Sunday, December 04, 2016

This Stock Market is a Market of Stocks

The above chart of sector performance over the past three months from FinViz really is quite remarkable.  There have been big moves during this recent period, but the moves have been very different across the sectors.  If you have been long industrial conglomerates and commodity-related shares, you've likely done well.  If you have been long consumer staples shares, healthcare issues, or utilities, your returns have been significantly negative.

Here's another interesting perspective, courtesy of the excellent Index Indicators site.  As of Friday's close, we had 48% of SPX stocks trading above their three-day moving averages; 43% above their five- and ten-day averages; 58% above their 20-day averages; 60% above their 50-day averages; 54% above their 100-day averages; and 61% above their 200-day averages.  In other words, at every time frame, there have been a large proportion of stocks you could identify as weak or strong purely on a moving average basis.

In short, we've had less of a true stock market than a market of stocks.  

From a cycle perspective this is important, because the bull and bear phases of cycles are characterized by trend and momentum.  When we are in a true bull or bear market move, the tide tends to lift or lower all boats.  When markets spend significant time topping or bottoming, we see a meaningful degree of rotation, with the stronger and weaker sectors diverging in performance.  

It is not clear to me that the moves off the election evening lows represent a fresh bull market in stocks.  Yes, we did see significant share creation in the SPY ETF after the election; this has leveled off and even dipped a bit since mid-November.  And, yes, we did see an expansion of the number of stocks making fresh 52-week highs following the election.  That has leveled off in the past week, but interestingly 100-day new highs minus lows among the SPX stocks only hit 94 at their recent peak, below levels seen off the late June bottom.  Much of the breadth strength in the aggregate market numbers are a reflection of relative strength among small caps and mid caps.

As long as that aggregate breadth stays positive, with few shares actually registering fresh new lows, I don't expect any major near-term corrections or transition to bear market conditions.  When I see all ships not rising, however, I question the tide.  End of year performance dynamics for fast money participants have led markets to price in a significant degree of expectation for the new Presidential administration.  I am watching breadth statistics carefully to handicap the odds of continuation versus consolidation, and I'm carefully tracking the relative performance of the strongest and weakest sectors to determine the staying power of the post-election themes.

Further Reading:  The Momentum Curve

Saturday, December 03, 2016

Three Powerful Measures of Character

Character is more than personality.  Character reflects our deepest values and priorities and our most fundamental commitments.  When someone has a good personality, we might like that person.  When someone has a good character, we're likely to admire that person.

Here are three simple but powerful measures of character:

1)  How does the person spend his or her free time?  Per Ayn Rand's observation above, what does he or she do for enjoyment?  

2)  How does the person respond to your successes?  Many people are willing to commiserate with you when you're down and elevate themselves in the process.  A person of genuine goodwill celebrates your successes and is happy for your happiness.

3)  What strong beliefs does the person voice and live through their actions?  Character means standing for what you believe in and living your beliefs.  Go along and get along might be comfortable, but commitment is what powers effective action in the world.

Now apply the three criteria of character to yourself.  What do you do for enjoyment?  How do you respond to the successes of family members and colleagues?  If someone were to read your writings, hear your speech, and observe your actions, what would they conclude about your beliefs, values, and commitments?

Character is a magnet:  who we are determines who is drawn to us.

Further Reading:  Personality and Character in Trading

Friday, December 02, 2016

A Unique Measure of Stock Market Cycles

A rule that has held up well is that successful traders tend to look at unique data and look at common data in unique ways.  It's pretty difficult to distinguish ourselves from the herd if we're part of what the herd is looking at and listening to each day.  Some of the best traders I know view unique data uniquely.  That means they're looking at things others aren't.

Above we see an indicator created by tracking every stock listed on the NYSE and whether it is giving a buy signal, no signal, or a sell signal on the Parabolic SAR system created by Wilder.  The indicator, in red above, simply cumulates the buy signals minus the sell signals and keeps them as a running total, like an advance-decline line.  I scrape the raw data from the excellent Stock Charts site daily.   

