Sunday, July 13, 2014

Cultivating Winning Habits

While posting to the blog the other day, I noticed that TraderFeed is closing in on 4000 posts.  It struck me that 4000 is a large number.  If I wrote a blog post daily for 10 years, I still wouldn't accumulate 4000 posts.

Now someone observing that amount of writing might marvel at the level of motivation, passion, and discipline it takes to maintain such a blog.  In point of fact, however, motivation, passion, and discipline have little to do with the writing productivity.  And therein lies an important, but underappreciated reality for trading psychology.

The recent posts on turning success into a habit and the importance of small wins suggest that the right habits are crucial in cultivating a positive sense of self.  Many small wins, strung together, become winning habits.  When we have winning habits, we don't need to rely on discipline or passion or motivation to do the right things.  I take a shower every morning without fail.  No one lauds my motivation or my passion for cleanliness.  The truth is that taking a shower in the morning has become an automatic act...the day wouldn't feel right if not begun with a shower.

That makes sense from an evolutionary vantage point.  Habits enable us to do what we want/need to do in more or less auto-pilot mode, while saving limited attention and willpower resources for novel tasks and demands.  Because of that, we can engage in relatively complex tasks--driving in NYC traffic, for example--while carrying on a conversation with a passenger and watching for the next freeway exit.

A look at my recent blog posts reveals the times at which they were written (Central, US).  Going from most recent to older posts this month the times have been:  1:41 AM; 4:24 AM; 3:53 AM; 4:01 AM; 3:05 AM; 3:25 AM; 2:07 AM; 5:14 AM; 4:38 AM; and 6:40 AM.  You get the idea.  I start my day with writing, just as I start my day feeding my cats and taking a shower.  It's not the result of coaching, counseling, journaling, discipline, motivation, or any of those other staples of trading psychology.  It's the result of cultivating positive habits.   

We can create habits for productivity, habits for happiness--habits for most any positive outcome we care to generate, according to recent research.  Charles Duhigg, who wrote the excellent book The Power of Habit, suggests that there is a "golden rule" of habit change:  retain the cues that trigger a habit and the rewards that sustain the habit and find fresh, constructive routines to link these.  I used to write journal articles and books while at home, but I found that when I needed to take breaks, I inevitably drifted mindlessly to the refrigerator.  I got my writing done--and I put on the pounds to prove it!  That's when I hit on the idea of doing my writing at coffee shops and grocery stores.  My breaks consisted of coffee and whatever small snack I purchased--no more grazing at the fridge.

When I first began attending open AA meetings as a community psychologist in Upstate New York, I joked with a colleague that the members had retained their drinking habit:  they had simply replaced alcohol with coffee.  Little did I appreciate that habit truly is the backbone of 12-step programs.  Does AA seek to cure alcoholism with willpower, motivation, or planning?  Not at all!  Indeed, one of the prime tenets of AA is the member's declaration that they are powerless against alcohol.  It's not about willpower.  

So how to AA members overcome their destructive habit?  They start with 90 meetings in 90 days.  "Bring the body and the mind will follow," is a popular slogan.  By the time 90 days are over, the coffee urn has replaced the barstool and AA buddies have replaced the drinking ones.  One member put it very well:

"What I’ve learned is that taking action is almost always the gateway into feeling better. Rarely have I been able to think my way into different behavior or results, instead it’s only when I take action (especially when I don’t want to) that things begin to shift, and I begin feeling better.The program, like life, doesn’t work when I’m into thinking, only when I’m into action."

It isn't that we think ourselves into new action patterns.  Rather, new ways of acting create new ways of experiencing ourselves, which cultivate new--and potentially constructive--habits.  Doing changes our viewing.  Action, harnessed to routine, is a gateway.

Further Reading:  Turning Goals Into Habit Patterns
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Saturday, July 12, 2014

The Momentum Curve: Expanding the Search for Market Profits

Let's say an explorer discovers gold in the mountains of Alaska.  The initial group of miners prospecting the territory has a pretty wide open field of opportunity.  They don't need sophisticated equipment to see and extract the gold from river beds.

