Monday, July 06, 2015

New Trading Views For A New Trading Week

*  After a considerable period of tepid new highs vs. lows among NYSE shares (data from the excellent Index Indicators site), we've recently seen an expansion of the number of stocks registering fresh three-month lows.  I will be tracking this closely to see if what is already oversold breadth exhibits further deterioration in the wake of problems in Europe and China.

*  Why do smart people do dumb things in markets?  This post takes a fresh look at a perplexing problem for traders--and how it can be overcome.

Interesting series on mindfulness in trading from Bruce Bower at SMB.

Perspectives on volatility and more from See It Market.

*  New Trader U suggests several valuable screening tools for traders.

*  Questioning the 200 day MA and more views from Abnormal Returns.

*  A stock/bond trading strategy and more from Quantocracy.

Have a great start to the week!


Sunday, July 05, 2015

Trading Success: What It Means to be Process Driven

We often hear that traders, to be successful, should "follow their process."  But what really goes into trading processes?  The recent post described a few common elements of successful trading.  One of those was selectivity.  Faced with an infinite number of possible trades and times to trade, even the active trader must find some way of filtering out the majority of possibilities and focusing on the smaller number that offer distinctive opportunity.

How does such selectivity work?  I would argue that every successful trader and portfolio manager filters trades by three criteria:

1)  An Idea - The trading idea expresses the underlying logic of the trade.  It is what gives the trade a potential positive expected return.  The idea could be that risk assets will rise when the rate of change among a host of macroeconomic indicators is positive; the idea could also be that a company's shares will fall if they experience a parabolic rise because of promotion not grounded in fundamentals.  The trading idea defines the field of opportunity.

2)  An Expression - Any trading idea can be expressed in a variety of ways, and those expressions ultimately determine the risk/reward of the trade.  For example, daytraders might run several scans of stocks in the premarket to identify promising "pump and dump" candidates.  Portfolio managers might express a view in currencies, equities, and/or rates, depending upon the positioning in those assets and how they might fit together in a portfolio.  An expression could be in options, in a relative value trade, or in an outright long or short cash position.  Each brings different risks, different rewards.

3)  An Implementation - To a surprising degree, the way in which a trade expression is implemented impacts its ultimate profitability.  Two traders could have the same trading idea and decide to express it with a long stocks trade.  One trader predicates entry execution on strength, buying when there is upside price confirmation and then adding to the position on strength.  Another predicates entry execution on weakness, buying pullbacks in price and scaling out on strength.  The profitability curves for the two traders over time will look radically different.  Indeed, for the ES futures, the former implementation strategy could have easily led to flat to negative returns even in the recent bull market!  Placement of stops, sizing of trades--all of these greatly impact trading outcomes.

I would propose that a truly process-driven trader has studied each of the three areas above, so that all three contribute to an overall trading edge.  The process-driven trader should be able to justify the trade on all three criteria, and the process-driven trader should be able to review performance across the criteria to determine where improvements can be made.  There is much more to profitable trading than arriving at good ideas, and there is much trading of randomness in the place of good ideas.  Not all who follow routines are process-driven.

There are also psychological processes underlying success across performance domains.  Further Reading:  Feeding Your Head And Developing Your Self

Saturday, July 04, 2015

What Successful Traders Do

I recently wrote a foreword for a very interesting book of interviews with successful daytraders that will be coming out shortly.  Among the excellent contributors were @modernrock, @OzarkTrades, @InvestorsLive, @lx21, @offshorehunters, @elkwood66, @kroyrunner89, @DerrickJLeon, @johnwelshtrades, and @TomKellyLV, Although my trading is different from theirs--and theirs is quite different from that of portfolio managers I work with--I notice three broad areas of overlap.  These seem to be common elements of what makes traders successful:

1)  Resilience - Successful traders take risk.  Successful traders are sometimes wrong.  Successful traders take hits.  Successful traders learn from the hits, get up, and move on.  They are resilient.  They succeed, as Churchill observes, by moving from failure to failure with enthusiasm.

