Saturday, October 31, 2009

More Good Saturday Reading

* Crash coming in commercial real estate?

* Fed may not bail out commercial real estate;

* Excellent global/economic overview;

* Eye-opening economic summary in graphs;

* A research look at clean energy and investment;

* The case for big oil;

* Default rates on homes much lower than the percentage of homes underwater;

The Dangers of Going on Tilt

One of the most self-defeating attitudes I've found among some traders is that it is somehow competitive and even desirable to "go on tilt". My experience is that traders on tilt are frustrated; they fight market movement and overtrade out of emotions. In fact, I can't think of a time when I've seen a trader on tilt actually trade well and make significant money. It always ends badly.

That is very different from being motivated and psyched up. The motivated trader is responding to anticipation: the expectation that comes from seeing markets well and looking forward to taking advantage of that vision. The trader on tilt is simply frustrated by prior events. Tilt is the epitome of being reactive, not proactive in outlook.

If you doubt that tilt is an undesirable state, imagine yourself as a patient in an operating room. Your surgeon has begun the prep for your surgery. With each successful step, he pumps his fist and yells out. When a portion of the preparation doesn't go well, he loudly curses, throws his surgical instruments, and yells at the OR staff.

Is that the surgeon you want for your procedure?

You get the point: consummate professionals don't go on tilt. Ever. Not in the operating room. Not in the cockpit of a plane. Not on the battlefield leading troops. Not anywhere there is significant risk. Professionalism means staying task focused and dealing with powerful emotional responses later.

After all, would you turn your money over to a money manager who swung high and low, hot and cold, with each gain and loss in your portfolio? So why manage your own money that way?

When Trading Dreams Seem to be Fantasies

Well, I'll date myself in the goth scene by telling you that I'm listening to
one of London After Midnight's tracks from "Violent Acts of Beauty" while writing this. What else does one listen to on Halloween?

The song, though, is about disappointment: what happens when everything you felt was perfect and pure were but nothing more than fantasy.

Just about every trader I've known has gone through that wrenching period of doubt. The successful ones get to the other side, where the fantasies are replaced by hard--but useful--realities.

The fantasy is that you'll start trading and, within months, begin making a fine living. You'll be your own person, doing what you love, making plenty of money, and having time for all that is important in life.

It doesn't happen. Not within months. Not within trading, nor within any other performance discipline.

You don't pick up the golf clubs for the first time and, within months, join the PGA tour. You don't go on stage for the first time and, within months, land a contract on the Broadway stage.

So much of what frustrates us in trading is not the trading itself, not the markets. It's the expectations--the unrealistic expectations--that we bring to our trading. The demands that we place on ourselves. The fantasies that ensnare us.

You start as a novice and first grow to competence. Only after that do you hit that elite level of expertise where you can make a living from your performances.

But if you have to reach competence before you reach expertise, that means that when you start out you are *not competent*: you are incompetent. It's not easy to embrace that reality. For months when I first swing golf clubs or play a piano, I'm not going to impress many people. And that's OK.

Because in the beginning, you don't have to be good; you just have to get better.

And better.

And better.

Sean sings about "going to the open sea and...going to say goodbye to me". To kill off our fantasies and unrealistic expectations seems like a kind of suicide. Some people can never let them go. But once you've enter that sea, you can find a different "me": someone who finds opportunity in setbacks and pride in the real, challenging, and sometimes wrenching efforts that define the path toward genuine success.

Friday, October 30, 2009

Important Reading to Start the Weekend

These aren't the easiest readings, but they're what some pretty smart people are looking at, so I thought I'd pass along, with major props to Morgan Stanley:

* Roadmap for the Fed's exit strategy;

* Issues associated with excess reserves on the Fed's balance sheet;

* Outlook for inflation and why the Fed might want "controlled inflation";

* Prospects for hyperinflation;

* Stealth inflation will become manifest when Fed stops paying interest on reserves.

More Volatility, More Weakness

Stocks did indeed close near their lows, trending lower through most of the session. By day's end, we saw the number of stocks making new 20-day lows across the NYSE, NASDAQ, and ASE stay over 2200--remarkable given yesterday's solid bounce.

