Sunday, November 30, 2008

Site Seeing Excursion for a Sunday Eve

* More Linking to Come - When I began the Twitter "blog within a blog", about 200 traders signed up for the free subscription and I was quite pleased. Now that the Twitter "tweets" include market stats, links to market themes, and links to relevant blog posts, the subscription level has risen to above 1200. I'm always happy to help showcase good work; if you are a blogger writing on themes of special relevance to Trader Feed readers, by all means email me the URLs and I'll include in a Twitter blast.

* Reviewing Performance
- Here's an instructive example of a professional trader's end of month review. See also this post on avoiding overtrading.

* A Bear Market Look - How the current market stacks up with mega bear markets of the past.

* Resistance Overhead - Trader Mike reviews the markets after a week's rally.

* Metal or the Miners? - Jeff Miller takes a fresh look at gold.

* Market Views - Ray Barros has been drawing upon Austrian economics to offer his market views.

* Good Reads - Market at fair value, 10-year yields and risk aversion, and other market themes.

* Monitoring Credit Markets - The Learning Markets site explains the LIBOR-OIS spread.

A Look at the Week's Stock Market Rally

Hats off once again to the fine Decision Point site, which separates out the common stocks from all the other NYSE issues for analysis. Above we see the advance-decline line (bottom pane) for NYSE common issues; clearly it's bounced nicely off its lows. The site also reports that 54% of NYSE issues are now trading above their 20-day moving averages and 18% are above their 50-day benchmarks. The latter is the highest percentage since the October market drop.

Friday also saw the number of NYSE, NASDAQ, and ASE stocks making fresh 20-day highs exceed new lows by 304 to 120. I will be watching those numbers closely; despite Friday's gains, we did not see an expansion of new 20-day highs. Friday's money flows were slightly negative for the Dow Industrial stocks at -$15 million, though the week's flows were modestly positive at $33 million. We will need to see continued expansion in new 20-day highs and continued positive money flow numbers to keep the rally going.

Saturday, November 29, 2008

Themes of Recession and Deflation Continue to Dominate Markets

As the charts from the excellent Barchart site indicate, anticipations of quantitative easing moved ten-year Treasury note yields below 3% last week, sending prices soaring (top chart). Interestingly, with so much pumping of liquidity, we continue to see a relatively strong U.S. dollar (middle chart) and weak commodity prices (bottom chart). These themes continue to be deflationary, or at least anti-inflationary. Money continues to seek relatively safe havens, including--amazingly--the U.S. dollar. Investment grade bonds continue to outperform high yield issues; the currencies of developed economies continue to greatly outperform those of emerging markets.

Among equities, the best performing industry group according to Barchart is "soap and cleaning products"; mining and steel bring up the rear. Defensive, recessionary themes remain dominant.

Electromagnetic Pulse (EMP) Threat: No Bailouts For This Crisis

"You never hear the one that gets you," snipers say. A bullet traveling faster than sound will impact and wreak its damage before the brain can process what is happening. That little piece of military lore ran through my mind upon reading the Report of the Commission to Assess the Threat to the United States from Electromagnetic Pulse (EMP) Attack. An April, 2008 update of a 2004 report, this report outlines the near-instantaneous effects that an electromagnetic bomb would likely have on the nation's power, telecommunications, banking/finance, fuel, and other systems.

Tightly coupled systems are particularly vulnerable to breakdown, catastrophic failure, and disruption. This is one lesson from the recent subprime-induced meltdown of our financial system. A lengthy breakdown of a country's electrical systems, shutting down everything from the power grid to computers to electronics systems in automobiles, trains, and planes, would have significantly greater impacts than the financial crises we currently bemoan.

The attacks in Mumbai are a stark reminder that rogue groups possess the will to disrupt modern society. The threat assessments from the recent reports cited above suggest that it is only a matter of time before they also possess the means. Research is under way to protect vulnerable systems and the cost of hardening new components and systems is not prohibitive. The cost of retrofitting and hardening existing systems is significant, and that leaves much of our infrastructure vulnerable--and almost all of us unprepared.

Friday, November 28, 2008

Stock Performance of Banks Continues to Show Geographic Disparities

A couple of months ago, I made note of geographic variation in the performance of bank shares. Specifically, banks located in regions that had seen greater real estate boom and bust were performing significantly less well in the stock market than banks in real estate markets that had seen no such bubble.

These differences in bank performance continue to be dramatic, despite government efforts to shore up both banks and real estate. The excellent Barchart site tracks the relative performance of industry groups. Banks located in the southwestern and the northeastern regions of the country currently rank #5 and #7 in stock market performance out of over 150 groups. Midwest banks rank #43, southeast banks are #49, and banks in the west rank #98.

By way of comparison, the stocks of 6 out of 15 listed banks in the Southwest are up on the year; 27 out of 80 in the Northeast are green for 2008. In the West, only 4 out of 55 banks are showing annual stock market gains. Indeed, 12 of the 55 banks in the West are down more than 70% for the year. Only 4 of the 80 banks in the Northeast are down that much.

The economic recovery, when it comes, may display significant geographic variation, as weakened banks find themselves more unable to lend money and spur economic activity than banks less saddled with bad loans.

Thoughts on Giving Thanks

Researchers have identified several components to psychological well-being, including our overall happiness, our energy level, and closeness in social relationships. Another important component to well-being is contentment: one's satisfaction with life. The literature finds that contentment is different from happiness. The former reflects a global appraisal of one's life situation; the former is an emotional experience. We can do many things that make us happy and yet not achieve overall life satisfaction and fulfillment.

Too many traders equate contentment with complacency. They are afraid of being satisfied, because they assume that this will reduce their motivation to move ahead. As a result, they never find contentment; they are never satisfied.

In my own experience, I trade best when I have reached a particular point of peace within myself. If I miss a move or exit a trade too soon, it's no more that a temporary frustration. There will always be other opportunities. I don't need to catch each move in its entirety to be OK with where I'm at in my trading and in my life.

When I fail to find that internal peace, wanting to succeed becomes need to succeed. I find myself trading out of that need, chasing moves and overtrading. I'm not trading from a position of emotional well-being; I'm trading to try, vainly, to find well-being. But no happiness from winning trades can sum up to life satisfaction.

The content trader operates in a universe of plenty. The trader lacking satisfaction operates in a universe of scarcity.

Thanksgiving is more than a day in the year; it's a state of mind. And I suspect it's a state that has much to do with long-term success. The contentment of giving thanks is not laziness or complacency; it's the state that clears our minds for creative insights and the perception of opportunity.

Thursday, November 27, 2008

Sector Update for Thanksgiving

Last week's sector update found a highly oversold situation across all the S&P 500 sectors followed. With the powerful rally this week, the Technical Strength numbers for the sectors have changed, and we are seeing patterns of relative strength and weakness among the sectors:

ENERGY: +280

We can see that the sectors are nowhere near overbought, but are much closer to neutral trending levels in their technical strength. The most interesting shift is in energy, which has turned decidedly bullish. I'm watching commodities in general, gold and energy in particular, vis a vis the U.S. dollar, as the government progresses in its shift toward quantitative easing.

