but ultimately will top out and return to the late 2014 trading range as part of the market's broader topping.

This is a general roadmap; a broad hypothesis rather than a hard and fast conclusion.  As always, I will be tracking the market measure and updating that roadmap.

Further Reading:  Views of Market Breadth

Saturday, February 14, 2015

Weekend Readings Out of the Comfort Zone

My latest post for Forbes illustrates how we can make ourselves better through psychology--not by writing in a journal or talking to a coach--but by organizing our lives as series of workouts.  It's a great example of fresh directions coming out of the new, positive psychology.

*  Here's an insightful lesson from Cliff Asness on how leverage can work for your trading.

Gems of insight from Ray Dalio; very relevant applications of his Principles

*  A better form of trend following and other worthwhile podcasts from Abnormal Returns.

*  It would be helpful to predict the day's trading volume from knowing the volume traded in the first minute.  Here's a fascinating way to accomplish that from MKTSTK.

*   Views on currency wars from Mohamed El-Erian.

Sector rotation:  commodity-related sectors have been up lately; rate sensitive issues down.

Have a great weekend!


Friday, February 13, 2015

An Enduring Formula for Life Success

I'm writing this from the library of the Oheka Castle on Long Island.  The Gatsby-like stay is part of our 31st wedding anniversary; a special way of commemorating a special event.

What I've learned in 31 years of marriage is that relationships don't stay special unless you nurture their specialness.  Relationships built on the neediness of each member are so self absorbed that partners cannot truly perceive the specialness of the other.  But specialness, once perceived, has to stay visible to stay alive.  As I've alluded in a different context, love doesn't die--it has to be killed.  And what kills love as much as hate is disuse.  Marriages become so routine that they no longer remain special.

Hence castles and warm cocktail toasts and snuggling in bed with purring cats you've rescued.  It's part of what makes life special--and interesting--and worthwhile.

The same lesson holds for careers.  Once they become routine, they become jobs.  If you're not learning and developing--if you're not challenged and stimulated--you eventually fall out of love with your life's work.  You're most likely to thrive in marriage by staying in love.  You're most likely to thrive in trading by staying infatuated with markets.  It's not enough to love what you do.  You have to actively keep that love alive.  That's what leads to 31 years of fulfillment.

Further Reading:  The Spouse of a Trader

Thursday, February 12, 2015

A Different Way of Measuring Strength and Weakness in the Stock Market

One of my works in progress is tracking the number of NYSE stocks each day that give buy signals and sell signals across different technical indicators.  Above are charts for NYSE stocks giving buy vs. sell signals for Bollinger Bands (top chart) and the Commodity Channel Index (bottom chart).  (Raw data from the Stock Charts site).  As a rule, we see the number of buy signals peak ahead of price during a market cycle and the number of sell signals anticipate a cycle price low.  Sell signals for the current cycle peaked in mid-January, with fewer sell signals posted at the late January/early February lows.  Buy signals for the current cycle peaked early in February.

One interesting facet of the Bollinger measure is that it is the absence of weakness--and not just the presence of strength--that alerts us to a strong stock market.  When the market is ready to turn over, there are typically weak shares and sectors leading the way and that shows up as a relatively elevated number of sell signals for the Bollinger Band measure, even as the index price has been near highs.  On the other hand, when very few stocks and sectors are weak, the market often drifts higher, as selling pressure is minimal.

For example, I looked at the period from early May, 2014 (when I first began assembling these data) to the present and broke down the number of sell signals for the Bollinger Band measure in a simple median split.  When we had few sell signals, the next five days in SPY rose by an average of +.37%.  When we had more sell signals, the next five days in SPY rose by an average of only +.06%. 

Interestingly, daily sell signals for the Bollinger Band measure correlate only +.07 with the RSI measure and only +.21 with the MACD measure.  The absence of sell signals for those latter two indicators has not led to superior returns going forward.  Indeed, when we've had few MACD sell signals, the next five days in SPY have averaged a gain of only +.09% vs. +.34% when we've had many sell signals.  

It appears that separating the number of buy and sell signals and looking within each indicator captures different time frames and different patterns of momentum and reversal.  This strikes me as a most promising area of research, particularly when we focus on technical indicators that are not highly correlated.

Further Reading:  Technical Indicators From the Bottom Up

Wednesday, February 11, 2015

Several Views of Stock Market Breadth

Recent market behavior in stocks has been confusing for traders, as we've had a good deal of volatility during 2015, with little ultimate directional movement.  VIX has stubbornly stayed above 15 for much of this time, a notable change from most of 2014.  Here are three views of breadth in the U.S. stock market that can help us make sense of what has been going on.