2)  Selectivity - Successful traders have clear criteria for what makes good trade ideas.  They also have separate criteria for what turns good ideas into good trades.  They don't watch everything, and they certainly don't trade everything.  They wait for good ideas to become good trades.

3)  Calling - Successful traders have an uncanny sense that this is what they're meant to be doing.  It's not a job, and it's not a career for them.  It's a calling.  That's the only thing that can keep people searching and re-searching, banging away for good ideas and good trades.  And it's the only thing that enables them to gain the immersive pattern recognition experience that separates them from average traders.

To be sure, there are other success ingredients, from discipline to creativity.  What I see among the traders listed above, as well as those I work with, is an unusual combination of these three factors.  It's a pleasure and a true education to study successful people.  There is much more to success than avoiding failure.

Further Reading:  The Real Source of Trading Success

Wednesday, July 01, 2015

Going On A Healthy Psychological Diet

It's good advice:  the right foods can be the right medicine.  I recently met with someone who was experiencing feelings of depression and a loss of energy.  Those, in turn, affected his concentration and that interfered with his trading.  It turned out that he had gained significant weight.  His weight gain influenced his sleep quality, as he began snoring and experiencing interruptions of sleep (apnea).  The disrupted sleep prevented him from entering the deeper, restorative stages of sleep, which left him tired and run down by the morning.  On the advice of his physician, he changed his diet, lost weight, stopped snoring, slept better, and regained his energy and concentration.  Had he resorted to sleeping pills and antidepressant medications instead of diet, he could have compounded his problems.

In the recent Forbes article, I make the case for a different kind of diet.  Our daily experience is what we process each day, and that is what we internalize--for better or for worse.  The work we perform, the people we interact with, the activities we engage in: that provides our psychological diet.  What we do in life and who we do it with shapes our experience--and our experience shapes how we view ourselves.  I recently spoke with a young trader who aspired to doing great things in markets.  My first questions asked about the great things he was doing each day.  Can we really expect extraordinary results from a series of ordinary days?

Ask yourself to define the ideal you:  how you would like to be as a person, as a romantic partner, as a trader.  Then identify those specific things in your daily diet of experience that will lead you to move consistently toward those ideals.  If you're not progressing toward your goals and find yourself dreaming of ideals but not achieving them, perhaps it's time for a diet.

Further Reading:  Role Modeling and Mirrors

Monday, June 29, 2015

Money Flows and Other Views for the Market Week

*  Above we see the SPY ETF (blue line) plotted against the money flows into the SPY ETF.  Note that we've seen prolonged outflows from SPY since the start of the year.  That has corresponded with a period of prolonged sector rotation.  Year-to-date, for example, the healthcare sector is up over 13% and consumer goods shares are up 6.6%, while materials stocks are down 1.7%, conglomerates are down 5.3% and utilities are down 8%.  (Data from FinViz).  Interestingly, flows have recently turned higher in SPY, even as we're seeing turmoil abroad.  With uncertainty in China and Europe, I'm open to the thesis that U.S. stocks could become an increasing safe haven both because of relative growth and relative yield.  If that's the case, those money flows should grow and the SPY chart would start to look quite different.

*  If there's a theme that has run through this blog and the books I've written, it's that we develop, not by changing who we are, but by understanding our strengths and leveraging those.  If you want to become a better trader, study the hell out of your best trading.

*  BIS notes that we're less prepared for future financial crises, with rates running out of room to the downside.   

Great post from Ryan Detrick on how data lookback periods can be manipulated to give either bearish or bullish forecasts.

*  Most hated stocks and other top views for the week from Abnormal Returns.

Top quant links from Quantocracy, including the derivation of a promising losing streak indicator.

*  SMB Trading on why it can be a problem to bump up your risk-taking too quickly.

Have a great start to the week!