As more prospectors move in, the low-hanging fruit is gone.  Now gold must be extracted from rocks and from deeper in the ground.  This requires special equipment.  The single miner with his pan, combing through the river bed debris, no longer has an "edge" in discovering gold.

Still later, as more of the territory is mined, extracting what remains becomes a more complex task.  Deep drilling into the ground and exploration of more remote mountain areas is required to make the investment of time and effort worthwhile.  Individual miners, picking through areas that have already been explored, have almost no advantage in discovering gold--even though they still recount the stories of big strikes just a few years prior.

A well-mined area means that either you have to find new areas to explore or you have to find new means of exploration.  In the case of natural gas and oil, fracking has been a new mode of exploration.  Drilling in the Arctic would be an example of finding new areas to explore.  Either way, ingenuity is required to find value once others have been searching for a while.

Financial markets have been well-mined for a while.  Excellent traders, portfolio managers, and system developers around the world have been attracted to the gold rush of markets.  While looking for nuggets of profitability in new ways and in new places does not guarantee success, looking for them where others have been searching for years with sophisticated tools inevitably invites failure.

I recently have been posting on the topics of understanding vs. predicting markets; looking at markets in new ways; and using quant processes to aid discretionary expertise.  The common theme is becoming better at the exploration for profits by looking at new things and looking at old things in new ways.

Above is a chart of what I call the Momentum Curve.  It takes every stock in the SPX and gauges whether it is trading above its 3, 5, 10, 20, 50, 100, and 200-day moving averages.  The aggregated data are charted (available through the excellent Index Indicators site), so that you can see how the percentages of stocks shift over time.  Observe from the graphic that--going into Friday's session--we had been undergoing a meaningful short-term correction (most stocks moving below their 3, 5, and 10-day averages) in a strong uptrend (most stocks above their 100 and 200-day averages).  

It turns out that the shape of the Momentum Curve is important in forecasting future stock market returns.  The return profile looks very different depending on where the kinks are in the curve, whether the curve is steep or flat, etc.  I find it useful as a qualitative tool--it provides a quick visualization of where we stand across multiple time frames--and also as a source of quantitative hypotheses regarding curve shape and forward price movement.  

Some of the best market tools don't generate conclusions.  Rather, they suggest hypotheses worth testing.  The first step in finding fresh answers is asking fresh questions.

Further Reading:  The Psychology of Quantitative Analysis
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Friday, July 11, 2014

Understanding the Markets You're Trying to Predict

The recent post highlighted the notion of event time and the potential value in redefining the X-axis of charts.  Once we have a fresh X-axis that normalizes intrasession changes of volume and volatility, cyclical patterns in markets become clearer.  It's yet another example of how quant processes can potentially benefit discretionary traders.

The chart above runs from May 6th, 2014 to yesterday morning:  it's one of the things I was tracking closely at the start of Thursday's trade.  Each point on the chart represents 500 price changes in the ES futures.  So, in other words, every time we get 500 ticks higher or lower in the ES front month contract, we draw a new bar.  So time is measured in units of market movement, not in movement of the clock.  

What that does is create many bars during busy, volatile market periods and fewer ones during slow, non-volatile ones.

Suppose we get very little price movement during the course of 500 ticks in the index.  What that tells us is that price change is occurring within a very narrow band:  there is a high degree of consensus in the market at that moment regarding the location of value.

If we get a great deal of price movement during the course of 500 ticks, it means that price change is occurring within a much wider band.  That suggests a higher degree of uncertainty in the market regarding the location of value.

The above chart measures current value uncertainty versus its longer-term moving average.  When we have values above 1.0, there is relative uncertainty regarding the location of value.  When we have values below 1.0, there is relative certainty.  

As with traditional measures of volatility, you can see the tendency for there to be greater levels of uncertainty at relative market bottoms and greater levels of uncertainty at relative market peaks.  The normalization of the X-axis and the construction of the indicator around its recent moving average--creating a measure that is relative, rather than absolute--makes that relationship easier to identify.

One certainly could test this measure in- and out-of-sample and use it as part of a trading system.  Indeed, I have conducted such tests and have found the value uncertainty tool to be helpful.  My use of it, however, is more qualitative and discretionary:  I'm using it simply to identify whether the market environment is becoming more or less uncertain.