The top chart represents all stocks listed on major exchanges and the number making fresh three-month new highs vs. three-month new lows.  (Raw data from the Barchart site).  You can see that breadth has been waning since the late October and late December market peaks.  Breadth has tended to peak ahead of price during intermediate term market cycles.  What I believe has helped make recent market action confusing is that the current cycle has been very choppy, but the breadth measure peaked in late December and we're in the process of topping.  An implication of this view is that the downside to the current cycle should ultimately break us below the 2015 lows to date.

The middle chart represents only stocks from the SPX average and tracks the number making 5, 20, and 100-day highs minus lows each day.  (Raw data from the Index Indicators site).  This, too, tends to top ahead of price during intermediate-term cycles and hit its recent peak in late December.  Notice how new lows did not expand for either the top or middle measures when we made recent early February lows.  That set up the current upswing.

The bottom chart represents the cumulative number of NYSE stocks closing above their upper Bollinger Bands vs. those closing below their lower bands.  It is a running total, like an advance-decline line.  (Raw data from the Stock Charts site).  That measure has been on the upswing and is consistent with the lack of fresh weakness at the recent market lows.  It is one of several factors that has kept me from prematurely shorting the current market.  Note, however, how we are well below 2014 highs in this measure.

Bottom line is that we are seeing positive breadth, but weakening breadth over time.  I continue to view this as part of a larger topping process in stocks.

Further Reading:  Perspectives on Breadth

Tuesday, February 10, 2015

Trading as Training in Mental Toughness

Every year you start with a zero P/L balance.  At any time, a rogue event could turn your portfolio and your account upside down.  If you don't kill, you don't eat:  you're only as good as your latest performance.  When you're very good, you'll still lose on roughly half of everything you do.  That means you'll have strings of losers and periods of drawdown.  Markets will sometimes change faster than you can adapt.  You'll question whether your edge in the marketplace is gone.  You'll see others whose edges truly have eroded and you'll wonder if you can ever hope to compete with the machines.  

Little wonder that those who do succeed in the money management world display a good amount of mental toughness.  There are tremendous rewards to those who succeed and precious little job security for those who don't.  The entire profession is based upon the ability to act in the face of uncertainty and take meaningful risks.  How many fields--even in sports--require such daily endurance?

An excellent overview article identifies several components to mental toughness:

1)  Hope - A strong degree of self-belief;
2)  Optimism - A general expectation of favorable outcomes;
3)  Perseverance - Consistent pursuit of one's aims in the face of adversity;
4)  Resilience - The ability to adapt to challenging situations

Mental toughness thus requires the grit described by Angela Duckworth--that ability to keep going when the going keeps getting difficult.  Learning to handle smaller pressures and challenges builds the toughness needed to handle the larger ones.  Dealing with day to day, week to week setbacks in trading is training for dealing with the inevitable larger setbacks.  

This can only happen, however, if the elite performer maintains what Emilia Lahti describes as an "action mindset".  The Finnish concept of Sisu describes the ability to tap into hidden wellsprings of resources during times of extreme challenge; Lahti describes it as a kind of second wind, in which environmental demands bring out more than we thought we had.  It is not enough to endure; fueled by Sisu and in an action mindset, we can find and pursue the opportunity in challenges.

I have spoken with many traders who go on winning streaks and then become complacent.  They cut back on their rigorous preparation and take more marginal trades.  It's as if, instead of a second wind, they lose their wind--or at least their willpower.  What if winning is as challenging for the competitor as losing?  What if it's not just adversity that challenges us, but any cognitive/emotional state that greatly differs from our norm?  Ironically, the trader who experiences win after win after win may be as challenged as the one who experiences a series of losses.  

That would explain my observation that the best traders double down on their discipline and planning after they have made money.  In Lahti's terms, they sustain the action mindset.  Their Sisu kicks in, not because they experience extremes of pain, but because they experience extremes of positivity.  It is any shift outside our normal experience that taxes us--even shifts that we desire.  Most traders have a plan for dealing with drawdowns.  How many have a plan for dealing with draw-ups?  

Maybe, just maybe, sustaining performance after consistent winning requires as much mental toughness as sustaining performance after consistent loss.  Perhaps success brings its own adversity.

Further Reading:  Emotional Resilience in Trading