The indicator provides a useful sense of overbought and oversold.  More to the point, when values have been in their strongest quartile since 2014, the next 20 days' return has been superior.  That's a momentum effect.  When the values have been in their weakest quartile, we've also seen a superior average return over a 20-day period.  That's a value effect.  The trajectory of the cumulative measure acts reflects the cyclical nature of market movement, with returns shifting between value and momentum at various phases of market cycles.

Note that we've shifted downward from a peak in the measure recently and have been heading lower, though are not yet near oversold territory.

Thinking of market movement in cycles has helped me frame when I expect prices to trend and when I expect mean reversion.  Tracking cyclical behavior over time has been useful in identifying longer-term market strength and weakness.  Perhaps most of all, having a cycle framework means understanding that no market move will last forever.  "This, too, shall pass" helps place many things in a useful life perspective.

Further Reading:  Volatility and the Dynamics of Market Cycles

Thursday, December 01, 2016

Developing Your Trading Playbook

Here's one you can take to the bank:  

The most successful traders can talk in detail about the patterns that they perceive in markets and how they have traded those patterns.  The patterns make sense to them and represent some manner in which markets are "offsides" and thus offer a favorable reward relative to risk.  

The least successful traders talk about catching moves in markets and are not focused on particular patterns or setups.  They let market movement define opportunity, rather than allow their definition of opportunity guide their involvement in the market.

In other words, the best traders, to use Mike Bellafiore's phrase, develop a playbook just like any football or basketball team.  The plays they practice are ones that make use of their strengths and that exploit weaknesses in the opponent.  The playbook defines opportunity set.

As a trading coach for developing traders, I can readily identify the traders on the right track.  The ones who are progressing talk about their playbook trades and how well they are exploiting their opportunity set.  They are getting better and better at running their plays and, every so often, they develop new plays as they see new patterns and fresh opportunity.  The ones who aren't progressing talk about their feelings, how they missed the last move, whether the market will go up or down, etc.  

What is your playbook:  the patterns that you see setting up and that make particular sense to you?  How well are you recognizing those patterns in real time and running your plays?  How well are you exploiting those patterns once you get into the plays?  What factors help you make the most of your plays?  Which interfere with pattern recognition and acting on your areas of opportunity?

Before you ever get good at trading, you'll become good with specific trades.  Grade yourself on how well you ran *your* plays.  Get better and better with your playbook and gradually add to it.  If your trading journal doesn't reflect your playbook, is it really going to help you play the game better?

Further Reading:  Training Yourself in Pattern Recognition

Wednesday, November 30, 2016

Trading Model and Market Update

Here's an update of the multivariate trading model I keep for SPY.  A number of variables go into the ensemble model, including buying pressure, selling pressure, breadth, sentiment, and volatility.  Readings of +3 or greater and -3 or less have had particularly good track records in and out of sample, anticipating price change 5-10 days out.  Note that we hit a -3 reading on Friday; prior to that we saw +3 readings shortly before and after the election.

Thus far, we are not seeing significant breadth deterioration in stocks.  For ten consecutive sessions, we have had fewer than 200 stocks across all exchanges register fresh monthly low prices.  This breadth strength generally occurs in momentum markets; weakening of breadth--particularly an expansion in the number of issues making fresh lows--tends to precede market corrections.  It is not at all unusual for momentum markets to correct more in time than price.  We've seen selling pressure the past two sessions, but not significant price deterioration.  This dynamic allows momentum markets to stay "overbought" for a prolonged period as price consolidates and often grinds higher.

Further Reading:  Previous Model Update

Tuesday, November 29, 2016

Working on Our Trading by Working on Ourselves

The recent post emphasized pattern recognition as a core trading skill.  That same skill is key to trading psychology.