So, for example, I closed out a long position late Wednesday because, although we had a bounce that day, the market uncertainty was rising, not falling.  At the same time, I could see that some sectors of the market--most notably small caps--were not participating meaningfully in the bounce.  Indeed, all told we had only about 500 more advancing stocks on the day than declines.  Stock sentiment was bullish--the equity put/call ratio was a relatively low .76--but that bullish tide was not lifting all boats.  Nor was market action suggesting greater certainty in the location of value.

Notice in this example that I am using tested market measures to anchor a reasoning process.  My goal is as much understanding as prediction.  (Indeed, I did not predict Thursday's sharp overnight decline; I simply identified Wednesday's absence of strength).  I want to understand what is happening in the market and why; not just blindly predict future movement on the basis of an algorithm linking variables that happen to fit a given lookback period.  A major turning point in my trading occurred when I stopped predicating trades on predictions and instead used predictive inputs to inform a process of understanding.  Trading systems and tested indicators are most useful when they reflect an underlying understanding of markets; they cannot substitute for such understanding.

Further Reading:  Putting Historical Odds on Your Side
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Thursday, July 10, 2014

Quantitative Resources for Discretionary Traders

My recent post on aligning the head and heart in trading reflects my observation that many of the most successful traders I've known meld discretionary and quantitative elements in their approaches to trading.  In doing so, discretionary traders with a demonstrated edge in their decision-making can add additional sources of edge based upon rigorously researched and tested historical patterns.

There are a number of quant blogs and sites that detail market strategies and provide starting points for generating one's own testable ideas.  The blogrolls on The Whole Street site and the Quantivity site provide an excellent starting point.  Some interesting sources I have encountered include Nautilus Research; Quantified Strategies; CSS Analytics; Millenial Invest; StockSpotter; Quantifiable Edges; Market Tells; Paststat; Sentimentrader; Quant Research; and Financial Math

For those interested in developing trading systems, check out Adaptrade, including these articles, as well as Trade Station, including their user group, and Ninja Trader

For those interested in stock screening and backtesting stock screening criteria, check out Trade Ideas.  

If you have other favorite quant tools and sites, by all means feel free to recommend them via comments to this post.  Thanks!

Brett

Further Reading:  Every Trader is a Trading System
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Wednesday, July 09, 2014

Resources for Continuing Trading Education

Lots of good conditions for learning out there:

*  This new Masters in Business interview series by Barry Ritholtz looks especially promising;

Excellent selected readings from Abnormal Returns; interesting to see lots of talk about bubbles lately;

The $STUDY posts to StockTwits invariably have material worth learning from;  

*  Great interviews via the Michael Covel podcasts;

*  Almost always a good quant read on the Whole Street site, including specific trading strategies;

*  Very useful market pattern studies from Rob Hanna's Quantifiable Edges

*  FinViz does a great job of tracking relative sector performance and industry performance.

Index Indicators is a very useful site for breadth information and more, including backtests of indicators.

Stock Charts has charts of relative performance and much more.

*  I respect StockSpotter for posting ongoing performance of their stock picks; truly unique service.

Creating your own learning culture; which is why links such as the above are so important.
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Tuesday, July 08, 2014

Aligning the Head and Heart in Trading

In coming posts I'll be exploring the use of data and quantitative tools to aid the discretionary decision making of traders.  

Like anything powerful, quant methods can be used to great advantage or misused in destructive ways.

The goal is not to supplant individual decision making, but to inform it.

Just as aircraft pilots, physicians, and engineers rely upon data-driven methods to aid decision-making, traders can use well-constructed tools to identify valid trading opportunities.

Those same tools can lead traders to become fixed in their views, however, and fall prey to confirmation biases.  Tools are only useful if employed for the right tasks in the right ways.  

When discretionary decisions are grounded in proper research, the benefits are psychological as well as financial.  It's easier to have real conviction in an idea if you've studied it, run the numbers, and seen how signals behave "out of sample" and in real time.  It's like buying a car once you've conducted a compression check of the engine and taken it for a spin.

