Sunday, October 04, 2015

Here's A Macro Trend Not Enough Traders Are Focusing Upon

I've long thought that financial markets are master magicians.  They get you looking at the one hand that's waving around, while the real magic is being performed with the other hand.  There have been a lot of waving hands in 2015, including the U.S. dollar and rates, stocks, and assets in China and emerging markets.  All that hand waving has led some investors and traders to lament an absence of clear themes and trends in macro markets.

Meanwhile, real magic can be found in the trends depicted above.  The top chart is a weekly chart of the WIP ETF, which tracks the prices of international inflation protection bonds.  The middle chart is a weekly depiction of the JNK ETF, which tracks the prices of high-yield bonds.  The bottom chart is of the EMB ETF and takes a weekly look at the prices of emerging market bonds.

Since the middle of 2014, these have been in a steady decline.  We are seeing global deflationary forces, with higher quality debt significantly outperforming lower quality debt.  In short, there is too little growth and too much debt globally.  Per the charts above, markets continue to price in continued deflation and continued concerns with the sustainability of debt.  

Now this is the point where the blog writer is supposed to trot out the uber-bearish scenario and headline the piece with a dire warning that will attract the eyeballs in cyberspace.  I strongly suspect, however, that the perma-bear thesis is yet another hand wave of the magician.  Here's what I'm watching in the magician's other hand:

1)  Quality - There are too many baby-boomers still out there needing to protect their capital.  Many have been reaching for yield and seeking returns in stocks.  Stocks have been a mixed blessing: strong if you've been in consumer-related sectors, weak if you've been in commodity-related shares; stronger if you've been in developed market stocks, weaker if you've emphasized emerging markets.  Those of us old enough to recall the "Nifty Fifty" know what it's like when a market reaches for quality:  large, stable companies with decent dividends and growth and little debt.  If the trends depicted in the charts above continue, it's not difficult to imagine a "boring is good" mindset among investors:  own stable, quality stuff that won't interfere with your sleep.

2)  Volatility - Some debt will not be sustainable and continued deflationary forces will weigh on global growth.  That could lead us far from the low volatility markets we've enjoyed under global regimes of quantitative easing.  The smart money managers I know express concern for the liquidity of many assets.  With investment banks no longer as active as counterparties that can warehouse risk, we are increasingly vulnerable to shocks.  That's an environment in which you want to own negative tails and be long volatility.  Predicating trading and investment strategies on the kinds of markets we've had from 2012 to mid-2014 has not worked well of late.  It's not difficult to imagine that the recent discussion of Fed hiking will look quaint in 2016.

If all this is correct, a tipping point might come when central banks continue their easing but no longer can produce the low volatility shift from bonds to stocks that we saw from 2012 to recently.  In other words, deflation dynamics would outweigh QE dynamics across assets.  In such an environment, the reach for yield would be replaced by a reach for stability.  For those not prepared, that could look suspiciously like black magic.

Further Reading:  Why Traders Succeed and Fail in Financial Markets

Saturday, October 03, 2015

Taking Intelligent Risks: How To Stay In The Trading Game

You have to risk money to make money.  You have to make sure you don't risk so much money that you can lose your stake and go out of business as a trader.  Bet too little and you never make a good return on your capital.  Bet too much and you court career risks.  So much of trading success boils down to taking intelligent risks.

Here is a useful calculation tool that can tell you the probability of hitting a drawdown threshold.  

Let's say you have $1,000,000 in your trading account, you place roughly two trades per day (500 trades/year), and you're willing to lose $200,000 of your capital before you shut down.  Your win rate is 50% and the average size of your winners is 30% larger than your losers.  You're willing to lose 1% of your capital ($10,000) per trade.  The odds of your hitting your downside limit--even with that edge--is 8.6%.

Suppose you cut your trades in half and can take only the best trades, those in which winners are 50% larger than losers.  All else being the same as above, you now have only a 0.4% chance of hitting that downside barrier.