I took a look at what has happened historically after we've had three consecutive days of 20-day lows exceeding 2000. Going back to late 2002, which is how long I've kept these data, we find only 39 instances of such weakness. The next trading day, the S&P 500 Index (SPY) has averaged a gain of about 1% (24 up, 15 down). I find no significant upside or downside edge after such a relief bounce.

What *is* particularly noteworthy is that such weakness has tended to occur during periods of heightened volatility. The standard deviation of next day returns following three days of significant weakness has been 3.63%, nearly three times the level of the remainder of the sample. Such heightened volatility was evident as far as 20 days out, doubling the level seen during other periods in the market.

That suggests that, whether or not weakness is finished, the recent levels of heightened volatility may persist into next week.

Signs of a Trend Day to the Downside

Well, I posted on the topic of a trend day to the upside; I guess it's only fair that the market show us some dynamics of a candidate trend day to the downside.

What are the tells?

* Inability to take out overnight highs on economic news;

* Break below the opening price range (blue line);

* NYSE TICK consistently negative;

* Intermarket themes show strong dollar, weak commodities;

* S&P 500 sectors consistently down from their opening prices;

* S&P 500 Index trading consistently below its volume-weighted average price;

* Volume in ES futures consistently hitting bids over lifting offers;

* Price consolidations at successively lower prices (blue arrows above).

If this is a trend day to the downside, the Thursday lows should now act as resistance for any midday bounces.

NYSE TICK and Intraday Sentiment at a Glance

The NYSE TICK gives a reading of intraday sentiment, as it shows the number of stocks trading on upticks minus those trading on downticks. Since it takes program trades to move stocks up or down in unison, very high or very low readings of NYSE TICK provide a tell as to the directional bias of such programs. Note that, to this point today, we've had only two readings above +800, but many more below -800. We can also see that TICK has spent more time below the horizontal blue zero line than above. When you combine those observations with this morning's intermarket themes (weak commodities, strong dollar), you can see why it has made sense to lean toward the sell side in stocks.

Morning Briefing for October 30th: Some Renewed Dollar Strength, Stock Weakness

The U.S. dollar is showing renewed strength vs. the Aussie dollar (bottom chart), and we're seeing a pullback of stocks (top chart) back into their 10/28 range, after having broken above that range yesterday. That leaves us in a broad trading range defined by the overnight highs today/Thursday highs and the 1040 level in the ES futures from which we launched yesterday's rally/Wednesday lows.

USD strength reflects, in part, concerns over the Fed meeting next week amid signs that some central banks (Australia, Norway) have begun their exit strategies from low interest rates and monetary ease. Any hints of rate rises on the horizon could impact the dollar to the upside, which has seen weakness translate into appetite for commodities and stocks.

Yesterday's sharp rally after recent considerable weakness suggests that we may have seen an intermediate-term momentum low put in by the stock market. If so, I'd be looking for signs of bottoming--fewer stocks making fresh 20-day lows and fewer stocks trading below their 20-day moving averages on weakness--before seeing a fresh bull leg. It would not surprise me to see markets trade hesitantly and in range fashion as we move closer to next week's Fed announcement.

If You're Fighting a Trend, You're Defending Your View

One of the most common problems I see among intraday traders is that they end the day flat in their positioning, but not flat mentally. That is, they have no overnight risk, but they have a strong directional opinion on a swing or larger time frame.

Worst of all are intraday traders who become enmeshed in opinions about long-term market action, economic fundamentals, and political developments. Those views take the active trader away from the simple supply and demand that govern action on the day time frame.

Perhaps an example would be instructive. If I want to anticipate where my wife is likely to want to go out to eat, I don't reflect upon her distant past or her long-term aspirations. I'll look to where we've eaten most recently, what new places have opened, and what looks good for that night. If it's Saturday evening, I might not lean toward the most crowded areas of town, knowing she doesn't like to wait on lines. The longer-term information about her history or about her future plans simply does not drive the decision-making on such daily matters.