Sunday, June 28, 2015

Solving Your Trading Problems by Finding Your Trading Solutions

In a recent blog for Forbes, I described the essence of a solution-focused approach to trading:  studying your own successes.  As da Vinci's quote suggests, it's not just dry, academic study, but study with desire:  the desire to know what makes you the best you can be.

Here's an interesting observation:  

When I ask traders to tell me what they do wrong in their trading to make them lose money, most can name a variety of mistakes they make.  They talk about chasing trades and getting in at bad levels; they describe sizing positions too large or small; etc.  When I ask traders to tell me what they do best in their trading that leads them to make money, most offer vague generalizations or simply say that they don't make the losing mistakes.

Even more to the point, if I ask most traders to map out a detailed flow chart of their best trading, starting with the gathering of information and generation of ideas to the structuring of trades, management of risk, and the trader's own self-management, in the vast majority of cases it would be a difficult task.  The result would be a sparse flow chart. 

Now imagine that I give that same exercise to an executive at a successful company.  You can rest assured that there would be no problem generating a flow chart describing how raw materials are assembled into a product; how the product is packaged and delivered; how the product is marketed; how sales are tracked; how product changes are made; etc.  

The idiot trader has no sense of process.  It's all seat of the pants and randomness.  The enlightened idiot trader talks about "following my process", but cannot produce a detailed flow chart of what they do and why they do it.  That is because, for the enlightened idiot, process is merely a code word for engaging in some general routines.

Successful businesses don't "follow their process."  Successful businesses understand that they have many interlocking processes, and their quality management tracks both those processes and their successful coordination.  

An important question:  If you started a business in your community and managed it with the same rigor as you apply to your trading, how successful would that business be?   

Consider the expert baseball pitcher watching game films.  He will focus on the mechanics of each phase of his delivery.  He will study his pitch selection and the execution of each kind of pitch.  He will examine his pitching accuracy and the factors responsible for achieving good and poor location.  He will study the best way of pitching to specific batters and exploiting their weaknesses and avoiding their strengths.  That is study with desire:  the desire to dig and dig and dig and understand the drivers of superlative performance.

The idiot trader keeps no journal and has no structure to his or her reflection.  The enlightened idiot trader keeps a journal and writes down all of his or her mistakes and frustrations, but never transforms those observations into concrete goals, plans, and commitments for change.  An expert business knows its best practices, turns those into robust processes, and tracks them religiously.  

As the Forbes article emphasizes, an exclusive focus on what you do wrong will, over time, help you internalize the identity of a wrongdoer.  In studying your successes and turning those into solutions that anchor best practices, you reinforce an inner sense of achievement.  There are no lifetime accomplishments that do not begin with daily achievements.  Many, many times the answers to our trading problems lie in what we're doing when those problems are not occurring.  The first step in becoming a better trader is understanding how we currently trade when we trade at our best.

Further Reading:  Solution-Focused Performance

Saturday, June 27, 2015

Role Modeling: The Power of the Mirror Principle

Think of parenting.  Think of apprenticeships in the trades.  Think of training to be a professional in medicine.  All are developmental processes, and all facilitate development through a combination of teaching and role modeling.  Development occurs through learning, but learning is internalized through role modeling.  This is the flaw of many "education" efforts in trading.  They attempt to facilitate the development of the trader by teaching.  That creates an informed person, but it doesn't create a successful trader.  The latter requires role modeling--an internalization of what has been taught.

A model in mathematics or physics is an approximation of the reality we're trying to understand and predict.  A scientific theory, at the end of the day, is a model of reality.  A role model is our theory of the reality we hope to achieve; it is a model of our desired reality.  In studying a role model, immersing ourselves in the model, and imitating the model, we make that desired reality part of our reality.

The mirror principle suggests that we internalize our life experience.  Who we spend time with, where we spend our time, and how we spend our time all become parts of our internal worlds.  We see ourselves in life's mirrors, and our day to day activities comprise our mirrors.  Look at what you're doing in your life; look at who you're spending time with:  that's what will be inside your head, and that's what will drive your heart.

