Tuesday, September 29, 2015

Trading Notes: Week of September 28th

Friday, October 2nd

*  I'll be presenting at two trading conferences in October; both have unusually strong programs and are worth taking a look at.  

*  The weak payrolls number has led to a premarket selloff after we dipped and bounced back yesterday.  As noted yesterday, all of this is consistent with a market that is in a bottoming process.  My intermediate-term measures are significantly oversold; my models are neutral.  I am watching carefully to see if we can stay above yesterday's lows.  If so, we could see an excellent intermediate-term buying opportunity follow from that.

Thursday, October 1st

How we develop ourselves through adversity; do losses defeat us, or help us grow?  Very important topic.

*  Yesterday's entry mentioned good odds for a bounce and we sustained early strength into the day session and then overnight.  Two perspectives strike me as important here:  1) During the corrections of 2010 and 2011--ones that were not outright extended bear markets--bottoming took place over multiple months.  Further tests of the downside are not out of the question; 2) The intermediate-term oversold measures referenced yesterday are nowhere near being worked off.  I expect those to be worked off in time and price, with limited upside if we are indeed to see more bottoming and more upside momentum if we've truly completed a test of August lows.

Wednesday, September 30th

*  Overnight action in the stock index futures has given us the bounce referenced in yesterday's post after a day of again testing lows and holding in the 1860 area.  We continue to be short-term oversold and my swing models are moderately bullish.  

*  We continue at oversold levels on an intermediate term basis that have led to positive swing returns, as the chart below indicates.  This measure takes the number of SPX stocks registering fresh 5, 20, and 100-day highs minus lows and calculates a five-day moving average.  (Raw data from Index Indicators).  When this strength measure has been in its bottom quartile (lows outnumbering highs), the next three days in SPX have averaged a gain of +.57% going back to 2010.  All other occasions since 2010 have averaged a loss of -.02%.

Tuesday, September 29th

*  Yesterday's market was a textbook trend day to the downside.  It's very worthwhile studying the characteristics of trend days, so that they can be identified as early in the session as possible.  I find the distribution of NYSE TICK readings to be especially helpful in that regard.  

*  I had mentioned last week that my intermediate-term indicators were relatively overbought.  With yesterday's broad decline, we find ourselves at much more oversold levels, nearing the August lows.  Interestingly, we had 1212 stocks across all exchanges make fresh three-month lows yesterday.  On August 24th, that number was 2906.  Per earlier market notes, I am open to the idea that we are testing those August lows and that we will ultimately succeed in that test. Note, however, than past higher volatility corrections in May, 2010 and August, 2011 took multiple months to find an ultimate bottom.

*  We're seeing elevated index and individual stock put/call ratios, also supporting the idea of a bounce here.  Fewer than 10% of SPX stocks are trading above their three and ten-day moving averages, a level that in the past has tended to yield bounces over a next five-day basis.  My models are moderately bullish over the next three to five day horizon.

*  Thanks to readers for the many positive comments about the recent trading conference and the lessons learned.

Monday, September 28, 2015

How to Be Great at Networking

It was great meeting up with Jack Schwager, Peter Brandt, and a host of energetic and experienced traders at the recent Traders4ACause event.  I just posted an important article on four important takeaways from the conference that can benefit traders and investors alike.

I am a firm believer in the value of networking: connecting with the right people to expand our horizons and build effective professional and support systems. One of the best ways of adapting to changing markets is to observe how others we respect are adapting.  We can learn from our own strengths and weaknesses, but if we're observing the strengths and weaknesses of many others, our learning becomes exponential.

Sadly, most people are not good at networking.  They don't feel they have much to offer.  They tell themselves that they will lose their edge if they share too much.  They don't come to events prepared to give and that severely limits how much they'll receive.

I enjoy presenting at good conferences because I know that if I offer value, valuable colleagues will seek me out and I will leave with an enriched network. By focusing on what we can teach, we set ourselves up to attract eager, hungry, passionate minds--and then we learn from them.  

We become great at networking, not by focusing on what we can extract from others, but on the value that we bring to others.  Teach good people and you'll come away with valuable lessons.

Further Reading:  Building a Learning Network

Sunday, September 27, 2015

A Three Question Self-Assessment for Traders

Here are three questions that will help with self-assessment and the assessment of your trading:

1)  What, specifically, are the talents, skills, and strengths that will fuel your success? - A very successful business needs a distinctive competitive advantage.  What is yours?  What do you have that others don't that will make you succeed where others fail?  What are you superlatively good at, and how is that concretely and consistently expressed in your trading?  In your life?

2)  Where in your life, specifically and consistently, are you making super efforts?  - We don't grow by staying in our comfort zones.  Growth, whether in the gym or in life, requires a conscious, directed push outside our comfort zones so that we exercise fresh competencies.  What are the super efforts we're making here and now to be more tomorrow than we are today?

3)  Who brings out the best in you? - It is human nature to adapt to our environment.  If we're in an enriched social environment, we rise to the occasion; we absorb positive role modeling.  A challenging and stimulating work environment inspires us to rise to ever higher levels.

If we want a successful life, a meaningful life, a happy life, our days must be populated with experiences that yield success, meaning, and joy.  We can live comfortably and we can live well.  Or we can make super efforts and live to our fullest.  Each day, the choices we make shape our future and who we will be.

Further Reading:  Gurdjieff, Turtles, and Trading

Saturday, September 26, 2015

There Is No New Doing Without New Viewing

One of the most common mistakes traders make is that they want to do new things--find fresh opportunities, change the way they manage trades or themselves--while retaining their existing ways of seeing the world.  If we look at the world through the same lenses, we'll pretty much see the same things and respond in the usual ways.  New doing requires fresh viewing--the ability to wear a different set of lenses.