Wednesday, November 26, 2008

Sustaining Innovation: Perspectives From Andrew Hargadon

An interesting thesis of Andrew Hargadon's book How Breakthroughs Happen is that creative breakthroughs in organizations are more the result of innovation than invention. Organizations that stay ahead of the curve foster collaboration that leads to recombinant innovation: ways of assembling old things in new ways. "For these companies," he explains, "innovation isn't a process of thinking outside the box so much as one of thinking in boxes that others haven't seen before" (p. 13).

What kills creative breakthroughs is insularity and a lack of communication. Teamwork fosters innovation by helping participants think in unnoticed boxes. This is particularly the case when team members can "broker" information across disciplines.

One of the greatest threats to trader success and longevity is isolation and insularity. Without the free flow of ideas from different sources and perspectives, individual traders become trapped in limited ways of viewing and doing. Hargadon argues that creativity requires both bridging and building; it is a fundamentally social process. Perhaps that is why I have consistently found that successful traders and portfolio managers have well-developed networks of contacts.

One of the great challenges of the online medium is to create virtual networks that can sustain one's own creative processes. In the right kinds of networks, participants serve as knowledge brokers, combining and recombining ideas and perspectives. If one's trading is a business, it is helpful to understand how successful businesses innovate. A large part of success is situating oneself in the right social networks.

Tuesday, November 25, 2008

Using the Short-Term Moving Average of NYSE TICK to Trade Range Days

The previous post showed the distribution of the 10-minute moving average of the NYSE TICK during an uptrend day. Today (above) we saw a very different market.

One of the most important tasks for a daytrader is to identify, as early in the day as possible, the likely day structure. That means trying to differentiate a likely trend day (i.e., one that will close far from its open and near its high or low for the day) from a non-trending day (one that trades within a range). I find the distribution of the NYSE TICK, which continuously measures the number of stocks trading on upticks vs. downticks, to be quite useful in that regard.

On a candidate trend day, I want at least a piece of my capital entering in the direction of the trend early in the day and riding the move throughout. On shorter-term trades, I will trade almost exclusively in the direction of the trend, entering on countertrend moves in TICK.

On a candidate range day, I want to be as nimble as possible. Very often I'm buying pullbacks in TICK and selling bounces. Not infrequently, we'll see "support" and "resistance" levels for the TICK MA on range days, as both buying and selling are relatively contained. That showed up today, with most bounces and dips contained within the range of +400 to -400. Because I'm not expecting a trending move, I'm quicker to take profits on a range day: buying when the TICK MA goes negative and selling when it goes positive often provides a good short-term trade.

When we see relatively constrained values--upside and downside--for the TICK MA during the first hour of trading, and when we see the TICK spending a relatively even amount of time above and below its zero line, that's when we start to think of the day as a candidate range day. False breakout moves are common on those days. Knowing that we were in a range environment, for instance, helped keep me from selling the price lows a little after 1 PM CT.

For reference, the 10-minute moving average of TICK shown above comes from e-Signal data; it is a simple 10-minute moving average of the one-minute high/low/close values for TICK. The chart is in Excel, but the TICK MA can be charted directly within e-Signal.

Trading With A Short-Term Moving Average of NYSE TICK

I find that a 10-minute moving average of the NYSE TICK removes much of the noise from the one-minute values. In the chart above of Monday's trading, a few things stand out:

1) We can often identify strong days to the upside and downside when the first hour's TICK is persistently positive or negative. This means we have skewed sentiment, with stocks aggressively trading on upticks or downticks. When TICK MA pullbacks can't even go into negative territory, you know that the sentiment is quite positive. That's a hallmark of a trending day.

2) At a glance we can see if the 10-min. MA of TICK is spending more time above or below the zero line, which tells us that the Cumulative TICK is running positive or negative. Consider the possibility of a trend day when we're persistently above or below the zero line in the TICK MA. The moving average of TICK also helps us identify intraday turns in sentiment and trend, when markets shift from primarily above/below zero to primarily below/above. Non-trending markets will generally spend more balanced time above and below the zero level.

3) In a strong market, pullbacks in the 10 min MA of TICK are often good short-term entry points; in weak markets, bounces in the 10 min MA are candidates for selling. I generally find it useful to wait for these countertrend bounces, so as to not get whipsawed buying highs and selling lows. Even in a market that is about to change direction, we'll often get a retest of previous highs/lows after one of these TICK pullbacks/bounces, making it much easier to scratch trades. Good execution counts for a meaningful share of profitability.

Monday, November 24, 2008

A Trading Performance Insight From Ziad Masri

Dear Readers,

I thought this email from reader and commenter Ziad Masri was so insightful, that I asked for his permission to share with others. His key observation, that it's not how long you trade, but how many patterns you observe and act upon, that determines the learning curve helps explain how active traders can develop expertise in far less time than is commonly observed in other performance fields.

Notice also the emotional tone of Ziad's communication. To sustain enthusiasm and learning during the most challenging markets is a real accomplishment. Without that drive, the learning curve stalls out. Many people love trading and love making money. Not so many like the things you have to do to learn markets and make good trades.


Just thought I'd write and share an observation with you. A trader friend of mine and I were talking recently and it occurred to us that the recent market environment not only is giving incredible opportunities for some large profits, but it is also giving incredible opportunities for accelerated learning. With volatility running at all time highs, what used to take 2 weeks to transpire is now taking one day (like you alluded to in your ATR study). As such, and with the abundance of trends that we're seeing, there are literally hundreds of more patterns appearing in a given time-frame than we used to see before. I remember early last year I'd sit there and watch the market for hours as it moved in a 6 point range with nothing happening. Now it's almost non-stop action. The effect of all this extra exposure has been accelerated learning.

This was all brought home to me when I noticed starting a couple of months ago that my trading skills seemed to make an instant leap. I was suddenly seeing the market differently and being able to sense moves to a much better degree. I couldn't understand the reason for this, but now I see it was the result of accelerated learning given the market conditions of late. Quite literally, it's as if I just got 2 years of added experience compressed within 2 months. Realizing this has not only been interesting, but it has also benefited me indirectly because I was starting to doubt how my results could be so good. I was thinking this is too good to be true for it to be happening so fast (which can be a form of self-sabotage), but now I realize that the length of time I've been trading can be deceiving as it's not the length of time itself that determines learning but how much exposure we have to patterns during that time. And from that point of view, there's never been a better time to learn and grow as a day trader... this market, far from just offering ample opportunity, is offering a crash graduate course. And I'm happy to be enrolled!

Indicator Update for November 24th

Last week's indicator review concluded that "while recent selloffs have not been as broad and sustained as in early October, neither are we yet getting indications of sustained buying interest. Until that occurs, it is premature to assume that a durable intermediate-term bottom is in place." What followed in the past week was a broadening of the decline and a move, not only to new bear market lows, but also below the bear lows of 2002/2003.