Quite a few intraday traders yesterday were run over by the strong uptrend day, which followed a strong downtrend day. Now if you had held a short position overnight, it's understandable that you would incur a drawdown. But if you went home flat overnight and spent yesterday fighting the market movement, it means that you didn't go home flat mentally. You weren't processing the mass of data that were telling you that this was a strong market day.

A while back, when I reviewed my trading results, I found that my performance was much better when I waited at least 10-15 minutes into the day to enter my first position. The reason for that was that, by then, most stocks had opened and I could see if the market was behaving in strong or weak ways. If I didn't wait for the early market action, I was more likely to be trading my opinion or prediction of what would happen--not what was actually transpiring on the day time frame.

All of this is not to say that longer-term trends and market data are unimportant. To the contrary, they are an important context to intraday market movement. But awareness of context cannot substitute for a reading of text: you cannot ignore *what* a person is saying and simply focus on their setting and how they're speaking. Worse still, you can't understand a person and respond sensitively if you're engrossed in predicting what he or she will say next.

If you're fighting a trend, you're defending your view. And that means you're ignoring the market. When the ego is out of the way, the view doesn't matter: you're free to sit back, read the market, and follow its signals. Conversations, with markets and people, go much better if you maintain an open mind and simply listen.


Thursday, October 29, 2009

Thursday Items on the Radar

* Sign of the times: commodities are the asset class of choice;

* Banks making fewer loans and holding more risk-free Treasuries;

* Thanks to an alert reader for the link to this stunning display of industrial pollution in China;

* Hedge funds betting on gold;

* Lessons from a Navy SEAL;

* A Market Profile view of major stock indexes;

* Thoughts on the impact of oil prices;

* A reality check for traders;

* An ETF if you're bearish on semiconductors.

Signs of a Trend Day to the Upside

Here are some clues as to an upward trend day, referencing the Market Delta chart above:
* Price breakout above the overnight trading range on good volume;
* Price staying above the overnight range on pullbacks;
* More volume transacted at the market offer price than at the bid (bottom histogram);
* Price consistently staying above the day's volume-weighted average price (VWAP; red line);
* Accepting value higher by building volume at higher price levels within each bar;
* Repetitive breakouts above areas during the day where volume accumulates (side histogram);
* A very strong intraday advance/decline ratio;
* Persistently positive NYSE TICK, with few readings < -800 and many > +800;
* The vast majority of stocks and sectors trading up from their opening prices.
The earlier you can see these signs, the quicker you'll be able to identify the day structure and adapt your trading strategy accordingly.

My Visit to SMB Capital

It was excellent visiting the traders at SMB Capital and their new offices a hop, skip, and jump away from Wall Street.

Here's what I observed first hand:

* A structured training program with a well organized curriculum that teaches specific setups and trading methods;

* Dedicated teaching and mentorship; not just learning from the seat of the pants;

* Morning meetings to prepare for the trading day in which multiple traders participate with ideas;

* A coherent philosophy of trading that focuses on tape reading skills among stocks that are moving and offering opportunity;

* A thoughtful strategy for managing risk and maximizing reward.

It may not be the type of trading that is for everyone, but it was nice to visit a firm that has integrated training and trading in a positive learning environment.

A Visit to SMB Capital

Here's a nice post from Mike Bellefiore of SMB Capital regarding how he trades a particular stock. The takeaway from the post is that, when you have good reason to be in the market, you stay there until there is a definitive reason to exit.

Mike is in the process of writing a book that explains a great deal of the philosophy behind their trading firm. You can also get a peek into their trading through their Stock Twits video segments, such as "stocks in play" recently outlined by Steve Spencer.

One of the things I've gathered from an early draft of Mike's book is that the firm seeks three sources of edge: 1) managing risk/reward both per trade and across the day; 2) deploying capital across the best stocks (those "in play"); and 3) putting traders through a highly structured training program that features hands-on mentorship.

I'll be talking with the SMB traders later this morning, and I understand that the presentation will be videoed for later broadcast via Stock Twits. The topic of the talk will be "Going Off Tilt": how to manage frustration during the trading process. It's a pleasure working with pros who are also great guys. I'll post the URL for the video once it's published.