I was pleased to see that my new book, Trading Psychology 2.0, is finally available.  I gave the book that name to convey an important theme:  recent research in psychology has moved us a long way in recent years, challenging our traditional ways of thinking about the psychology of trading.  In other words, recent work in psychology provides a new set of lenses that allows us to view our trading--and our growth as traders--in a fresh light.

Margie and I recently spent an evening and morning in Tusayan, AZ, just outside the Grand Canyon.  We visited the Canyon around sunset and then again around sunrise (see above).  The light on the rocks and canyon was completely different at the two times.  What you saw in the evening--the textures, colors, and details--was radically altered in the morning light.  It was like viewing two master paintings of the same subject.

Notice how the process of visiting the Canyon at sunrise and sunset is very different from the tourist's process of coming to the site at a random time of day, taking a look at the big canyon, snapping a few pictures, and then going on for the rest of their trip.  

Most traders approach markets the way the average tourist visits the Grand Canyon.

What the new psychology teaches us is ways of seeing markets at sunrise and sunset--in one light, and then a very different light.  That is how we arrive at fresh insights; that is how we see things that others miss.

One set of charts that I keep examines price levels--and rates of changes of those levels--at different time intervals.  Another set of charts I keep examines volatility readings--and changes in those--at different time intervals.  One set of price and volatility charts is denominated in price change units--each "bar" represents a given amount of movement in the asset, not a fixed time period.  Another set of price and volatility charts is denominated in volume units, where each "bar" is drawn after a fixed amount of contracts trade.

The opportunities exist at the intersection of those four sets of charts, where price change and volatility patterns line up.  If I view markets as a tourist, looking solely at time-based price charts, I never see the intersections.  The tourist who comes to the Canyon at noon never sees the Canyon at sunrise or sunset--and can never appreciate the changes between the two.  The tourist who looks at markets one way cannot see the opportunities that spring from a fresh set of perspectives.

An important takeaway from Trading Psychology 2.0 is that we can't master markets while we're stuck in our own 1.0 version of trading psychology.  Only by viewing ourselves and markets in new ways can we set ourselves up to do new things.  There is no edge in consensus perception.

Further Reading:  The Most Important Trading Trait

Monday, September 21, 2015

Trading Notes: Week of September 21st

Friday, September 25th

*  Once again we saw an expansion of stocks registering fresh lows on Thursday, as early selling dominated.  We saw 300 stocks across all exchanges make fresh 52-week lows, the highest number since August 24th.  Buyers became more aggressive into the early weakness and we closed well off the day's lows.  We've since rallied sharply overnight, consistent with the breadth query and model forecasts reported on Wednesday and Thursday.  My models remain moderately bullish over a 3-5 day horizon.  This will have me buying oversold weakness that occurs at successively higher price lows as a general game plan.

*  I've mentioned in the past that I like to track markets in event time, rather than in chronological time units.  Below is a chart where each data point for the ES futures represents 250 price changes.  This means that we draw more "bars" when markets are busy and volatile and fewer when they are quiet.  This 50-bar rate of change measure has been a useful gauge of overbought and oversold conditions per the game plan mentioned above.

*  I will be posting thoughts and ideas coming out of the weekend Traders4ACause event tomorrow and Sunday.  My talk will deal with research-grounded best practices for traders.

Thursday, September 24th

I'll be bringing a one-page best practice to the Traders4ACause conference this weekend and exchanging with others who choose to write up a useful trading strategy.  Great way to leverage mutual learning.  My practice will be an intermediate-term overbought/oversold indicator that captures both momentum and value effects in SPX.

*  We saw an expansion of new lows yesterday and again selling of bounces worked well intraday and again we stayed above overnight lows.  I continue to show us short-term oversold but intermediate term a bit overbought; my models are modestly bullish over a next three day horizon.  My intraday leaning is to buy dips that hold above overnight lows, but so far I have been less than inspired by the buying strength we've seen coming out of market selling.  A reduction in selling pressure is very different from an influx of buying: something I'll be watching going forward via NYSE TICK.

Wednesday, September 23rd

*  Once again, selling bounces worked well for much of the session on Tuesday as the decline continued.  We did see reduced selling and increased buying late in the session, but still closed with fewer than 10% of SPX stocks above their three and five-day moving averages.  When we've been in a moderate volatility regime going back to 2006 (N = 44), we've had 33 occasions up, 11 down for an average four-day SPX gain of +.83%.  Although we had weakness following the PMI number out of China, the market has since recovered and I would not be surprised to see further bounce from the short-term oversold condition.

*  I continue to find it useful to track the frequency of occasions in which NYSE TICK exceeds +800 and falls below -800.  It's been a good gauge of whether buyers or sellers have been predominantly in control and shifts in the distribution of those occasions has been helpful in identifying shifts from buying to selling and vice versa.

Tuesday, September 22nd

*  Selling bounces that failed below the Friday day session highs ended up being a good strategy in yesterday's trade, though we were able to hold above overnight lows and bounced strongly at the end of the session.  Action remains consistent with the thesis outlined yesterday that we put in an intermediate-term high with the Fed announcement.  My models are modestly bearish, overnight action in Europe has taken out those prior lows, and my intermediate-term measures continue overbought (see below).  We're short-term oversold at present, so my game plan is to sell short-term overbought levels that fail below today's overnight highs.