One of Freud's central insights was that of the "repetition compulsion":  the idea that we unconsciously repeat patterns in our lives, often with negative consequences.  Change in therapy occurs when we become aware of our patterns and are able to interrupt and change those.  The different approaches to helping--psychoanalytic, behavioral, cognitive, family systems, solution-focused--are simply different ways of understanding and changing the patterns we unwittingly relive.

One trader I worked with never felt fully accepted and valued by his parents.  He was compared with his brothers and often found wanting.  He latched onto trading as a way of making a name for himself and becoming wealthy and successful.  Each time he lost money in the market, he experienced the loss as something more than the dollars and cents.  The losses felt like confirmation that he really was inadequate.  With his self-esteem riding on each trade, he found it difficult to make sound decisions.  He took profits quickly to regain the feeling of winning and took losses very reluctantly, unwittingly repeating those mistakes.

When we track our trading mistakes--and our trading psychology--in journals, we can often detect patterns that sabotage our profitability.  This is particularly the case when the same emotions crop up in trading situations, such as frustration, depression, or overconfidence.  Once we become aware of those patterns, we can begin to identify triggers that set us off.  That enables us to anticipate the patterns and rechannel our emotions and actions.  The trader I worked with learned to take breaks after losses and process his self-talk at those times.  Gradually he learned to separate his self-worth talk from his trading talk, allowing him to accept losses without experiencing himself as a loser.

It all starts with self-awareness.  We can't change a pattern if we're not aware of it.  When we become observers to our patterns, we are no longer immersed in those patterns.  As observers we can control those patterns and ensure they don't control us.  If you're experiencing repeated emotions and self-talk during your trading, the chances are great that there's a life pattern controlling you.  Market mastery and self mastery go hand in hand; working on ourselves can be the best way of working on our trading.

Further Reading:  How to Break Negative Trading Patterns

Monday, November 28, 2016

Growing Your Pattern Recognition as a Trader

A concept central to trading is that of pattern and pattern recognition.  Different approaches to trading frame patterns differently, but all focus upon relationships that are deemed to be meaningful.  After all, any particular configuration among market elements can occur and reoccur through random happenstance.  It is when patterns happen for understandable reasons that we find them meaningful.  We may or may not be able to predict when that pattern will occur next, but that is not necessary for successful trading.  If we become very sensitive to meaningful patterns and their myriad expressions, we can identify their occurrence as they unfold.  A psychologist, for instance, might not be able to predict when a patient will next experience a depressive episode, but can become highly attuned to occasions in which depression is starting to set in.  Similarly, when couples make progress in their counseling, they can recognize patterns to their arguments and circumvent those by doing something more constructive.

Many active traders look at a very limited number of markets--often, only those that they are trading or thinking of trading--and so they miss important patterns that occur *among* markets.  These intermarket relationships often reflect macroeconomic factors that are driving the participation of large market players.  Recognizing when those relationships are waxing and waning can provide important clues as to whether particular market moves are likely to continue.

I've been reading a large--and excellent--book from John Netto called The Global Macro Edge.  It touches upon a number of worthwhile ideas, including the importance of viewing performance (one's own and those of markets) in risk-adjusted terms.  One idea I particularly liked was the ongoing tracking of correlations in the price movements among markets as a way of identifying market regimes and shifts in those regimes.  The same concept is valuable in tracking correlations of moves among equity sectors.  When we see dramatic changes in correlations, those patterns can alert us to the emergence of important themes that are driving market action.  For example, after the recent election, we saw dramatic co-movement among equity sectors (industrials and financials versus higher yielding sectors) and markets (US dollar, rates, developed markets versus emerging ones).  New flows were coming into markets, and the patterns of correlations alerted us to the drivers of those flows.  