When we seek role models, we seek to replace ordinary life mirrors with positive, inspiring ones.  If you're not focused on heroes and heroines, you will not experience yourself as heroic.  If your mirrors don't reflect greatness, you will not experience yourself greatly.  There is no superlative achievement in the absence of extraordinary mirrors.  

Who are the role models that bring out the heroic in you?  For whom are you a role model?  If you understand the mirror principle, you will recognize that serving as a role model for others is the best way of consistently accessing the best within you.

Further Reading:  Living In Tomorrow By Fighting For It Today

Monday, June 22, 2015

Appreciative Inquiry and More Views to Kick Off the Market Week

*  Above we see the number of stocks listed on the NYSE that are giving buy signals minus sell signals for the ADX indicator (raw data from Stock Charts).  The number of buy signals correlate with the number of sell signals by -.52.  That's significant to be sure, as we'd expect, but is far from a perfect negative correlation.  Indeed, when we look at buy signals vs. sell signals independently, it's the number of buy signals that ends up having the greatest relevance for short-term price movement.  Specifically, when the number of buy signals is in its lowest quartile, the next two days in SPY average a healthy gain of +.46%.  All other occasions average a next two-day loss of -.07%.  It's been when we've had the least strength that swing returns have been most favorable.  Summing buy and sell signals across technical systems for all stocks has been a useful way of tracking strength and weakness in the broad stock market.

What is appreciative inquiry and why is it crucial to your development as a trader?

The complicated world of social security payouts.  Consistently excellent perspectives from The Mathematical Investor.

*  A simple portfolio that has ridden recent trends quite well and other excellent perspectives from Abnormal Returns.

Applying a moving average trading system to your returns rather than to price itself appears to bring some performance benefits.

Very useful overview of economic data and more from A Dash of Insight. 

Favorite reads from Steve Burns and New Trader U.

Have an excellent week!


Saturday, June 20, 2015

Momentum, Value, and Short-Term Movement in the Stock Market

Above is a plot of an interesting measure that tracks the difference between short term and intermediate term new highs minus new lows for SPX stocks only.  (Raw data from the Index Indicators site).  When that difference is highly positive, it means that there has been a short-term rally from relatively oversold intermediate term conditions.  When that difference is highly negative, it means that there has been a short-term plunge from more overbought conditions.  This measure is another way of capturing what I call a Momentum Curve, which is the relationship between strength and weakness across multiple time frames.  

Since the start of 2014, when the high-low difference has been in its most positive quartile, the next five days in SPX have averaged a gain of +.33%.  When the high-low difference has been in its most negative quartile, the next five days in SPX have averaged a gain of +.47%.  Across the two middle quartiles, when the momentum curve is neither positively or negatively skewed, the next five-day change in SPX has been essentially flat.  

What the momentum curve captures are short-term momentum and value effects in the equity index.  These, in turn, reflect the dynamics of intermediate-term cycles in markets and the interplay of volatility, correlation, and directional price movement.  Knowing where you're at in a market cycle is quite valuable in harvesting momentum (price continuation) and value (price reversal) effects in the market.  Essentially all of the market gains over the past year and a half can be attributed to momentum and value factors. 

Further Reading:  The Psychology of Quantitative Analysis

Wednesday, June 17, 2015

A Quick Look at Sentiment in the Stock Market

I find it interesting--and surprising--that the five-day equity put/call ratio is hovering at its lowest level since the start of 2014.  Amidst concerns about rate hikes and Greece, traders of individual stocks don't seem particularly bearish on their names.  Breadth also continues mixed, as we had 594 stocks across all exchanges make fresh monthly highs and 530 register new monthly lows.

When the five-day equity put/call ratio has been in its highest quartile going back to 2012, the next three days in SPX have averaged a gain of +.55%.  When the five-day ratio has been in its lowest quartile, the next three days have averaged a gain of only +.03%.  In general, we've made the best returns when traders have been most bearish on individual stocks, and that isn't happening at present.

Further Reading:  Reassessing Trading Strengths and Weaknesses