*  The intermediate-term strength measure takes a 10-day moving average of the percentages of SPX stocks making 5, 20, and 100-day highs minus lows.  (Data from the excellent Index Indicators site).  I generally like to be selling when new highs have been elevated but are now waning and buying when new lows have been elevated and are now drying up.

*  The measures of put/call activity that I follow, for all indexes and for all individual stocks, are on the low side.  I'm not seeing particular signs of bearishness on those measures, which has generally yielded subnormal returns over the near term. 

Monday, September 21st

Understanding how we best process information takes us a long way toward finding our edges in markets.  Most traders do not clearly understand and draw upon their signature cognitive strengths, in my experience.

*  We hit a buying crescendo after the Fed announcement, with NYSE TICK hitting multiple extreme positive readings.  What was significant was the strong selling pressure attracted by those higher prices, taking us lower late Thursday afternoon and pretty much all day Friday.  Friday saw 334 stocks across all exchanges register fresh monthly lows, highest in over a week.  My intermediate-term indicators remain elevated, and I'm operating on the premise that we put in an intermediate high with that Fed buying.  The quality of the buying attracted to the short-term oversold condition will tell a lot about where we go from here; my game plan is to sell bounces that fail to take out the day session highs from Friday.  I have one model neutral to slightly weak and another that is modestly bullish for the 3-5 day horizon.

*  Below we can see a chart of buying vs. selling balance since June; the data are derived from NYSE TICK.  The five-day moving average of this balance has been a useful short-term overbought/oversold measure.  Since 2012, when it's been above zero, the next four days in SPY have averaged a gain of +.09%; when it's been below zero, the next four days have averaged a gain of +.36%.  When the five-day average of buying pressure has been high, the next four days in SPY have averaged a gain of +.33%.  When buying has been in its lowest half of its distribution, the next four days in SPY have averaged a gain of +.03%.  When the five-day average of selling pressure has been light (little selling pressure), the next four days in SPY have averaged a loss of -.07%.  When the selling pressure has been heavy (top half of distribution), the next four days in SPY have averaged a gain of +.44%.

Stepping Back to Take a Step Forward in Trading

If appearances were accurate guides to reality, we all would make a ton of money in markets.  The challenging truth of the matter is that our cognitive biases ensure that what is apparent is not always what is real and true.  Often, we have to step back from our analyses, stop watching screens, and truly make an effort to see.  It is by stepping back that we can synthesize our observations and arrive at fresh conclusions.

This is a topic I took up in the recent podcast interview with Andrew Swanscott of Better System Trader.  He's assembled a great lineup of interviewees in his podcast series and did an excellent job of preparing for the session with his own questions and those from listeners.  We tackled the topic of creativity, among others, and the importance of opening the mind after focusing the mind.

Several traders I know engage in intensive chart reviews prior to the trading day and week.  They look at many charts at different time frames, often not spending a huge amount of time on each, but definitely watching in a highly focused state to observe detail.

Initially, I was skeptical of this practice, because I'm not convinced charts, in and of themselves, have a great deal of predictive value.  Because these were consistently successful traders, however, I knew that I should take their routines seriously.  The odds were good that something of value was derived from the exercise.

As Ayn Rand would have counseled, I should have checked my premises.  These traders weren't in the business of making predictions.  They were attempting to *understand* what was happening in markets.  So what did they gain from their chart review?

*  An idea of trending:  what was moving directionally and what wasn't; what was breaking out and what was in a quiet range;
*  An idea of context:  was the recent move part of a larger trend or range?
*  An idea of volatility:  were markets showing more or less movement over time?
*  An idea of correlation:  which markets or stocks were moving together?  Which correlations were breaking down?

All of these ideas were valuable, but what was most valuable was what came afterward.  The traders put aside their charts, stepped back, and simply pondered what they had observed.  Many times this occurred while taking a walk or relaxing in a chair.  What they were doing was looking across the charts and finding themes and patterns that made sense of their observations.  It was those themes and patterns that gave them their trade ideas.

Collecting and connecting puzzle pieces occurs in a different state of mind--a different workflow--from seeing the picture being assembled.  The deep look into things has to be followed by a broad look across things.  Stepping back allows us to see a larger picture, but if we don't precede the step back with intensive focus, we'll have no puzzle pieces to connect.  

Look into the charts.  Look across the charts.

Look into the data.  Look across the data.

Creativity lies at the intersection of microscope and telescope.

Thanks again to Swanny for the opportunity to share ideas with traders.

Further Reading:  The Role of Cognitive Style in Trading Success

Sunday, September 20, 2015

The Mindset of the Winning Trader

A major challenge for traders is dealing with noisy environments.  No, I'm not writing about volatility or even the volatility of volatility, but rather the noise of our own internal environments.

We become caught up in what screens are telling us.  We keep tabs of what others are saying and trading.  We follow news, we read emails, we message back and forth.

The one person we don't listen to is ourselves.  That requires quiet.

How much quiet do we experience in our trading?

It is ironic that some of the traders who most rely upon an intuitive feel for markets operate in the noisiest environments that block access to any possible messages from the gut.  Can there be effective intuition and market feel without quiet within?

When we are noisy, we are trying to keep up with markets and find trading ideas.  When we are quiet, we allow the market to come to us.  

Markets don't speak to us; they whisper.  A quiet mind makes for a keen ear.

Further Reading:  The Challenge of Developing Intuition

Saturday, September 19, 2015

Emotional Volatility and Emotional Volatility of Volatility

Suppose the volatility of markets is a proxy for the emotional volatility of market participants.  In an ultra low volatility market, nothing is moving very much.  There's not much to get excited or worried about.  In an ultra high volatility market, things are moving much more than normal.  That is an environment ripe for fear, greed, uncertainty, overconfidence, and underconfidence.