A Jump in Stock Market Volatility and Its Implications

Here we see the S&P 500 Index (SPY; blue line) plotted against the average five-day high-low range for SPY. Notice the significant jump in volatility during the recent selloff, as the average range has essentially doubled from its October lows. This has meant in recent days that the more distant profit targets, as published each morning before the market open via Twitter (follow here), have been consistently hit and even exceeded.

It is interesting that many traders will adapt to directional changes quicker than they adapt to shifts in volatility. That is, they will notice a breakout or trending move, but will not adjust stop loss levels and price targets to account for enhanced (or dwindling) volatility. The increase of volatility becomes a double-edged sword when traders trade well vs. poorly: if a trader increases his or her size in a rising volatility market, the variability of daily P/L will rise significantly. That is why going on tilt in a rising volatility environment can be so dangerous.

Wednesday, October 28, 2009

The Essence of Trading Psychology

Let's see if I can capture the essence of trading psychology in a single image.

Imagine the distribution of an active trader's daily P/L across a calendar year. There are peaks near the center of the histogram, with many days of relatively small winning and losing days. There are fewer big losing and big winning days.

How fat and extended the tail is at the right side of the distribution tells us how many big winning days the trader has had. This is a measure of aggressiveness and risk-taking: the ability to press an advantage when it's present.

How fat and extended the tail is at the left side of the distribution tells us how many big losing days the trader has had. This is a measure of discipline, prudence, and self-control.

How many winning vs. losing days the trader has is a measure of edge: one's ability to find opportunity in markets across market conditions.

The ability to go for the knockout when you have the market on the ropes; the ability to play defense when the market is fooling you; the ability to stay mentally flexible and find an edge across the many market conditions that occur during a year: all of trading psychology boils down to those virtues--and the resulting shape of one's P/L distribution.

A Look at Recent Market Weakness: Technical Damage

Note the price breakdowns today in the Russell 2000 Index (IWM; top chart); banking stocks ($BKX; middle chart); and homebuilding stocks (XHB; bottom chart). Each group has broken below recent lows, making multimonth lows.

I note also that, today, we registered 790 new 65-day lows among NYSE, NASDAQ, and ASE issues. That is the highest level of new lows since the March stock market bottom. What that means is that an increasing number of stocks are no longer in a bull market mode of making higher price lows on pullbacks.

We've also taken out the early October low in the advance-decline line specific to NYSE common stocks, as reported by Decision Point. Clearly the recent drop has inflicted some technical damage to this market. As mentioned earlier, as long as we continue to expand the number of stocks making new lows and Supply is handily outstripping Demand, it is premature to try to call a market bottom.

Midday Briefing for October 28th: Reversing the Risk Trade

We're seeing some unwinding of the "risk trade", in which portfolio managers betting on global growth buy commodities and emerging market stocks (as well as the currencies of the commodity-producing countries). Thus, we're seeing metals and energies weak among the futures contracts (top heat map from Barchart) and the Canadian and Aussie dollars weak, especially vis a vis the "carry" currencies of the yen and U.S. dollar. Seeing these intermarket relationships is helpful in gauging the likelihood of reversal vs. continuation of the downmove in the stock market. As long as risk assets are selling off pretty much across the board, stocks will tend to follow suit.

Idiot Trades and Trending Markets

In this post, I'll define what I call "idiot trades" and then I'll define trending markets.

An idiot trade is one that occurs in a market that has already made a healthy directional move. As the market is further moving to new highs or lows, the idiot trade chases the movement with large size transacted at the market. Thus, it's hitting bids into market weakness or lifting offers into strength. The trade is sized up, so that the trader is basically going "all in".

The reason it's an idiot trade is that, most often, it's a capitulation. The trade is made either out of panic (can't stand the heat and ignored earlier stop levels) or out of a fear of missing "the big one". The key to an idiot trade is that it is made more for psychological than logical reasons.

Make sense? We've all placed idiot trades. They make us feel like idiots when the market, having made its healthy move, then makes a normal retracement, leaving us under water with good size on or just leaving us with the bitter feeling that we sold the low tick or bought the high one.