Sentiment, as measured by the Cumulative NYSE TICK, has been quite bearish during the past week; price weakness has extended to all major sectors. The Cumulative Demand/Supply Index, which generally does an excellent job of tracking intermediate-term market highs and lows (top chart), is back at levels from which we've typically seen intermediate-term rallies. Note, however, that we continue to see a pattern of highs and lows in the Cumulative DSI corresponding to lower price highs and lower price lows. That is typical action in a longer-term bear market.

The number of NYSE, NASDAQ, and ASE stocks registering fresh 65-day lows expanded dramatically last week (bottom chart), hitting its most extreme level since the second week of October. Once again, the weakness was quite broad. On Thursday, for example, almost 1100 NYSE common stocks made fresh 52-week lows; 300 of the S&P 500 stocks and 323 of the S&P 600 small caps also made annual lows. The advance-decline line specific to NYSE common stocks and the line for the two S&P averages all made fresh bear market lows this past week; money flow for the Dow Jones Industrial stocks was negative on the week.

In short, we have been quite weak, we are at oversold levels that have corresponded to intermediate-term rallies, but so far the indicators are in clear bear market modes. To begin a bottoming process, we need to first see a sustained rally on solid breadth, cumulative TICK, and money flow prior to any further testing of lows. To this point, rallies have been short-lived and have not been accompanied by sustained, positive money flow. We saw a solid money flow rally late on Friday, and we are trading higher today as I write. I will be tracking the indicators closely each AM via Twitter to see if this rally differs from the ones previous.

Sunday, November 23, 2008

Bearish Stock Market Sentiment Continues

In general, I have found that my best short-term trades have been in the direction of the Cumulative NYSE TICK Line (blue line; chart above), but executed on contratrend bounces/dips in TICK. Since we tested the 1000 level in the S&P futures (pink line), intraday sentiment has been consistently bearish, with more NYSE stocks trading on downticks than upticks. We've taken out the October lows in the Cumulative TICK Line, which confirms the new lows we've been making in the advance/decline line for common stocks within the NYSE universe. It is difficult to see signs of bottoming in these indicators; thus far, weakness has led to further weakness, with oversold markets becoming yet more oversold and selling pervading all sectors.

Trading Systems and Quantitative Insights Into Markets

* Going Public - Nice to see that system developer Henry Carstens has started his own hedge fund with his portfolio of trading systems.

* Developing a Trading System
- Excellent post from A Dash of Insight, with links to useful tools.

* Articles from a System Developer - Here are free downloads from the Breakout Bulletin, featuring Mike Bryant's work.

* Sharing Quantitative Insights - Here are a few popular blogs that feature worthwhile market research. Please feel free to add others in the comment section for this post; thanks!

Saturday, November 22, 2008

Sector Update for November 22nd

Last week's update found the S&P sectors in moderate downtrends. A look at the current Technical Strength readings shows that the downtrends have intensified:

ENERGY: -260

These are some of the weakest figures of the year. In the recent past (2007/2008), such extreme negative readings have tended to precede intermediate-term bounces. This last occurred late in October. I'll have more to say about this in Monday's indicator review.

Money flow was quite positive for all sectors on Friday, but the Dow Jones Industrial stocks still finished at -$165 million for the week. The weakest flow numbers were seen among the health care and consumer services stocks; the strongest readings came from telecommunications, energy, consumer goods, and utilities.

For the month, money flow was weakest for consumer services and financial stocks; strongest for telecommunications and health care. As has been the case for a while now, monthly money flow among Dow stocks remains in negative territory.

A Historically Oversold Market

This past week, the Dow Jones Industrial Average traded about 34% below its 200-day moving average. This eclipses the oversold conditions from the post WWII era. Indeed, as the chart above indicates, since 1902 we've only had one period of greater oversold conditions: the Depression market of 1932. Looking for market bottoms using historical analogues from modern markets has been hazardous to investors' wealth.

Friday, November 21, 2008

Three Market Relationships

Here are a few relationships that have been on my radar:

1) Gold, unlike other commodities, has been performing well relative to stocks (top chart). Should we see a weakening of the U.S. dollar, this could get interesting.

2) Banks have resumed underperforming stocks overall. The reversal by Treasury, deciding to not use TARP to rid banks of their bad debt as was first planned, has been one catalyst in the banks' swoon.

3) Consumer discretionary stocks continue to greatly underperform consumer staples issues, in a classic recessionary relationship.

Many good trade ideas follow, not just what is moving, but what is moving relative to other things.

Quick Takes for a Bear Market Friday

* Finding an Analogue - People have compared the current market to other bear markets, including 1987, 1974, and even the markets of the 1930s. I find it interesting that many of those comparisons implicitly equate the current year with the years in which past bear markets made ultimate lows. In many ways, the current market is acting like it did in 1973, which was the one year since the 1960s in which huge numbers of stocks making fresh 52-week lows did not lead to intermediate-term rallies going forward. We stair-stepped down in volatile fashion, and did not see an ultimate price low until late 1974. It's the inability of the market to find buyers and sustain rallies even amidst extreme weakness that is most troublesome about the current market.

* Do Bonuses Work? - Thanks to an alert reader for noticing this New York Times article on how incentives can actually lead to poorer performance. When we want something too much, our need interferes with our performance--something we see when traders too desperately need to make money.

* Lowry's Perspective - Excellent market overview from Trader's Narrative.

* Insider Buying - It hasn't been a good indicator of late, but interestingly it's been rising considerably as the market has weakened and now is at post-1987 crash levels, according to the excellent Sentimentrader service.

* Finding Market Themes - MarketSci follows up with a look at the relationship between SPX and the Consumer Discretionary shares.

* Extremity - Quantifiable Edges takes a look at how extreme this market really is.

Thursday, November 20, 2008

New Lows, New Opportunities: Themes for Thursday

* Finding New Lows - Ten-year Treasury note yields broke below their 2003 levels today (top chart), as the S&P 500 Index (bottom chart) also broke the lows from the previous bear market. The last decade has resulted in a more than 33% drop in stock prices (November, 1998 to November, 2008), a crushing blow to those who have relied on buy-and-hold for their retirements. Add to that corporate bond prices that are priced for default and housing values that continue to fall and you begin to see the destruction of wealth that will affect the economy for years to come.

* Where There Is Opportunity - I was interested to see that retail traders opened a large number of accounts and increased their trading at E*Trade, even as customer assets dwindled. This pattern also manifested itself at Ameritrade and at Schwab. Indeed, according to one report, eight of the ten busiest days at Scottrade were during October, with the number of new accounts running three times the average level. It appears that volatility is bringing out the speculative sentiment among individual traders. Perhaps in response to the growing interest in trading, Scottrade has begun a program of free trader education at their branch offices. It's an interesting venture; over time we may see retail brokers developing their customers much like prop firms develop their traders.

* Figuring Out Bloggers' Personality Type - Thanks to a very helpful reader who found the Typealyzer app, which categorizes blogs by the personalities of their authors. Mercifully, the categories of "narcissist", "idiot", and "antisocial" are not part of the scheme.

* Thematic Trading - Here's an interesting idea that's held up well in the recent, difficult market from the MarketSci blog.

* When to Get Out - Worthwhile investigation of the performance of different exit strategies from the RipeTrade blog.