So what is the emotional significance of the volatility of volatility?  When volatility itself becomes volatile, emotional stability is itself unstable:  we swing abnormally between calm and arousal.  It may well be the case that the volatility of volatility is more important to performance--market performance and trading performance--than volatility per se.  If we are in a stable volatility regime, we can adapt to low or high levels of market movement.  But if volatility itself is moving around, adaptation becomes far more tricky.

Above is a volatility of volatility measure based upon pure volatility (volatility per unit of trading volume) from November, 2013 to the present.  Note how we are in a far different vol of vol regime than in the recent past.  This also shows up on traditional measures of volatility of volatility, such as $VVIX.

When pure volatility is in its lowest quartile and volatility of volatility is low, the next three days in ES have averaged a loss of -.25%.  When pure volatility is in its lowest quartile and vol of vol is high, the next four days in ES have averaged a loss of -.02%.

When pure volatility is in its highest quartile and vol of vol is low, the next three days in ES have averaged a loss of -.27%.  When pure volatility is in its highest quartile and vol of vol is high, the next three days in ES have averaged a *gain* of +.77%.

Like I said, it may well be the case that vol of vol--and not just volatility--is key to market performance and trading performance.  When we have had volatile markets and volatility itself has been volatile, those markets have provided the best upside returns.

Do we have ways of adapting, not only to volatility, but to volatility of volatility?  In our trading?  In our self-management?

New promising answers come from asking new, promising questions.

Further Reading:  Pure Volatility

Monday, September 14, 2015

Trading Notes: Week of September 14th

Friday, September 18th

*  In a sense for stocks, not a lot changed with the Fed meeting, as a hike is still in play for later this year, but financial conditions are not justifying a hike at this time.  We traded above the recent range and since have fallen back into the range, as we're now intermediate-term overbought.  Selling buying strength in NYSE TICK that cannot generate fresh price highs is my general approach going forward; models modestly bearish.

*  This posting is late in part because of my participation in a podcast for the Better System Trader site.  Do check out their podcast page; it's an excellent set of resources.  Will link my podcast when it's up early this coming week.

Thursday, September 17th

*  We saw modest buying pressure early in the session on Wednesday, followed by a notable absence of selling interest, with NYSE TICK largely staying above the -500 level.  This was significant, given that we were trading at a short-term overbought level near a range high.  Unlike in previous situations, those conditions did not bring out sellers, and the result was an upside breakout on strong breadth.  It was a great example of how indicators and models can alert traders to directional tendencies, but it is actually the tape action that makes for good intraday trades.

*  I now show over 70% of SPX stocks above their 20-day moving averages and well over 80% above their 3, 5, and 10-day averages.  While my models suggest the likelihood of pullback over a 3-5 day horizon, action clearly will be dominated by perceptions of the Fed decision and rate guidance later today.

*  Given the uncertainty of the outcome of the Fed meeting and the unusual attention placed on this meeting, I expect considerable volatility surrounding the announcement and press conference.

Wednesday, September 16th

*  We did indeed hold recent lows on early selling pressure on Tuesday, leading to a solid rally toward the range highs.  We're overbought across a number of the measures that I follow; the chart below tracks the percentage of SPX stocks trading above their 3, 5, 10, and 20-day moving averages (raw data from Index Indicators).  In general, when a minority of stocks are trading above their 100-day averages, my models point to subnormal returns when short-term breadth is strong and superior returns when short-term breadth is weak.  My leaning is to sell bounces that cannot take out the overnight and previous day's highs.

*  I'm hearing quite a dispersion of views regarding what the Fed might do tomorrow, which leads me to believe a reasonable proportion of traders will perceive themselves to be offsides.  That could contribute to significant volatility.  I was surprised by the relatively low index and equity put/call ratios yesterday; both were the lowest in the past two weeks.  That has tended to lead to subnormal returns over a next 3-5 day horizon.

Tuesday, September 15th

*  We saw net selling flows on the day Monday, but it was a quiet holiday trade and we held above the recent support around ES 1928-1930.  New monthly highs expanded to 306; lows dropped to 298, across all exchanges.  So while there was net selling pressure, breadth did not deteriorate.  That normally has me looking for a bounce, particularly if we can hold the overnight lows in early trade today.  One of my models is modestly bearish; one modestly bullish--not unusual to get weak and indecisive signals in a range market, as the models pick up overbought and oversold extremes.  I suspect we could see a continuation of the range trade going into Thursday's FOMC meeting.

*  Below is a chart of an 80-period rate of change measure for ES, where each period represents 50,000 contracts traded.  I've found overbought/oversold measures that normalize for volume traded to be quite helpful in putting overnight action into context and adjusting to faster and slower market conditions.  We're bouncing off an oversold condition; I'm watching the quality of this bounce carefully.

*  The CBOE $SKEW measure is at its highest level in a while.  That means that out of the money put options are being bid up ahead of the Fed.  Interestingly, as I noted a while back, skew is not necessarily a contrary indicator.  Near-term returns following high skew readings have been subnormal.

Monday, September 14th

*  What I see among successful traders is a network of successful relationships.  There is simply too much to follow in markets to trade in a completely siloed fashion.  That is why even independent traders and solo portfolio managers cultivate strong information networks and support systems.  There is a key to building strong relationships that I recently wrote about; ultimately it's a critical part of one's long-term edge in markets.  The strongest individuals get that way by cultivating strong teams.