What makes it worse is that sometimes we *know* we're making an idiot trade even as we're executing it. My worst exits have been idiot trades, where I'm getting out simply because I'm afraid of giving back a profit or losing a larger amount of money. The idiot trade is made to seek relief, not necessarily to maximize reward relative to risk.

So what's a trending market?

It's one that ultimately does not punish idiot trades.

If you watch trades come into the market at key price levels (Market Delta is good for this), you can see the idiot trades and sometimes you can see herds of idiot traders acting in concert.

How the market ultimately treats those positions tells you quite a bit about whether we're in trending or range bound conditions.

Morning Briefing for October 28th: Dipping Below the Line

Thus far in the bull run, it's been a pretty linear rise, with dips below the 20-day volume-weighted moving average representing intermediate-term buying opportunities. We're seeing just such a dip at present, with over 1500 NYSE, NASDAQ, and ASE stocks making fresh 20-day lows.

As a rule, the longer a market spends topping out (i.e., the longer the time that elapses between a momentum peak and an ultimate price peak), the more extended the subsequent decline. The trick is that the decline can become extended in time (as we saw during the June to July period) as well as price.

With the September momentum peak and the October price high, I expect that any decline could be extended in time--not just price--which is keeping me so far from buying this most recent dip below the 20-day VWAP. I will begin nibbling at the long side when we see signs of bottoming in the new highs/lows, Demand/Supply, and percentage of stocks below their 20-day moving averages. I track all of these daily via Twitter; you can follow here or keep an eye on the blog page for the last five tweets.

Tuesday, October 27, 2009

Tuesday Market Perspectives

* Henry Carstens is posting the positions from his trading system via Twitter; I see he has doubled down on the long side;

* Looking at signs of a double top;

* Getting close to the bottom of the stock market's linear regression channel;

* Since the March bottom, weak closes have tended to be buying opportunities;

* An inflation-hedged ETF and more good reading;

* A few noteworthy bearish signs;

* Great way of tracking ETFs each week;

* The future of the dollar as a reserve currency.

Three Reasons Traders Don't Make More Money

Here are three common problems that I've observed among experienced, talented traders who are struggling to get to that ever-beckoning next level of performance:

1) Position Sizing - They don't take their largest risk when they have their greatest feel for the market and conviction about direction. Very high confidence trades may be sized relatively small; lower confidence trades are sized too large (often to make money back from earlier losses). They are taking their biggest cuts at the plate when the ball is out of their strike zones;

2) Execution - They wait for markets to go up before they buy and to go down before they sell. As a result, they get in at prices that leave them unusually subject to pullbacks. Many times, particularly if the trades are sized large (see above), the heat will take them out of good trades. In short, they're not patient about getting into positions; they chase moves, fearful that they'll miss a profit opportunity;

3) Rigidity - They don't adapt to changing markets. They look for big moves in markets with declining volatility; they trade breakouts when signs point to range conditions. They set stops and profit targets in ways that don't adapt to shifting volatility. They expect the market to accommodate what they're doing rather than vice versa.

How much money you make is a function of what you trade and how you trade it. Many traders will switch what they trade (markets, stocks, time frames), only to continue making the same mistakes outlined above. Getting into good risk/reward trades and then maximizing the risk/reward while the positions are on is a major driver of long-term trading success.

Morning Briefing for October 27th: From Support to Resistance?

I'm posting this from a car taking me from LGA to the trading firm where I'll be working for the next two days. Thank goodness for wireless broadband!

I guess I was tired enough a little after 3 AM CT, when I posted to the blog and Twitter, that I didn't realize I had reached my 3000th post on TraderFeed. Whew!

I'm watching the lows of 10/22 and 10/23 to see if that former support now acts as resistance for any market strength. As long as we're expanding the number of stocks making 20-day lows and seeing Supply handily outstrip Demand in my momentum measure posted each AM to Twitter, I'm not looking to wade in on the long side just quite yet.

Understanding Market Movement With VWAP

As noted in my recent post, there are many price levels that I utilize as reference points for intraday trading. One of the most valuable is the volume-weighted average price (VWAP). This can be calculated in Market Delta as an indicator; I typically chart it on my Market Delta screen as a red line that begins with the start of the new day's futures session.