* Trading Sentiment - A followup on a promising trading system idea from the Buyside blog.

Three Common Trading Mistakes

Trading is a lot like dating: often you have to make enough mistakes and suffer the consequences when you don't have much on the line before you start making good decisions when you're playing for keeps. Here are some of those bad dating experiences that I find developing traders make with markets, preferably when they're not risking too much of their capital:

1) Short circuiting their process - Most traders develop a "process": a way of looking at market data and gathering information in order to generate promising trading ideas. For the scalper, that process is quicker--with faster-moving data--than for the investor; each has his or her own cognitive style and preferred information sources. When traders short circuit their process, often in order to catch a move under way or avoid a normal adverse price excursion, they tend to make decisions reflexively, on the basis of superficial data and processing. That often makes them part of the herd, and markets don't reward that over time. A great example is getting out of a winning trade prematurely (before it hits its price target), with the idea of "I'll get back in at a better price later". When the better price doesn't materialize, the short-term gain pales beside the missed opportunity. Another great example is rationalizing a losing trade by turning it, on the fly, into a longer-term position.

2) Failing to become aggressive during winning trades - This is something I've noticed about very good traders: it's not so much that they have so many more winning ideas than their peers. Rather, they have a keen sense for when they're right, so that they can scale into those profitable moves. This is different from chasing a move, and it's different from adding to losing trades; they will patiently wait for the market to retrace, and then they'll add to the trade. The losing trader will be threatened by the retracement and will be thinking of exiting altogether. The aggressiveness that led to the trade isn't sustained during the trade. As a result, the average size of winning trades is not so different from the average size of losers over time, limiting overall performance.

3) Easing up after winning periods - When I review trading results with a trader, I like to identify winning stretches and then see how the trader made decisions after those periods of profitability. Many times, the trader will alter how they trade due to overconfidence or just plain sloppiness. Sometimes they'll start trading with more risk, trading more frequently, or trading with less preparation at the start of the day. Successful traders bear down when they see markets well to take full advantage. Many times they'll ask me to make sure that they don't let up. When traders stop doing what has made them successful--particularly when they're telling themselves that they've finally broken through--that's when they're most vulnerable.

I see where SSK is posting "brief therapy" video snippets to supplement his series on "a great day trading". The idea is to use review to highlight your mistakes and turn those into "therapy" goals, even as you review your "great days" and stay in touch with your strengths. Your three common trading mistakes may be quite different from the above list. The key is to know where you can best improve your performance--and then turn that information into a directed program for self-improvement.

Wednesday, November 19, 2008

High Yield, Low Performance and Other Market Ideas

* Unyielding Yield Play - One rule that's held consistently in the recent market is that reaching for yield has cost investors in performance. I took a look at the FINRA data and the numbers were eye-opening. Here are the advance/decline numbers this past week for bonds in their investment grade index and bonds in their high-yield index (in parentheses):

Tuesday, Nov. 18th: 1611/1232 (347/639)
Monday, Nov. 17th: 1374/1422 (317/650)
Friday, Nov. 14th: 1540/1140 (401/555)
Thursday, Nov. 13th: 1379/1471 (360/631)
Wednesday, Nov. 12th: 1607/1390 (334/728)

As we can see, advancing bonds and decliners have been pretty even for the last five trading days among the investment grade issues. Decliners have been ahead of advancers by about 2:1 among the high-yield bonds, however.

Significantly, we had 266 out of 3211 investment grade bonds traded on Tuesday make fresh 52-week lows, less than 10% of the group. Among high-yield bonds, 285 of the 1118 bonds traded made new annual lows, more than 25% of the group. Bond pricing is an excellent sentiment gauge, when you consider that pricing is reflecting perceived odds of default.

* Twitter Update - You may have noticed that I'm adding more blog links to my Twitter posts; I'll also be tracking daily money flow figures for the Dow, with some observations about flow numbers specific to market sectors. Subscription to the Twitter postings is free, of course; you can sign up on my Twitter page or simply track the last five posts on the blog under "Twitter Trader".

* Blog Traffic - We hit new lows today; the market was really ugly throughout the session. Still, I'm not seeing the expansion of blog traffic the way I did during the October routs. Over the weekend, the numbers were more consistent with levels seen at market tops, as I noted in a Twitter post. It's not a perfect measure, but it's held up pretty well during this period of weakness.

* Free Webinar - Dave Mabe of StockTickr is speaking at the Las Vegas Traders Expo tomorrow, and his talk on automated trading will be webcast free of charge. Sweet.

* Lots of Good Reading - Fresh links from The Kirk Report, including a look at sector P/E ratios and more trouble ahead from derivatives.

Under Pressure: Insurance Stocks and Commercial Mortgage Backed Securities

While banks have received much of the attention among financial stocks, life insurers have come under particular pressure of late. The insurance index ($KIX; top chart) reached a new bear market low on Monday, thanks to unusually weak performance by MET, PRU, and others.

Meanwhile, concerns over defaults in the commercial mortgage space led to a widening of spreads for even the most creditworthy tranches of commercial mortgage backed securities (CMBS; bottom chart). Many insurers are highly exposed to the commercial real estate market; those default fears mean that insurers are moving opposite in price to those CMBS spreads. Indeed, we've even seen a tripling in the cost of default insurance for blue chip insurer Berkshire Hathaway in the past two months. Should commercial real estate markets continue to crumble, we could see further price pressure on the insurers--and yet more calls for rescue funds from the government.

Tuesday, November 18, 2008

How Volatile Is This Stock Market?

I went to the cash S&P 500 Index from 2003 through June of 2007 and calculated that the median weekly high-low price range was 2.09% (mean 2.32%).

I then looked at the *daily* high-low range for $SPX from July, 2007 to the present and found that the median was 2.63% (mean 3.58%).

The discrepancy between the mean and median for the recent daily time period indicates that we have had a number of outlier, high-volatility days that have skewed the average upward. This skew was less pronounced during the earlier period.

Bottom line: a single day's trading range in the S&P 500 Index is at least 30% larger than a week's trading range from 2003 to mid-2007. When we consider those outlier days, we're getting an average of 50% more volatility per day than we used to get in an entire week.

That has real implications for the sizing of positions and the need for tight risk management. As we saw late this afternoon, an hour in the present market can make all the difference in terms of entries and exits.

Stress and Performance in Trading

An excellent review of research by Mark Staal, conducted for NASA, offers fascinating windows on the variety of ways that stress can affect human performance. Examining hundreds of research studies, the author finds that stress interferes with attention, memory, decision making, and perceptual motor performance. His review questions the common notion that people perform better under moderate loads of stress than under very low or very high levels. Rather, in many spheres, there is an inverse linear relationship between experienced stress and performance.

The behavioral finance literature suggests that one reason stress might affect performance among traders is by skewing their assessments of risk and reward. Under pressure, traders may narrow their cognitive scope to only the information most salient to them (availability bias) or relevant to their expectations (confirmation bias); focus only on superficial qualities of observations (representativeness heuristic); or become more likely to take profits than losses (disposition effect). In other words, stress disrupts performance by altering normal, sound information processing.