*  My models are modestly bearish over a 3-5 day horizon, but I expect the week's trading to be dominated by Thursday's Fed meeting.  The signals I'll be taking will be largely intraday and tactical up to that point.  The setups that have worked best lately have been periods of buying/selling that dry up before making a fresh new high or low--it's a pattern common to range markets.  I use NYSE TICK as a proxy for buying and selling interest; also the percentages of stocks trading above their short-term moving averages.

*  Not everything is trading weak, as a savvy trader pointed out to me over the weekend.  Fully 32% of SPX stocks are trading above their 20-day moving averages, not so bad after the kind of drop we had in August.  Homebuilders (XHB) have been notably strong, as have been some of the tech leaders like AMZN. I noticed a number of bearish articles in financial media the last couple of days.  Very difficult to find people in an opportunity mindset.  While I do think we could see follow through weakness, I do think quality companies with safe dividends will continue to look good in a world that remains largely within QE regimes.

*  Despite a bounce in stocks on Friday, we had only marginally more monthly highs on the day (237 vs. 213 across all exchanges) and more monthly lows (368 vs. 305).  I am watching breadth closely for clues as to direction of the eventual breakout from the recent trading range.  

Sunday, September 13, 2015

What Should I Do With My Failing Investments?

A Stock Twits reader asks a difficult question:  "Much of my retirement is in PG stock.  Any idea when this slow bleed will stop?  What can I expect in short term?"

There are many possible answers to this; let's start with the most basic.  If you're asking a similar question following a market decline, you've made a cardinal error.  A sizable proportion of your retirement funds should be concentrated in no single stock, even if it's a solid, dividend paying company that you've researched well.  If you look at how those stocks traded during the bear moves of 2001-2003, 2008, and 2011, for example, you'll find stomach-wrenching drawdowns.  When it's your future financial security at risk, it's difficult to tolerate those drawdowns.  That increases the odds that you'll bail out at the worst possible times.

Diversification is not only important in investing; it's important as a life principle. Although there is no lack of chest-beating quotes about the virtues of concentrating your bets, the psychological reality is that we can best take aggressive bets when a host of other bets are working for us.  I can take risks in my career because I have steady payouts from my relationships, investments, and intellectual pursuits.  When you go all in and place a large proportion of your funds in one stock, with all its gap risks and market sensitivity, you end up in an unwanted psychological version of Russian roulette.

So what about that PG stock?  No one has a crystal ball into the future, short term or otherwise.  All we can do is lay out probabilistic scenarios and effectively prepare for each of these.     

If you study sharp bear declines where volatility has expanded and breadth has blown out to the downside, the most common pattern is that momentum lows--points at which the peak number of stocks registering new lows on the year--are typically followed by tests of those lows and often by further price lows.  That bottoming process can take quite a few months, as in 2002-2003 and 2008-2009, as well as in shorter declines in 1998, 2010, and 2011.  In other words, the "slow bleed" typically occurs over a period greater than a few weeks.  A stock like PG, that receives considerable institutional flows, is unlikely to buck the trend of the major indices.

Even if our base case is that the lows of August 24th represent a momentum low in stocks (2906 stocks made fresh three-month lows vs. highs across all exchanges; 800 stocks made new 52-week lows), we have to assign some probability to the scenario in which this is the start of an ongoing bear market, not the end of a short, sharp correction a la 1998.  In the bear markets that began in 2000 and 2007-2008, those seeming momentum declines were followed by bounces--and then further waterfalls.  All it takes is a policy error or geopolitical event--a failure to bail out Lehman; a World Trade Center attack--to turn a stiff correction into a full-blown bear market.  The possibility of policy errors abound in the current environment, from destabilizing actions in China to premature monetary tightening in developed markets.

PG lost close to half its value over the course of the bear markets of 2000-2003 and 2007-2009.  It's already lost about 30% from its recent highs.  It's not inconceivable that it could lose further value.  As an investor, I need to turn that worst case scenario into a survivable event.  I would do that by buying insurance, either with a portfolio hedge in the form of an offsetting short position or in the form of an options position.  As I've shared with readers before, I missed the market bottom in 1987 by only a day or two.  The problem is that the market plunged well over 20% during that time.  Had my stock portfolio not been protected by out of the money put options, I would have been decimated.  The hope with hedges is that you never need them, just as you hope you never need to make a claim on your homeowner's insurance.  Having the insurance in place, however, helps you sleep at night.

But having hedges in place helps in another big way.  The 1987-1988 period represented great longer-term investment opportunity.  Similarly, 2003, 2009, and 2011 were great times to buy stocks after those high volatility declines.  With world central banks continuing to pursue low interest rate policies and our own rate path likely to be mild, stable companies with attractive yields should be attractive longer-term investments.  You always want to be in a mindset where you have free cash to invest.  Bear markets offer the greatest risk, but also substantial rewards.  If your portfolio--and your life--are sufficiently diversified and hedged, you can treat periods of threat as future periods of opportunity. When experiencing a slow bleed, a tourniquet buys you time for a transfusion.

Further Reading:  Managing Your Money and Your Life

Saturday, September 12, 2015

The Big Mistake Traders Make

The big mistake traders make is labeling challenges as problems.  A challenge is a function of growth, pushing one's boundaries, becoming more than you presently are.  A problem is a shortcoming, a deficit, something to move past.

If you are never anxious, you are never pushing your boundaries.  Growth requires movement outside our comfort zones.  That brings uncertainty, nervousness, and doubt.  