The overnight session is thus included in the calculations, but tends to lose impact on the VWAP as time moves on, since volume is so much higher during regular trading hours.

The slope of VWAP gives a sense of intraday trend.

In a range market, we'll tend to trade on both sides of VWAP.

In a trending market, we'll stay dominantly to one side of VWAP.

When early moves fail to take out resistance or support, a return to VWAP often makes a high probability trade.

A valid breakout move during the day can often be seen as a rejection of VWAP, such that VWAP becomes a moving stop for the resulting trend trade.

If a number of sectors cannot sustain moves above or below VWAP even as the broad market trades above or below its VWAP, it's often an indication that we will not sustain a trending move.

Tracking moves above and below VWAP for individual stocks with programs such as Trade Ideas can give useful clues as to broader market movement, as certain sectors tend to take the role of market leaders for the session. (Financial stocks were an example today).

Monday, October 26, 2009

A Look at Lagging Segments of the Market

Above we see the Russell 2000 Index ETF (IWM; top chart); the raw materials ETF (XLB; second chart from top); the homebuilders ETF (XHB; second chart from bottom); and the regional banking ETF (KRE; bottom chart).

What do they have in common?

All failed to confirm the October price highs in the major large-cap indexes and now are falling back toward their September/October lows.

Whether those lows hold will tell us a good deal about the health of the overall market, as well as the economy. Weakness in raw materials, homebuilding, and regional banking suggests that some of the concerns from the financial crisis may not have been put behind us.

Midday Briefing for October 26th: Persistent Selling

Above we see the NYSE TICK for the morning; note the steady weakening, particularly as the U.S. dollar broke higher a little before 11 AM CT. The multiple readings below -1250 in TICK show very significant and persistent institutional selling, as we broke below the multiday range led by financial issues. Echoes of the bear market: It's been a while since we've seen panicky selling led by the banks.

Indicator Update for October 26th

Last week's indicator review found signs of weakening readings following a momentum peak in September. We did pull back in trading during the past week, putting most sectors in a rangebound mode. That moved us to a moderately oversold level in the Cumulative Demand/Supply Index (top chart), as stocks making new 20-day lows equaled those making new highs (bottom chart). Thus far, we continue to see the market indicators pull back at successively higher price lows; that is sustaining the longer-term uptrend. There is nothing in the current action thus far to change that pattern. Should we reach the oversold levels in the Cumulative DSI that have corresponded to intermediate-term lows in the recent past and sustain higher price lows (as well as higher new high/low readings), I would be a buyer for the next bull leg. Violation of those levels would have me viewing recent consolidation as a potentially more extended interruption of the bull market.

Weekly Pivot/Profit Target Numbers and Using the Numbers

As regular readers know, I publish each morning before the market open proprietary daily pivot and profit target numbers for the S&P 500 Index (SPY), along with a conversion factor (ESf) for the S&P 500 futures contract. Those numbers, along with other daily indicator data, can be accessed by following the Twitter stream for this blog. Here is an explanation of those numbers.

Reader and fellow blogger Matt recently asked a question regarding the value of pivot numbers. The way I use them is as rough guides for anticipated market movement, not as hard numbers for setting stops or taking profits. Because the figures are volatility-adjusted, I have a sense for the odds of hitting those numbers each day.

An analogy would be listening to the Chicago radio station for traffic updates. Those tell drivers roughly how long it will take to reach particular destinations, given current driving conditions. From that information, drivers can plot their path. When I have the pivot and target numbers and update my readings of sentiment (NYSE TICK, Market Delta), along with relative volume, I develop a rough road map that tells me about the likely path to various destinations. I find that useful in planning trades.

Here are the weekly pivot and profit target numbers (see this post for details):

Pivot=108.49; R1=111.23; R2=111.78; R3=112.51; S1=105.75; S2=105.20; S3=104.47. ESf=9.96.

Have a great start to the week!

Sunday, October 25, 2009

Sector Update for October 25th

Last week's sector update showed bullish short-term trending among most of the sectors, but stressed that this could be part of a topping process dating back to the momentum highs of September. We did indeed see a pullback in the market since then, with all sectors losing Technical Strength (a proprietary measure of short-term trending) from the week previous.