In a unique study, Lo and Repin found that veteran traders are less likely to experience the physiological effects of stress in response to market events than novice traders. A reasonable interpretation of the results is that, through repeated experience, traders learn to psychologically normalize the stresses associated with the risks, rewards, and uncertainties of financial markets. Directed training, in which traders rehearse sound decision making under particularly stressful market conditions, could greatly accelerate a trader's learning curve. Indeed, this is a model of training central to the development of many professionals in performance fields, from military special forces to the surgical sub-specialties.

A major flaw of much trader education is that it is not applied under conditions of stress, and so cannot train the trader to perform flawlessly in the heat of battle.

Monday, November 17, 2008

The Vote of No Confidence Among Financial Stocks

To date, government efforts have focused on stabilizing the financial sector, including banks and insurance companies. From the above charts, it seems safe to say that the stocks of these financial firms have not responded favorably to these rescue efforts. The financial stocks within the S&P 500 universe (XLF) has lost 2/3 of its value and are hovering at bear market lows (top chart). As the helpful chart from Decision Point illustrates (bottom chart), the advance-decline line specific to financial issues within XLF is steadily moving to bear market lows. We're also seeing unusually negative money flows from the XLF stocks.

It is difficult to imagine sustaining a bull move in stocks overall without seeing some signs of investor confidence in this key sector. At this point, XLF may be serving in part as a sentiment gauge regarding investor confidence in the government's rescue efforts. Thus far, the verdict is thumbs down.

Indicator Update for November 17th

Last week's indicator review noted, "Unless and until we can pierce that level with some decisive breakouts among the indicators, I view this as a range market and expect further testing of market lows." We did indeed get that testing of lows on Thursday morning, followed by a vigorous afternoon rally, and then by a swoon on Friday. By the end of the week, the various S&P 500 sectors remained in a downtrend, with money flow negative on the week and a weak advance-decline line for NYSE common stocks.

The Cumulative Demand/Supply measure (top chart) remains moderately oversold, and we're coming off of expanded new 65-day lows (middle chart) among NYSE, NASDAQ, and ASE stocks on Thursday. Each selloff since October has resulted in fewer stocks making new 65-day lows, but we have also been unable to sustain periods in which new short-term highs have outnumbered new lows. This lack of buying interest is reflected in the Cumulative NYSE TICK line (bottom chart), which has been falling steadily through the week.

So that's the dilemma: while recent selloffs have not been as broad and sustained as in early October, neither are we yet getting indications of sustained buying interest. Until that occurs, it is premature to assume that a durable intermediate-term bottom is in place. The followthrough to Friday's weakness--whether we can hold Thursday's lows--will tell us a great deal about how much firepower the bears retain.

Sunday, November 16, 2008

Trending Markets and the Volume Weighted Average Price (VWAP)

Brian Shannon has nicely described how the volume-weighted average price (VWAP) serves as an institutional measure of value for the trading day. VWAP builds during the day, with price weighted by the volume traded at that price. As a result, an uptrending market that is attracting volume from buyers will show a smoothly rising VWAP. During such an uptrend, price will remain above VWAP and will build distance above it. Conversely, in a downtrend that is attracting volume from sellers, we will see a steadily falling VWAP. Price will remain below VWAP and will build distance below it.

We can think of VWAP as the market's emerging estimate of value for the trading day. Thus, where we trade relative to VWAP tells us whether we are shifting value to the upside or downside. In the chart above, we can see that crossovers of VWAP told us we were not trending on the day. On range days, we will oscillate above and below VWAP; fading those moves for a return to value becomes a successful trade.

Much of intraday trading consists of recognizing when we are escaping the orbit of value/VWAP to the upside or downside and when we are bound to its gravitational pull.

Cumulative New Highs/Lows and Stock Market Trends

One way to define a trend is a period in which more stocks are making new highs than new lows. I've taken new 20-day highs and lows across the NYSE, NASDAQ, and ASE going back to 2002 and created a cumulative line from the data. When the (pink) line is rising, we have a period in which new 20-day highs are outnumbering new 20-day lows. When the line is falling, new lows are dominating.

At times of transition, we see a handoff between new highs and lows. When the market made a momentum low in October of 2002 (top chart), the cumulative new high/low line also made a low. This was followed by a significant rally in which new highs meaningfully outnumbered new lows. When stocks retested their lows in March of 2003, the cumulative new high/low line did not confirm.

The reverse was the case at the 2007 market top. We saw new 20-day highs consistently outnumber new lows into the momentum peak at mid year (middle chart), then a topping and meaningful pullback of cumulative new highs/lows, followed by price highs in October that were not confirmed by the cumulative high/low line.

As we struggle to hold recent lows in the S&P 500 Index (bottom chart, blue line), the cumulative new high/low line continues to march to new lows. So far, we see no non-confirmations on the order of the two trend reversals illustrated above.

Saturday, November 15, 2008

Sector Update for November 15th

Last week's sector update found that the eight S&P 500 sectors that I follow had turned bearish in their short-term trending. Here's how we're looking at the end of this past week, based upon the Technical Strength measure.

ENERGY: -140

We can see that, despite volatile moves to the upside and downside this past week, the trending behavior of the sectors is pretty similar to last week. While we've seen short bursts of impressive short covering/buying, we haven't yet been able to turn that into a sustained uptrend. As of the close on Friday, only 13% of SPX stocks were above their 20-day moving averages, according to Decision Point. One reflection of the market's weakness this past week: on Thursday, 155 out of the 500 S&P stocks made fresh 52-week lows. That remains lower than the 228 lows registered in late October and much lower than the over 400 (!) SPX lows that we saw in the second week of October.

Conflict and Creativity in Trading Performance

As part of elaborating a cognitive perspective on trader performance, I recently took a look at the role of creativity in trading. From this vantage point, idea generation can be described as a two-part process of observation and analysis followed by comparison and synthesis. The creative insight occurs when observation and analysis lead to contradictory conclusions, requiring a fresh perspective that bridges these contradictions.

Let's take an example that has occurred many times over in my work with portfolio managers and traders. Suppose I am working with an active trader while he is trading; he is intently watching the market and trying to make sense of what he is seeing. The market moves within a relatively narrow range near the highs for the day session. Once, twice, three times the trader starts to click on a price to enter a buy order, only to pull back. It looks as though support is holding and an upside breakout is imminent, but every time the S&P 500 futures tick up, they run into a wave of selling from market makers. The NASDAQ futures move to a marginal new high for the day...once again the trader is ready to buy...the bank stocks still look weak...the trader is glued to the screen.

Suddenly, the trader exclaims, "This thing is ready to collapse!" Not enough volume could eat through the modest offers resting above the market and suddenly there is a pulling of bids. "That's what happened yesterday!" the trader explains, recalling a similar intraday decline. He quickly sells the futures before a flood of sell orders hit the market, waits for the futures to take out an obvious near-term support level on increased volume, and covers his position into the selling.