The big mistake traders make is trying to eradicate uncertainty, nervousness, and doubt.  They want to trade with confidence and conviction.  They want to fearlessly pull the trigger.  So they stay in their comfort zones and they never grow and they never adapt to changing market conditions.

The trader who wants to develop embraces uncertainty, doubt, and fear.  Growth comes from mastering those, not erasing them.

The big mistake traders make is justifying stasis by calling it "sticking to a process", "controlling emotions", and "staying disciplined".  Every uncertainty is a challenge.  Every challenge is an opportunity for growth.  Mastering challenges means we continually evolve our processes and make growth our discipline.  

If you want to overcome a "problem", find the developmental challenge it brings to you.  Your problem is a gift.  Unwrap it.  Figure out how it will make you better.  Then tackle one small piece of the challenge and set yourself up for success.  Once you've gotten that under your belt, tackle the next piece, then the next.  Bryan was right: confidence comes from doing the things we fear, not from living a static life free of uncertainty.  

Further Reading:  Five Principles of Growth and Development

Tuesday, September 08, 2015

Trading Notes: Week of September 7th

Friday, September 11th

*  We're starting to see some expansion in the number of stocks registering fresh lows, with 213 new monthly highs and 305 new monthly lows across all exchanges.  The new highs is the lowest figure in the past three sessions; the new lows is the highest figure in the last three sessions.  I will be monitoring this closely, as it is consistent with a market that is topping and could test recent price lows.

*  I'm also watching crude oil and copper for indications of weakness, as those have been among commodities reflecting weakness in emerging markets.

*  I have one model that is modestly bearish and one that is neutral; both look 3-5 days out. We've seen some selling in rate-sensitive stocks; note the recent weakness in TLT (rise in rates).  I will be watching rates closely as we approach the Fed meeting; given the unusual degree of speculation about what the Fed will do, there could be quite a bit of volatility associated with that meeting.

Thursday, September 10th

*  Yesterday was a great example of an occasion in which cognitive flexibility is essential to trading.  Of course, one of the important ways we can stay cognitively flexible is by having many ideas or patterns that we're looking at, so that we can rapidly adjust to market conditions.  I had mixed indications going into the day's trade, with models neutral to slightly bearish and some indication of possible upside momentum over a several day period, per yesterday's post.  Once we opened, however, volume flows were decidedly negative and stayed that way for much of the session.  Because volume flow is a volume-weighted measure of upticks versus downticks for every stock, it captures the leaning of large traders to aggressively buy or sell shares.  Below is yesterday's chart for volume flow at 5-minute data points.  Monitoring cumulative NYSE TICK is also very helpful in this regard.

*  One thing we saw yesterday and again today's overnight market is that flows can shift greatly from one time zone to another.  I do not see high consistency of price action across Asian, European, and U.S. hours.  That has real implications for short-term traders.  We had a bounce in stocks in Asian hours today and recently sold back in the U.S. premarket.  Assuming trending behavior can be hazardous to our wealth.

*  My models are mixed, one modestly bullish, one modestly bearish.  Not a strong signal, so I'm happy to let the tape speak for itself.  I will be watching to see if we can stay above yesterday's lows on any early weakness in today's trading.  I'm also watching commodity markets per recent posts.   

Wednesday, September 9th

*  Buying weakness per yesterday's post turned out to be a winning strategy--much more than I anticipated, as stocks have rallied hard on the heels of strength in Japan.  This follow through suggests that equities are finding strong support, given perceptions that the Fed will not hike and other central banks are open to further QE.  My models are neutral to very modestly bearish; no strong signals.  A total of 340 SPX stocks registered fresh five-day highs versus lows yesterday.  I need to see evidence of weakness before entertaining trades to the downside.  Until then, my leaning remains to buy weakness that holds above overnight lows.

*  We're short-term overbought, with almost 90% of SPX stocks above their three- and five-day moving averages.  Note in the chart below, however, that my intermediate-term measure has moved off its lows and is not yet extended to the upside. If we can work off the short-term overbought situation more in time than price, I'd expect further upside.

*  An interesting momentum measure takes the difference between five-day new highs vs. lows among SPX stocks and compares that to the number of 20-day new highs vs. lows.  When the five-day highs/lows have exceeded the 20-day figure by more than 300 (N = 17 since 2010), the next three days in SPX have been 12 up, 5 down for an average gain of +.48%.  This pattern tends to catch short-term thrusts off relatively oversold conditions, which is what we have presently.

Tuesday, September 8th

A key to successful trading is also a key to living a successful life: diversification.  Trading many markets with an edge; trading many setups with edges; engaging in many positive life pursuits--all of these smooth out the personal as well as financial returns we generate in life.  Ironically, we're best positioned to take life's big bets when we have a host of smaller bets sustaining us.

*  We're trading smartly higher in premarket trade, continuing a range trade off the recent sell off lows. My new models, which focus on medium volatility markets, are modestly bullish.  My game plan for the day is buying weakness that holds above overnight lows; longer-term I lean toward a resolution of the range trade to the downside, testing those selloff lows a couple weeks back.  I won't be taking any short trades, however, unless the models point that way.

*  The new models reflect the short-term mean reversion patterns that are common in higher volatility markets.  Patience in buying dips and selling bounces should be rewarded on average.  I am carefully watching the percentages of stocks trading above their short-term moving averages, as well as the percentages of stocks giving buy vs. sell signals on traditional technical indicators. The former data can be found at the Index Indicators site; the latter is tracked via the Stock Charts site.