Alternatively, lets say you overtrade and place 1000 trades in a year and now your average winner is only 10% larger than your average loser.  You now have nearly a 64% chance of tapping out.

The challenge, of course, is that markets change and our hit rates and relative sizes of winning and losing trades vary over time.  To stay in business, you want to plan your risk taking around conservative estimates of performance, not the most optimistic ones.  By studying your historical performance, you can see how you trade at your worst and ensure that in any repeat scenarios you'll stay in business.  

In my own trading, I keep daily loss limits to 0.5% of capital and I'm willing to lose 10% of my total capital before tapping out.  If I were to place one trade per day and lose my edge entirely (50% hit rate; average win same as average loss), I would have a 35% chance of hitting my stop out level.  If I place one trade per week, the odds drop to 0.4% probability of tapping out.  A huge part of risk management comes from selectivity in trading:  by taking the very best setups, maximizing odds of success, and taking fewer trades, we can ensure that we stay in the game--even if our edge leaves us for a time.

This is why overtrading is so deadly.  It increases the probability that we'll have a streak of losers that knock us out of the game.  The eye-opening reality is that most traders could cut their total number of trades in half or even more, size up those best trades, retain the lion's share of their profitability, and keep their drawdowns modest.

We win the game and stay in the game not with low risk taking or with high risk taking, but with smart risk taking.

Further Reading:  Risk Intelligence

Friday, October 02, 2015

Two Great October Opportunities For Learning

There is a great deal to be said for breadth of learning and depth of learning.  Both enable us to see interrelationships that aren't readily apparent--and it's in those interrelationships that "edges" are to be found in financial markets.

Here are two upcoming conference events where I'll be presenting on topics that relevant to trading edge:

*  October 18 -20th: Stocktoberfest - "Investing for profit and joy" is the idea behind Stocktoberfest, and the program in Coronado, outside San Diego, promises just that.  The breadth of speakers is truly unusual and outstanding for a trader event, with topics ranging from global macro opportunities and social sentiment to Bitcoin.  I'll be talking about how traders can create their own training routines that build core skills, such as concentration, problem solving, creativity, and positive mindset.  Every day, knowingly or not, we are training ourselves and establishing habit patterns.  We want to make sure we're training ourselves intentionally, with the right patterns.  Stocktoberfest should be a great opportunity to meet a wide range of market participants in a beautiful setting.

*  October 28th - 30th:  InvestiQuant QuantFest - Many readers are familiar with Rob Hanna and the excellent Quantifiable Edges service.  Rob has teamed up with Scott Andrews to create InvestiQuant, a comprehensive research service for active traders.  The QuantFest event will be held in Tarrytown, NY, a great Westchester community north of New York City sitting on the Hudson River.  The agenda will feature many detailed presentations on quantitative strategies for day and swing traders, including combining long and short-term strategies for diversification and using volatility data to gain an edge.  I'll be presenting on the topic of integrating discretionary and systematic trading methods, introducing a proprietary measure from my own trading as a specific illustration.  For traders looking to expand their edges in markets, this promises a great set of programs and contacts.

The idea is to keep learning and keep developing new and valuable colleagues.  These events offer a breadth and depth of learning and social contact that should fuel success in 2016.

Further Reading:  Positive Principles of Performance in Markets

Thursday, October 01, 2015

Our Struggles Develop Our Strengths

This is a very important principle:  Our struggles develop our strengths.  Winning is the result of strengths; the struggles of training build those strengths.

One of the more important Forbes articles I've written recently helps to explain why some people succeed through struggles and why some don't. When we train, we develop our capacity to endure; our ability to access willpower's second wind.  We only get to that second wind if we're doing something we truly love.  It takes passion and purpose to fuel persistence. If we're not doing what speaks to us, what we find intrinsically interesting and rewarding, we never pour ourselves into our work and never reach the second wind that enables us to persist where others give up.

The last section of the article outlines a way we can identify what we're meant to be doing in life and trading.  Reverse engineer your sisu, your moments of second wind, and you can find your path.  Can there be anything more important?

Reading:  Mental Toughness

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