What we see in such an example is a careful process of observation and analysis initially leading to contradictory conclusions. During the tension of this contradiction, the trader is caught between competing impulses. Then a fresh set of observations leads to a new perspective: the way in which orders were entered and pulled near a resistance level brought to mind the previous day's market. That similarity reorganized the trader's thinking and led to the creative insight that the market was about to collapse. No longer trapped in contradiction, suddenly possessed of clarity, the trader is able to act decisively.

An important implication of this cognitive account is that many problems of trading performance are the result of a breakdown in the creative process. Effective creativity seeks contradiction; it thrives on dialectical tensions and resolutions. This tension, however, is not comfortable--and it does not come naturally. As we know from behavioral finance research, some of the most common trader and investor shortcomings are confirmation biases and disposition effects that lead us to avoid short-term discomfort. We look for evidence that supports our positions; we sell winners for quick gratification and hold off on selling losers to avoid pain.

Many of the most successful portfolio managers I've worked with are quite insightful about their process of idea generation. They know what to read, who to talk with, and how to process information to get to the point of "Aha!" Most market participants, however, are only dimly aware of how they generate good ideas for trading and thus cannot standardize how they think across situations. Imagine a factory that changed how it produced goods based on the ups and downs of daily sales: quality control would go right out the window. Traders, however, will shift their processes from hour to hour, day to day in ways that they don't recognize.

Much coaching of traders helps them think about performance. Some of the most effective coaching, however, helps traders think about their thinking and understand the processes that they utilize to make sense of markets.

Friday, November 14, 2008

The Role of Creativity in Trading

In my last post, I sketched preliminary ideas regarding a cognitive theory of trading performance. One important implication of such a theory is that declines in the performance of traders and portfolio managers may not simply reflect "discipline" problems in the face of emotional pressures. Rather, a host of internal and environmental factors may conspire to shift market participants out of their optimal modes of processing information.

How does one generate an idea for trading or investment? I propose that this is a two-step process in which observation and analysis is followed by consolidation and synthesis. In the ideal trade, a number of observations relevant to markets and market participants come together and crystallize as a core idea or theme. Traders are familiar with the feeling of "rightness" that accompanies a gratifying synthesis: suddenly, out of the welter of data, there is clarity. It all comes together, and the trader experiences an intuitive "feel" for what is likely to happen.

Readers will recognize this as a creative process, not unlike the creativity of scientists. After many observations of nature, a scientist will generate a model that is the basis for a theory. Many times, this model will spring from an insight derived from an analogy. The behaviorist B.F. Skinner, for instance, drew upon evolutionary thinking to explain how reinforcements select for certain behaviors and not others, resulting in learning.

The "models" created by traders may not be so elaborated or even conscious. They can take the form of an image of what is likely to happen or an idea of a theme integrating recent observations. We build such models according to our native modes of information processing. In each case, however, the model-building--the idea generation of the trader--is a synthetic process. It may unite fundamental information, information derived from price and volume, information from related markets, recent news, or some combination of the above. Synthesis is a fundamentally creative process, because it extracts fresh order and meaning from what is given.

Problems can occur in trading at many points in this analysis/synthesis process. We can fail to make market observations, simply out of an impulsive need to trade. We can make those observations, but then fail to make the shift to a mindset that facilitates synthesis. Many active traders underperform because they act before observation/analysis has an opportunity to crystallize in a creative insight.

An interesting article summarizes research into some of the factors that facilitate and interfere with creativity. One important conclusion from this work is that fear and time pressure hinder the creative process. "Time pressure stifles creativity because people can't deeply engage with the problem," the article notes. "Creativity requires an incubation period; people need time to soak in a problem and let the ideas bubble up." The competitive, fast-paced conditions that are present in much of the trading world don't naturally lend themselves to incubation. The active mindset needed to gather observations may not be the mindset necessary for integrating those observations into market insights and unique trading ideas. Traders, after all, can only be as good as the ideas they act upon.

More on this topic in the next post in the series.

Thursday, November 13, 2008

Toward a Cognitive Theory of Trader Performance

We tend to think of trading ideas and positions in terms of their objective characteristics: the market traded, the location of the trade, its direction, the size of the position, the target, etc. This can have the result of making any one trade look similar to others when a trader behaves in a disciplined fashion. It becomes confusing to the trader why some seemingly good ideas work out and others don't.

Suppose, however, we think of trading in subjective terms: how ideas present themselves to the trader. For example, some ideas are experienced by the trader primarily as subjective hunches and felt tendencies; other ideas may be expressed as explicit, planned ideas. Still other ideas can manifest themselves as images: pictures of what the trader thinks will happen. Yet other ideas take the form of analogies and metaphors, sometimes drawn from other markets, other times from entirely other spheres of experience.

Moreover, traders in the same market, looking at the same data (technical, fundamental, etc.) may process this information quite differently. Just as we have unique combinations of personality traits, we also possess distinctive cognitive styles.

Where fear, greed, overconfidence, stress, risk, and uncertainty may affect performance is by nudging traders out of their normal, effective cognitive styles. Under duress, a conceptual trader may act impulsively on a hunch. An intuitive trader might overthink markets. The trader who reasons in images or metaphors may become too detail oriented, analyzing where they should be synthesizing.

This suggests limitations to the usual coaching of traders, which tend to focus on strategies and feelings, not the cognitive path by which ideas are generated and expressed as trades. Traders may enter slumps, not because of market dislocations or psychological stress alone, but because of subtle and unrecognized shifts in how they process information.

A cognitive framework for thinking about trading performance strikes me as uniquely promising and fits well with my observations of hedge fund portfolio managers. In my next post on this topic, I'll offer a specific example and elaborate some of the implications of this view for self-coaching.

Tracking The Recent Stock Market Weakness

As the helpful chart from Decision Point illustrates, we're testing the October lows in the NYSE Composite Index (top pane), but we're already making fresh bear lows on the advance-decline line specific to NYSE common stocks only (bottom pane). Meanwhile, we had 1208 stocks make fresh 65-day lows across the NYSE, NASDAQ, and ASE, which is only about half the number that we saw in late October and less than a fifth of the number we saw during the second week of October.

With Wednesday's broad decline (declining stocks led advancing issues by over 2600 issues on the NYSE), the forty stocks in my basket (five highly weighted issues from each of eight S&P 500 sectors) have turned distinctly bearish. Only one stock is showing a neutral short-term trending mode on my Technical Strength measure; the remaining 39 are in downtrends.

While the non-confirmations to date from the new highs/lows and Cumulative NYSE TICK are enticing for bottom-fishers, the weakness among the S&P 500 sectors and the advance-decline line show us in a strong short-term downtrend. We've had some sharp upward bounces during the trading days this week, but the buying interest has not been sustained. We now need to see selling interest and momentum dry up at the range lows if this is indeed to be part of a bottoming process. To date, that drying up has not occurred.

Wednesday, November 12, 2008

Self-Coaching and The Sound Training of Traders

As we saw in the recent post, sustaining sound decision making during the heat of battle can be a major challenge for traders. Many traders try to correct that situation by writing in journals or simply by vowing to do things differently the next time. When the next time arrives, however, they are in a completely different state of mind and body and end up making the same mistakes. Working on decision-making under stress while you are cool and calm is not effective; you can't learn to operate under pressure unless you rehearse proper trading practices while you are under pressure.