*  My pure volatility measure continues quite elevated, suggesting that we are in a different regime from the one that prevailed for much of 2015 and that volatility should continue in the near term.  I continue to watch commodities as indications of global economic weakness, particularly in EM. 

Monday, September 07, 2015

Lessons From Basketball: Trade Like a Free-Throw Shooter

Looking back on my years at Duke, it seems I remember the time in the gym as well as the time in the classroom.  Many life lessons are taught on the court, in practice and during games.  Seemingly little stuff, like having Coach pull a key player from a game because he didn't acknowledge the assist that led to his score or ending practice by having to make 10 consecutive free throws.  Nothing quite prepares you for pressure at the stripe as wanting desperately to get showered and get home and needing to make that 8th, 9th, and 10th free throw--knowing that, if you miss the tenth one, you start over again.

A while back I wrote about self-coaching and the process of shooting free throws.  Good free throw shooting is all about proper form, concentration, and repeating your stroke without variation.  The really good shooters at the line don't work on making foul shots in practice; they work on making the shots and not hitting the rim.  That's when you know your stroke is perfect.

What messes up free throw shooting is anything that messes with your concentration.  Thinking about how important the shot is at the end of a game.  Thinking about missing the last two you took.  Fatigue takes its toll both on concentration and shooting.  When you're winded, you make those subtle mistakes that ruin your stroke.  You don't extend after releasing the ball.  You don't take the extra moment to distribute your weight properly.  You don't stay focused on the front of the rim.  

A lot of traders trade as if they're in a basketball game, when in fact they should trade as if they're at the foul line.  In a basketball game, it's all about situational adaptation.  At Duke, Coach used to call out "ball - you - man".  That meant that you were always supposed to position yourself between the player who had the ball and the man you were guarding.  Deny the pass.  Sure, they could go over the top and lob the ball over you, but that's a lower percentage pass, a slower pass that can be intercepted.  If the ball is lobbed over you, the situational adaptation is that the defender nearest the player receiving the ball will "go helpside" and rotate over to defend.  Knowing when to defend your man, when to go helpside, when to go from "ball - you - man" to boxing out after a shot, when to break downcourt after a missed shot--it's all situational adaptation:  knowing what to do in a very fluid environment.  

That's what trading is like for many traders.  They try to make situational adaptations in the fluid environment and, all too often, they get winded, lose their concentration, and make boneheaded plays.  If the situation is more fluid than your adaptation, you fall behind in the game.

The trader who approaches trading like a free-throw shot is not trying to keep up with the flow of the game.  The free throw is not a highly dynamic situation; it's all about proper form and excellent execution.  The trader who trades like a shooter at the line has his or her "setups":  certain patterns that repeat reliably and that should be traded the same way, with great fidelity.  It's about making the shot, not winning a game.

Now in point of fact, for those who truly play the game, there *is* a dynamic element to foul shooting, just as there's a dynamic element to bowling.  Playing on one court is not like playing on another; that's why you take plenty of practice shots when you're the visiting team.  One ball differs from another--even a little change in the pressure of the ball can affect the rhythm of bouncing the ball and shooting, as well as the feel of the ball and the way it bounces on the rim.  Is the rim tight or loose?  It makes a difference when you don't quite achieve "nothing but net."  In bowling, lane conditions can be very different from one tournament to another; the court surface in basketball affects the dribbling and the feel of movement. 

And of course the free throw early in the game can be very different from the free throw in the last minute of the game.  The 1 and 1 free throw is not quite the same as having two chances when fouled in the act of shooting.  In bowling, the tenth frame differs from the first; one spare conversion is not like another.

So you have your standard setups and ways of trading those, but you're always adapting to the situation.  The trading setup is like a snowflake:  it has a patterned structure, but no one exactly replicates another.  The setup looks and feels different in a high volatility environment; in a highly trending environment; in a very slow market.  The trader who trades like a free-throw shooter is all about discipline and standardization, but also all about adaptation.

Most important of all, when you trade like a free-throw shooter, you make the market adapt to you; you don't try to trade all markets all the time.  You decide when you take your shots and when you stand back.  Like the poker player, you bet when you have an edge and you stand aside when you don't.  If you're trading like someone playing a basketball game, then you have to adapt to all market conditions all the time.  Do you really have an edge doing that, or do you simply end up overtrading?

The two variables you can always control in markets is when you play and how much you bet.  Many psychological problems in trading come from not making use of those two variables.

Further Reading:  Reinventing Yourself

Sunday, September 06, 2015

Taking a Fresh Look at Your Trading Performance

The recent post described the most important characteristic of successful traders, illustrating one important difference between what I call Trading Psychology 2.0 and the traditional understanding of the relationship between trading and psychology. 

Another distinguishing theme in the new trading psychology is a reflection of the new directions that psychology itself has taken in understanding the positive dimensions of personal experience.  This positive psychology movement emphasizes the importance of happiness, life satisfaction, relationships, and energy level in our quality of life, health, creativity, and productivity.  Much of the blog I write for Forbes is an application of positive psychology to the world of finance and business.

The old version of psychology started from the premise that people have problems and the role of the psychologist is to help people understand and overcome their problems.  This is so ingrained in psychology that professional psychologists need to identify people's problems with the use of a Diagnostic and Statistical Manual in order to qualify for insurance reimbursement.

The new, positive psychology begins with a very different premise.  Each of us possesses signature cognitive, emotional, and interpersonal strengths.  Our fulfillment and success in life is a function of the degree to which we operate within the zones of those strengths.  When a person does not live or perform optimally, it is not necessarily a sign of an underlying disorder or set of conflicts.  Rather, that person may be unaware of their strengths or unable to consistently access them.