Let's combine two of Netto's ideas and imagine a situation in which your dashboard is tracking the risk-adjusted returns of different markets (a way of tracking quality of trend behavior) *and* the correlations among markets.  The combination would tell you when shifting correlations are manifesting themselves as growing trends.  That would be sweet for trend-following macro traders.  It would also provide useful alerts as to when markets are becoming choppy and less patterned.  After all, it's the pattern of patterns that ultimately defines the opportunity set for traders.

Further Reading:  The Greatest Mistake Losing Traders Make

Sunday, November 27, 2016

Hemoencephalography, Creativity, and the Trading Zone

Imagine a child diagnosed with attention deficit disorder (ADD).  Unable to sustain concentration, ADD impairs school performance, but also interferes with social life.  Lowered attention often brings diminished impulse control and unwanted consequences in relationships.  Our child, depicted above, is connected to a biofeedback unit that measures small changes in forehead skin temperature that reflect activation of the brain's executive center, our prefrontal cortex.  This hemoencephalography feedback controls a movie watched on the computer screen.  When the child's emotions are engaged by the movie and the forehead temperature drops as a result, the movie stops.  To continue playing the movie, the child must sustain a neutral, quiet focus.  Over time, the child learns to keep the movie going, building the capacity to flexibly shift between emotional, limbic processing and frontal, executive processing.

Why is this important?  As Kotler notes, heightened concentration and absorption in activity is a gateway to the flow state, the state we know as being "in the zone".  He observes an interesting relationship between flow state and creativity:  in flow, we have heightened focus, but diminished self-focus.  In other words, we turn off our self-critical, self-conscious activities and instead lose ourselves in what we are doing.  If our child became frustrated with the movie turning off, for example, and criticized himself for not being able to keep it going, the movie would remain paused.  Only an absorbed, calm, neutral focus on the movie can make the movie move.

I first encountered hemoencephalography (HEG) feedback when I heard of Dr. Jeffrey Carmen's work with migraine patients.  Interestingly, shifting blood flow patterns is significantly helpful in controlling migraines.  That same technology was helping children with ADD and, I later learned, was helpful in helping autistic children with their executive functioningAs I wrote on this blog, this raised the possibility that HEG feedback could similarly train traders for enhanced attention and self-control, minimizing distractions and impulsive overtrading.

Kotler's observations go one step further.  The zone not only brings greater self-control, but also higher levels of creativity.  When we are in a state of enhanced awareness of our world, we perceive the world in new ways.  Patterns and relationships in markets that we would miss when we are self-focused and frustrated with P/L jump out at us when we've quieted the self-critic and redoubled our market focus.  I recently wrote on the topic of creativity as a form of play.  When we witness children hard at play, we see them immersed--operating in a zone.  To play deeply, we both focus and relaxIt is this calm focus that appears to lie at the heart of creative synthesis.

If we can enhance the cognitive functioning of children with ADD and autism, can we take the normal cognitive functioning of professionals and turn it into an enhanced capacity to operate within the zone?  Can we become more flexible in our emotional and cognitive processing, thereby performing with greater self-control and creativity?  This remains truly frontier territory for trading psychology.

Further Reading:  How to Cultivate Our Creativity

Note:  Thanks to Dr. Jeffrey Carmen for pointing out errors in the original version of this post, which I have endeavored to correct 

Saturday, November 26, 2016

Trading Market Flows by Sustaining the Flow State

The flow state is one in which we become highly absorbed in our activities, losing a sense of time and experiencing deep pleasure.  A great example of flow comes from the drumming movie mentioned in the previous post.  The drumming greats are not explicitly thinking about what they are doing, what they should do, or what they should have done.  The skill is flowing through them, and they are performing in a profoundly fulfilling zone.