This is why sports teams scrimmage as a form of practice; why military troops drill under battlefield conditions. If there is a single principle that governs sound training, it is this: rehearse skills under progressively realistic conditions. Talking with coaches does not, in itself, change traders. What changes traders is the right kind of experience in "the heat of the battle". Training builds trader mindset; no amount of mind games--in Olympic sports, elite military, chess, or performing arts-- can substitute for learning by doing.

When you are functioning as your own trading coach, you are also acting as your own trainer. You are creating a directed program to train yourself to perform more effectively under given sets of emotional and market conditions. This is why so many traders fail to change their behaviors, despite the best of intentions. They operate as if a coaching session--with self-talk or journal entries--can correct their problems, when what they really need is an ongoing process of training.

So how do you train yourself to operate in the heat of trading? A very effective technique is to dedicate at least 15 minutes each day before the start of trading to guided imagery work. In this exercise, you recreate in your mind as vividly as possible actual situations that have triggered your worst trading behaviors. For example, let's say that missing a market move has triggered frustration for you, leading you to chase trends and execute trades with very poor risk/reward. You would want to keep yourself relaxed and focused, sitting still and breathing deeply and slowly, while you vividly imagine missing a market move.

The key word in the above is "vividly". You want to picture the market running away from you without your being on board. You want to imagine the frustration you feel in that situation and the thoughts that go through your head. Most of all, you want to summon that feeling of wanting to jump into the market to make the money that you missed out on. All the while, during this imagery work, you are keeping yourself physically still and calm, with the help of deep breathing.

This is where I find biofeedback to be especially helpful. When you're connected to a biofeedback unit, you can actually monitor your body's level of arousal, so that you're able to keep yourself cool physically, even as you're mentally rehearsing scenarios under the heat of battle. (I will post a biofeedback linkfest to the new blog shortly, for readers who are interested in making use of this technology).

Once you've been successful in recreating those thoughts and feelings associated with your problematic trading, you want to imagine just as vividly how you would like to respond to those situations. So, for example, if perfectionism is leading you to feel pressure because you missed a market move, you would want to visualize yourself feeling the desire to jump into a "revenge" trade, reminding yourself that this has lost you money in the past, stepping back from the screen, telling yourself that there is plenty of future opportunity, patiently waiting for your next setup, and executing that next trade with a clear mind and favorable risk/reward.

What you're doing with the above exercise is training yourself to stay calm, focused, and disciplined while you're immersing yourself in stressful trading scenarios. The key to success is repeating this exercise, varying the details of the scenarios, every day before you start trading until the thoughts and behaviors you're rehearsing become second nature. It's not at all unusual for this to take a month of daily work, devoting at least 15 quality minutes to the exercise. Remember: this is training and no one trains themselves for performance events overnight. The time you devote to reprogramming your responses to trigger situations, however, is an investment that will yield impressive returns throughout your trading career.

Tuesday, November 11, 2008

Becoming Your Own Trading Coach Blog

Most readers are probably aware that I started a new blog in support of the Trading Coach book that will be coming out in the first quarter of 2009. Over time I'll be developing the new blog into a resource collection for traders interested in the psychological aspects of trading performance.

Here are a few recent linkfests from the Trading Coach blog:

I will be adding resources to the new blog periodically, including supplementary material to update and elaborate the new book.

Staying Cool in the Heat of the Battle: A Key Skill for Active Traders

So often in my meetings with active (intraday) traders, I hear the phrase "in the heat of the battle." Usually what follows that phrase is a description of some trading mistake: trading too aggressively, ignoring risk guidelines, deviating from planned ideas, etc.

The problem is not that traders make these mistakes; we all do at times. Rather, the problem is that the mistakes become compounded "in the heat of the battle". Once traders are caught up in that heat, they lose the ability to recognize what is going wrong. They also lose their perspectives on markets.

Heating systems in homes have thermostats that control temperature. When the room becomes too cool, heat kicks on. When the room becomes warm, the heat turns off. Many active traders lack an emotional thermostat. They don't know their temperatures. They are like heating systems that get the room hotter and hotter, until the house is unbearable.

One of the core ideas from The Psychology of Trading--and perhaps one of the most important ideas I've ever put forward--is that many of the problems that affect traders are state-specific. How traders think and behave is relative to the states of mind and body that they are experiencing at the time. The reason that coaching (and self-coaching) often doesn't work is that we are in one state of mind and body when we are analyzing and working on our problems and in a completely different state when we are experiencing the triggers that set off those problems.

This explains the common experience that traders have when they look back on their day's performance and wonder, in amazement, how they could have made such rookie mistakes. In a normal frame of mind, they wouldn't have acted so rashly. In "the heat of the battle", they become a different person; they process information differently.

Few challenges are more important to active traders than the ability to develop an emotional thermostat. But talking with a coach, writing in a journal, or vowing to oneself that next time will be different won't touch the problem. As my earlier book stressed, you can only solve the problem by entering the state that is specific to that problem and then reprogramming your patterns of thought and behavior.

My upcoming book will have much to say on this topic, with specific exercises. In my next post in this series, I'll outline a specific strategy that has helped me and many of the traders I've worked with.

Monday, November 10, 2008

A Few Thoughts About Traders and Trading

I spent the day in Chicago meeting with traders; here are just a few thoughts from those meetings:

* Risk Management - If you lose 10% of your trading account, you need to make 11.1% on the remaining capital to get back to even. If you lose 20% of your account, you need to make 25% on the remaining capital to return to breakeven. At a 30% loss, you have to make 37.5% to become whole; at 40% loss, you have to make 67% to return to even. Once you've lost half your trading capital, you need to double the remainder to replenish your account. Much of trading success is limiting losses and avoiding those fat tails of risk.

* What is a Trader? - If you ask a trader what is a good market, he will tell you that it's a market that has good volatility; a good market is one that moves. If you ask an investor what is a good market, he will tell you that it's a rising market. Lots of people try to succeed as traders with the mindset of investors. It doesn't work.

* Refutation - The story goes that Samuel Johnson, upon hearing Bishop Berkeley's theory that objects existed in mind only, kicked a rock in front of him, announcing, "Thus I refute Berkeley!" The incident came to mind when I met with a trader today who trades very actively every day, has made money on more than 80% of days this year, and has made several million dollars this year. His performance was clearly documented by his firm and the firm's risk manager. Thus he refutes efficient market theory.

* Success - When I see traders like the one above (quite a few at his firm are up more than a million dollars this year), it's an inspiring reminder that success *is* possible to those who work diligently at trading as a career. The support of a superior firm doesn't hurt, either.

Indicator Update for November 10th

Last week's indicator review noted considerable strength among the indicators, overbought readings, and resistance around the 1000 area of the S&P 500 Index. After some continued strength early in the week that briefly took us above that 1000 region, very strong selling hit the market for two consecutive days before a bounce on Friday left us pretty much in the middle of the wide range defined by the October lows and the recent price highs. As I noted in that earlier review, until I observe signs of breakout or breakdown among the indicators, I continue to view this action as part of a bottoming process that started with a momentum low around October 10th.