Surely our trade ideas deserve as much due diligence as our automotive purchases!  Selecting a car has strong intuitive components of pattern recognition:  we sense what we like in a vehicle and know when it feels right.  That doesn't stop us, however, from reading reviews of the car, checking its reliability, and running those road tests.  The best decisions occur when head and heart are aligned.

In upcoming posts, we'll look at ways in which that can happen. 

Further Reading:  The Greatest Challenge in Trading
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Monday, July 07, 2014

Creating Big Gains Through Small Wins

Research suggests that the best way to achieve large gains is to make sure you experience small wins.  What is a small win?  Achieving a tangible step toward an important goal generates a small win.  Many times we fail to attain our large goals because we don't pave the path with small successes.

Why are small victories so important?  It turns out that progress in work you find to be meaningful gives energy and fuels creativity.  This is tremendously relevant to goal-setting.  If you fail to set goals, you deny yourself the small wins that come from reaching daily and weekly milestones.  If you set goals that are too distant or ambitious, you can unwittingly set yourself up for frustration and a loss of the momentum that small wins can bring.

Small wins can be very small--as small as engaging in a positive behavior to start the day or maintaining a better posture.  One reason engaging in exercise first thing in the morning is effective is that the energy of the workout also taps the energy of starting the day on a constructive, successful note.

Imagine yourself surrounded by small wins day in and day out.  The mirroring effect of so many wins means that you begin to experience yourself as a winner--which in turn energizes you to further set yourself up for success.

Conversely, consider perfectionists.  Because nothing ever reaches their expectations, they never achieve small wins.  Indeed, they continually experience small losses--frequent episodes of falling short.  What the research tells us is that you cannot internalize the sense of being a winner unless you set yourself up for frequent wins.  When each day is pursued as a masterpiece, over time you experience yourself as an artist.

The trading week to come may be a profitable one or it may not.  If you are focused on small wins and the processes that generate profits over time, however, the coming week can always be a successful one.  And that fuels the drive for truly big wins.

Further Reading:  Creating Change Through Positive Emotional Experience 
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Sunday, July 06, 2014

Turning Success Into a Habit

In the course of writing my next book, I've been reading The Power of Habit by Charles Duhigg.  It's an excellent read, citing a wealth of real-life examples and cognitive neuroscience research to explain how making life changes often boils down to making habit changes.

This flowchart provided by Duhigg explains the structure of habits and illustrates what must be done to change them.  Habits begin with cues that lead people to anticipate rewards.  Once cues are activated, the routines that bring the rewards become relatively automatic.  It is the automatic nature of habits, grounded in the brain's basal ganglia, that makes them difficult to change.  Only by restructuring the routines that connect cues and rewards can we channel automatic efforts in constructive ways.  Interestingly, this can be done by finding small, consistent ways to disrupt an existing habit, rather than by trying to overhaul bad habits in general.

For the most part, the problem is not that traders lack positive trading behaviors, but rather that they have not been able to turn those behaviors into routines.  To the extent that we rely on willpower to do the right things, we are vulnerable to inevitable lapses in willpower. The beauty of habits is that they take on a life of their own, freeing the conscious mind to tackle fresh challenges.  That life of their own, however, is precisely what traders lament when they find themselves reacting to cues in unintended--but habitual--ways.

Once upon a time, psychologists tended to operate with the conceit that talk therapies were somehow deeper and more profound than other change modalities.  Brain research suggests that precisely the opposite might be the case:  talking to people about their habits is a singularly ineffective way to change those habits.  If the action patterns are coded non-consciously in the basal ganglia, engaging the reasoning, conscious mind to initiate change is less likely to be successful than initiating fresh action patterns that reprogram the relevant brain region.

When traders become competent, they replace trading mistakes with best trading practices.  When they become expert, they turn those best practices into positive habit patterns.  Finding the right cues and rewards is half the battle in changing our trading routines.