The capacity for operating within a flow state is one that can be developed.  Indeed, we can look at deliberate practice as a training ground for flow.  As we tackle one challenge after another, we also extend our capacity to sustain the flow state.  Flow requires an ability to operate outside our comfort zones, but our limits of willpower make it difficult to stay outside our sphere of comfort.  A fascinating study by Judith Lefevre found that people experience flow more often in work than in leisure, and yet they are more motivated to seek leisure than work.  She notes:

"It is possible that the higher levels of concentration and activation in flow cannot be tolerated by most people for extended periods of time.  In making the choice to spend their leisure time in the low challenge, low-skill context rather than flow, the workers may be indicating their preference to rest from the demands of work, even at the cost of an overall reduction in the quality of experience."  p. 317

If the research on flow is correct, then much of traditional trading psychology is wrong.  The elite athlete, drummer, or chess player does not achieve flow by controlling emotions, imposing discipline, or basking in awareness of their feelings.  Rather, flow is achieved by shifting to an entirely different state of consciousness, not by rearranging the components of normal consciousness.  That different state requires sustained, relaxed focus and immersion in experience.  That shift of state is one in which we experience ourselves and the world differently.  It's also one in which we become sensitive to patterns in the world around us.  A wonderful portion of the drumming movie pans to the lake surrounding the camp and the sounds of the insects and lapping water.  It is impossible to not hear a poly-rhythmic drumming in the sounds of nature--something we would have never apprehended prior to watching the film.

 It is in this context that Campbell's observation is profound:  when we follow the bliss of operating within the zone, doors open to seeing the world in new ways.  Patterns that are hidden to us in normal, distracted consciousness pop out when we in a flow state.  In our normal state, we try to perform well; in the zone, performance flows through us.

Are you trying to correct your mistakes while you're trading?  Are you trying to avoid poor trading practices?  If so, you're trading in a flaw state, not a flow state.  Flow requires a loss of self-awareness; not thinking positively or negatively about ourselves, our P/L, or our performance.  

One of the greatest dilemmas we face as traders is that we benefit from following our bliss, but we are limited in our capacity to sustain bliss.  It may well be the case that the greatest value of preparation for trading and review of trading is the exercise of the capacity for relaxed concentration.  In building our capacity for flow, we cultivate the state of consciousness in which we're most sensitive to the flows of markets.

Further Reading::  Why It's Important to Go With the Flow State

Friday, November 25, 2016

Drumming, Trading, and Greatness of Performance

Thanks to an unusually creative and savvy trader for recommending the movie "A Drummer's Dream".  The movie, available via Netflix, takes place at a camp for young drummers in Canada.  The instructors at the camp are some of the world's most talented drummers.  The movie interviews the drummers and shows them in action, both as performers and teachers.

A few fascinating takeaways from the movie:

Many of the drumming greats started at an early age and practiced intensively, reaching a high level of talent early in life.  Watching someone like Mike Mangini, it's clear, per the Seykota quote in Market Wizards, he doesn't have talent; the talent has him.

Several of the drummers talk about being in a zone when they are performing at their best.  They also talk about drumming as fun.  There is an exuberance to their performance that suggests that immersing oneself in the fun of exercising a talent is essential to reaching and staying in that zone.

The learning process for the young drummers was one of observing the greats in action, having the great drummers explain and model techniques, copying those techniques under the watchful eye of the instructors, and repeating skills until they are familiar.  

There is an unusual bond among the drumming legends based upon respect for one another and a sharing of a common passion.  Many of the legends have performed with one another and value that collaboration.

Now think about the learning process for most traders:

*  Do most traders begin early in life and engage in intensive deliberate practice before actually performing in real life settings?

*  Do most traders find a zone of performance based upon love of what they do or does P/L emphasis and pressure make that zone difficult to find?

*  Do most traders truly learn by observing and copying masters and intensively repeating techniques and skills?

*  Do most traders find a collaborative bond with peers and mentors that sustains their passion and learning?

It is not surprising that there is a very high failure rate among new traders.  What other field features people trying to make a living from performance before they've truly learned how to perform?  How many traders, per Lionel Hampton, experience their work as a path to the divine?

Further Reading:  What It Takes to Trade in the Zone