We continue to see signs of buying interest in the Cumulative Adjusted NYSE TICK line and a downward trend in the number of stocks making fresh 20-day lows. Overall, however, the majority of stocks within the major S&P 500 sectors are in short-term downtrends. We have come off very overbought levels in the Cumulative Demand/Supply Index (bottom chart) and finished on Friday at relatively neutral levels. While we've seen a reduction in the number of issues making new 65-day lows (top chart), we have not yet seen a meaningful expansion of 65-day highs, given the sharp market decline of the past few months.

The advance-decline lines specific to the S&P 500 large cap stocks and the S&P 600 small caps are off their late October lows, but also off their recent highs after the strong two-day selloff. That 1000 region of the S&P 500 Index remains important resistance; we saw plenty of sellers enter the market when we hit that mark. Unless and until we can pierce that level with some decisive breakouts among the indicators, I view this as a range market and expect further testing of market lows.

Sunday, November 09, 2008

Learning to Trade: Viewing Yourself, Reviewing Your Trading

In a recent post, I emphasized that much of the development of trading expertise is a function of pattern recognition and the ability to act upon patterns promptly in real time. A classic example of performance by pattern recognition is the development of competence and expertise among radiologists. Reading an x-ray or other form of imaging means being able to detect normal variations from abnormal ones. In the beginning, to the untrained eye, most medical images will look alike. Only with repeated exposure to images and their variations will medical students learn to make and rule out diagnoses. No amount of book work can substitute for learning at the bedside and reviewing film with experienced physicians.

The trader who video records his or her trading has a powerful tool for accomplishing three learning tasks:

1) Seeing more market patterns and cementing those more firmly in mind;

2) Reviewing performance to assess areas of trading that need more work and to formulate goals for such work;

3) Reviewing performance to assess areas of trading that represent strengths, so that these can be crystallized and recruited during future trading.

When I left my full time work with proprietary traders in Chicago and began working with bank and hedge fund traders, I was surprised by the sophistication of the latter group in terms of portfolio management and equally surprised by that group's utter lack of feel for short-term market movement. Many times, a portfolio manager would describe an excellent idea to me and then execute it at the absolute worst time of day. I realized that, as savvy as the institutional traders were, they lacked the frequency of exposure to short term market patterns and hence had no real "feel" for when buyers or sellers were dominating (or losing their dominance) from minute to minute, hour to hour.

Traders who use video recording in essence double their exposure to market patterns--and to their own patterns as traders. Because pattern learning is a function of the number of repeated exposures to various configurations, the trader who not only views markets, but also reviews them, is more likely to enjoy an accelerated learning (and performance) curve.

The two most common means of recording that I've encountered in my work with traders is desktop video (software that records your screen) and actual video recording with a camcorder pointed at the screen. The former is available through programs such as Camtasia; the latter is best accomplished with a camcorder that includes a large hard drive.

Of course, it doesn't make sense to review the entire trading day, every trading day. In general, the best reviews come from your best trades and your worst: those will cement what you do right and what you need to improve. If traders only reviewed their single best and worst trades each day--what the markets did and what they did--I suspect they would be more likely to achieve competence, and would do so in less time than the trader who packs it in at the market close.

Remember, however, research suggests that it is not just what you review but how that makes all the difference in learning. The most powerful learning takes observations and turns them into concrete goals for future observation. Passive watching of markets (and one's own performance) is much less powerful than active watching and goal setting.

Call To Bloggers and More on Learning Markets

* Call to Bloggers - Thanks to the Twitter feature, which provides a blog within this blog, I'm able to link to blog posts that offer unique perspectives on trading and the markets. I'm looking particularly for interesting analytical content, not opinion pieces, emotive posts on markets and government policies, self-promotional material, or first person trading accounts. If you have a unique analysis of trading or markets (not necessarily quantitative), by all means pass along the URL and I'll be happy to link to your work. (My email address is on the blog page, under "About Me"). BTW, I just posted my 4000th Twitter post; thanks to readers for the continued interest.

* Viewing and Reviewing Markets
- SSK continues to offer nice examples of learning from market patterns by reviewing charts and by reviewing patterns of successful trading via video.

* Reviewing the Week - Jeff Pietsch offers a market rewind; check out the extensive sector ETF info in the table accompanying his post.

* Learning to Trade - Ana Wang notes that it takes more than spoon feeding.

* Annoyance - When the car service isn't there to pick you up at the airport.

* Only 499 Being Offered - Sweet!

Saturday, November 08, 2008

NYSE TICK, New Highs/Lows, and Testing Market Lows

Although we seemed to be headed toward a test of recent lows this past week, the cumulative adjusted NYSE TICK line has continued to show relative strength. Should we get that retest of lows, a number of indicators appear to be setting up non-confirmations. In addition to the TICK line, we're also seeing a very modest number of stocks hit fresh 20-day lows. On Friday, across the NYSE, NASDAQ, and ASE, we had 280 new 20-day highs, against 418 lows; Thursday had 297 new 20-day highs and 417 lows. Compare that to the 2564 new 20-day lows on October 24th and the 6561 new 20-day lows on October 10th. I will be watching these indicators closely to see if participation continues to wane on further weakness.

Sector Update for November 8th

Last week's sector update found a neutral short-term trending mode among the eight S&P 500 sectors that I follow via a basket of 40 stocks (five highly weighted issues within each sector). After briefly turning bullish, the two-day decline of Wednesday and Thursday returned many of the sectors to their short-term downtrends. Here's how we stand on the Technical Strength measure, with the percentage of stocks in each sector trading above their 20-day moving averages--as assessed by the excellent Decision Point site--in parentheses:

MATERIALS: -380 (23%)
INDUSTRIAL: -200 (16%)
ENERGY: -60 (38%)
HEALTH CARE: -140 (43%)
FINANCIAL: -280 (21%)
TECHNOLOGY: -280 (18%)

We can see that recessionary concerns are weighing on raw materials stocks and technology shares. Financial stocks, after seeing a solid bounce thanks to government support, have since fallen back into a short-term downtrending mode.

The percentage of stocks above their 20-day moving average captures trending on a more intermediate-term time frame. Note that sectors that bounced well during the recent market rise, such as health care and energy, still show fewer than half of their components trading above their moving averages. Particular weakness is evident among consumer discretionary, technology, and industrial sectors--all reflecting recessionary concerns.

Friday, November 07, 2008

The Relative Appeal of Gold

Gold is unusual in that it is both a commodity and a surrogate currency. While gold's value has fallen along with other commodities, note that it has also displayed relative strength with respect to other commodities since the mid-year swoon. The chart above depicts the ratio of gold (GLD) to the commodities ETF (DBC). When stocks made their October lows along with commodities, gold's performance relative to other commodities was breaking to new highs.

While many commodities are falling due to economic weakness (oil, industrial metals), gold may be retaining a degree of interest given the worldwide race to zero interest rates--and the monetary expansion likely to ensue if those rates prove insufficient to stimulate growth.