Further Reading:  Turning Stress Into Performance
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Saturday, July 05, 2014

Values, Innovation, Strengths, and Trading Success

I like this New York Times article on companies that pay employees well above prevailing normal wages in order to secure top talent and highest loyalty.  It's an example of thinking outside the box.  In this case, the box is that you have to minimize expenses in order to maximize profits.  The out-of-box idea is that maximizing compensation and benefits secures the best workforce, provides the best service, and ultimately generates the best retention of customers.  In the case of companies that provide premium compensation, values are an important driver of the business model change.  One executive put it this way:  "If we're talking about building a business that's successful, but our employees can't go home and pay their bills, to me that success is a farce."

Values enter the picture when the motivation driving the business is to do the right things, not just to do things right.  Values drive the innovation; they are the motive force that nudge people out of the box.

At several trading firms where I've worked, I've been part of the hiring process.  Over the years, I've had a front row seat to who succeeds and who does not.  The one conclusion that experience has taught me is that generic approaches to business cannot produce extraordinary results.  If a trader describes a generic thought process in a recruitment interview; if a company's traders are generating consensus ideas from reading the same research and looking at the same information; if a company's management does not innovate in the running of the business, then why should we expect uncommon results from them?

To innovate, however, you have to be willing to fall flat on your face.  It was Edison, after all, who said, "I have not failed.  I've just found 10,000 ways that won't work."  It sure feels like failure when you're at the 5,000 mark, though, and it's likely to look like failure to others.  The status quo seems far more secure; as Keynes observed, "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally."  If your profit margins are suffering and you're paying employees premium wages, you come perilously close to looking like a well-intended idiot.  It takes a deep level of commitment to values and vision to see any campaign through.

Back when Big Data was not a big thing, I recall meeting a trader who hired dozens of college kids to surf online and check prices for hotels, car rentals, airfares at different times and across different locations.  The kids spent hours and hours each week checking those prices and never once did they actually reserve anything.  Instead, the trader assembled the data into pricing curves that expressed whether business was getting firmer or softer over time, region by region, industry by industry.  The aggregated data provided a meaningful real-time window on consumer discretionary spending, which in turn had forecasting promise for the economy.

You know when you are in the presence of talent, because the originality of their efforts smacks you in the face and you have the unmistakeable impression of, "Why didn't I think of that??!!"  Looking at new information in new ways and assembling those data into fresh insights:  that's what creates a trading edge.

Those trading edges come from signature personality, social, and cognitive strengths.  The trader with the college shoppers was a data junky and loved piecing data together into coherent pictures, whether or not they led to a trade.  The values that drove his business were born of his strengths as an information processor:  he loved learning and investigation.  In a very real sense, the business was an expression of who he was as a person.

When you're doing what you believe in--when you're expressing the very core of your strengths and what you love doing--you don't need discipline to work long hours or stick to your plans.  You don't need to be pushed to do the right things when you're pulled by what you believe to be right.  If a strong trading business is the expression of the trader's signature strengths and the innovations that embody those, there can be no question of greater importance to trading success than:  "What makes me--and my trading--special?"

Further Reading:  Signature Strengths and Trading Success
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Friday, July 04, 2014

Loneliness, Solitude, and the Power of Time With Ourselves

According to this article, a shocking proportion of people don't like being alone.  It's literally a shocking proportion, because they choose to undergo electric shocks rather than the stillness of solitude.  As one news report put it, people apparently prefer negative stimulation to boredom.

There are many benefits to time spent alone, including time for deep and creative thought and activity.  While loneliness can be a painful emotional state, there are ample historical examples of artistic, spiritual, and intellectual genius emanating from periods of solitude.  Could this be why creativity is so often linked to introversion?   Solitary work fosters deep concentration, which is essential to generating unique insight.  Extroverts can dazzle us with charisma and leadership, but it is difficult to differentiate oneself from the herd if one is of the herd.  That is why successful invention is so often a joint function of research in solitude and implementation through collaboration

Show me someone highly successful in a field and I'll show you someone who seeks alone time to engage in work in that field.  That is because being alone is not necessarily being lonely; being alone is being all-one, in one's own company.  In solitude, we have nothing but our thoughts, feelings, memories, ideas, plans, values, and interests.  Whether that is appealing or aversive speaks volumes about an individual:  active minds are rarely bored ones.

Further Reading:  Life Lessons From Great Inventors
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