This has important implications for trading.  It is not at all unusual for a trader, frustrated with losing money, to seek underlying causes for their trading woes: everything from self-esteem deficits to mood problems.  They focus on these alleged problems and find little benefit in their trading.  Becoming more self-focused doesn't help one become better market focused.

When a trader is losing, the important question from the perspective of the new psychology is:  Do you show objective evidence of aptitude as a trader?  If the answer is no, all the psychological exercises in the world will not substitute for talent and skill.  If the answer is yes, then the question becomes:  What is the source of that aptitude?  What strengths are you engaging that provides you with an edge in financial markets?  How do you best access those strengths under various market conditions?

In other words, instead of placing a sole focus on your trading mistakes, you are intensively studying your successes.  You want to understand--deeply--how you operate when you are at your best.  If you can reverse engineer your successes, you have an opportunity to crystallize those into best practices.  If you have best practices, you have an opportunity to weave those into best processes.  

The goal is not simply to solve your problems, but to help you understand and be more consistent with your successes.  

If every day, you focus on your troubles and coping with those, you'll internalize the sense of being a troubled trader.  If you start with the idea that sometimes you are a great trader, then your goal becomes a positive one:  to understand that great trader as best you can and become ever better at being that person you already are when you're at your best.

Further Reading:  Positive Principles of Performance

Saturday, September 05, 2015

The Single Most Important Trait of Successful Traders

Great to see that the new book will be coming out on the 28th of this month.  I titled it Trading Psychology 2.0, because I wanted to update the standard version of trading psychology, which I find increasingly limited.

Traditional trading psychology has begun with an important set of premises:  Human beings process information emotionally and often non-rationally in the face of risk, reward, and uncertainty.  These information processing biases lead to poor trading decisions.  The natural conclusion that follows from these assumptions is that successful trading requires emotional control, self-discipline, and adherence to a grounded process.

I don't dispute the above at all.  My problem is that, over the years, I have met with a number of very emotionally controlled, disciplined, and process-focused traders who have not been able to make money.  Mastering cognitive biases is necessary for success in markets, but I found it's not sufficient.

What I'm calling the 2.0 version of trading psychology begins with a different set of premises:  markets are ever-changing, such that patterns and relationships that yield profits in one time period (regime) may be spectacularly unsuccessful in another.  A good example from recent financial history has been the impact of quantitative easing on the trading of stocks.  QE resulted in a crushing of volatility in stocks and a transfer of flows from lower-yielding bonds to stocks that possess both yield and the prospect of higher returns.  When the end of QE and possibility of interest rate normalization comes to the fore (think taper tantrum and the recent prospect of a Fed hike), stocks have traded with far greater volatility and risk-off bias.

What has made recent trading challenging is that the stock market is not behaving in anything like the way it behaved for much of the past two years.  We see higher volatility and strong selling flows.  For all intents and purposes, the trader who trades stocks now and in the first half of 2015 might as well be trading different asset classes.  

As long-time readers are aware, I build non-linear regression models of short-term returns in SPX.  Typically these models predict returns over a 3-5 day horizon.  The recent model I built covers market periods displaying a medium level of volatility; the prior model covered market periods with low volatility.  The variables in the models are entirely different, and they have different predictive power.  One important difference is that short-term strength and weakness is more likely to reverse in the higher vol regime; more likely to show near-term continuation in the low vol, QE period.

Now if a trader starts with the traditional set of assumptions and strictly adheres to a particular process, that trader will get torched when markets change from choppy, low volatility range movement to high volatility decline.  If discipline is defined as sticking to a particular set of rules and practices, then discipline eventually sows the seeds for a failure of adaptation.  The trader who used to make consistent money and now cannot succeed has not suddenly morphed into an emotional basket case or a massively biased thinker.  Rather, that trader has failed to adapt to a changing set of market conditions.  It is often a trader's virtues--consistency and discipline--and not vices that create losses during periods of market flux.

This is why the single most important trait of traders who achieve career success is adaptability.  Adaptability does require discipline and self-control, but importantly it also requires self-awareness, market awareness, creativity, and flexibility.  Companies continued to churn out personal computers when laptops gained traction.  Companies continued to emphasize laptops when tablets became popular.  There will be companies pushing tablets when wearable computing devices become the rage.  All of those companies had fine processes and disciplined execution.  They simply failed to adapt to changing markets.

Do stocks trade with higher or lower correlation to one another?  Is that correlation waxing or waning?  Are we trading with higher or lower volume and volatility?  Is volume and volatility waxing or waning?  Do we show evidence of trending/momentum or reversal on short time frames?  Longer time frames?  Do we see signs of weakening breadth or strengthening breadth as we make successive price highs or lows?  Which sectors of the market are leading performance?  Lagging?  Is leadership stable or changing?  How are stocks correlated with other asset classes?  Is that correlation changing recently?  What do those cross-asset correlations and patterns of leadership tell us about the U.S. economy?  The global economy?  How are we responding to economic data releases and market movements overseas?  Is that pattern of response changing?  What are those patterns of response telling us?

When you ask those questions, you take the first step toward developing meta-processes:  processes for adapting your best practices to changing market conditions.  Trading is *not* like poker, chess, or athletics: the rules in typical games of skill do not change from one competition to another.  Trading is like business.  The business marketplace never stays still.  Success is not about finding a magic formula and slavishly adhering to it.  It's about staying flexible and finding new formulas under evolving conditions.  The faster the pace of change, the more creativity becomes the essence of discipline.

Further Reading:  Why You Should Keep A Journal