Indeed, if you click on the chart above, you can see that almost all of the sectors have reverted to a neutral trend status. Recall that Technical Strength varies from +500 (strong uptrend) to -500 (strong downtrend), with neutral readings between -100 and +100. Here is how the sector readings looked as of Friday's close:


The pattern of strength and weakness is similar to what we saw with the data charted earlier, illustrating the percentage of stocks within each sector trading above their 20-day exponential moving averages. Energy stocks lead the pack in relative strength, with relative weakness among financial shares.

The fact that so many of the sectors are trading in neutral trending modes reflects the fact that we are in a multiday trading range. I thought Friday's early action was noteworthy, in that the market could not work higher on positive earnings news and housing data. I also thought it was noteworthy that the selling on Friday could not take out the Thursday lows.

I will be watching the trend, momentum, and strength data each day and publishing the indicator readings before the market open via Twitter (follow here) to gauge the odds of breakout from this significant range.

A Few Thoughts on Life as a Projective Test

There are a few corollaries that follow from the recent post on unstructured time and personality. I thought I'd highlight a few below:

* If we think of our unstructured time as a blank canvas, it isn't a far leap to the view that each of us is creating a work of art with how we fill that canvas. Do we create a masterpiece? A coherent work of art? Random scribbles? The noble life is one that creates a work of beauty from that blank canvas.

* One important facet of what we do with our unstructured time is who we choose to spend it with. We select our companions--friends and life partners--based upon our deepest interests, needs, and values. Who we select as a soulmate is the clearest window onto our souls.

* Some people frantically avoid unstructured time, making busy-ness their business. What painting to they create from their canvas--or do they run from the responsibility of holding the brush and taking the first strokes?

* Different version of the projective test: If you were to be stranded on an island for a year and could only bring one person and five possessions with you, who/what would you choose and why?

* How you would *least* like to spend your time is as informative as how you most prefer to use your time. We cannot value something strongly without responding strongly to threats to that value.

* A good relationship: when the person you love is also one you admire. Relationships transform us; good ones for the better.

Unstructured Time as the Best Projective Test

Projective testing has a long history within psychology. The basic idea is simple: people look at ambiguous images (inkblots, in the case of the Rorschach test; pictures of people doing things in the Thematic Apperception Test) and explain what they see. What we project into the pictures is believed to say something about our ways of seeing the world; it also says something about how we organize our perceptions and thoughts.

Consider the Rorschach image above, which I pulled from the Web. When I first took the test as a graduate student, I saw two things:

1) The bottom left and right were "two seahorses, turning from each other in a bashful way."

2) Turning the card upside down, I said that it looked like "two African native women cooking over a kettle, maybe as part of a ceremony".

All in all, those are responses you might expect from a psychologist-to-be: largely harmonious images of people (or animals-as-people) interacting with each other. The form of the responses dominated the use of shading or color, which is also typical for me--a more intellectual than emotional style of responding to the world.

In reality, we don't need cards to assess people in a projective manner. Anytime we face a relatively blank or ambiguous situation, we tend to respond with our own needs, values, and feelings.

Time may be the best projective test of all. What do people do when they don't have anything that they *need* to do? Unstructured time gives us no cues: we have to create activity--and what we create says something about who we are.

After a long work week, I knew that I would have unstructured time on Saturday. The thought of relaxing for a day never entered my head. I knew my daughter (who has some diagnosed learning problems) was having some problems in a couple of her college courses, so I drove to her campus and we spent the afternoon studying--just as we had in high school. For another person, driving two hours after a long work week and taking on large reading assignments would be overwhelming and most unappealing. For me, it was fun. It was a chance to be there for someone I care about. I could never have spent the time on a golf course or socializing with neighbors; to me, that would have seemed frivolous.

On other recent occasions of unstructured time, Margie and I have traveled to areas where we've never visited, including an ethnic neighborhood where we seemed to be the only native English speakers. On still other occasions, I've spent a long morning researching new market indicators and how they work with different money management strategies.

What I almost never do in unstructured time: go to parties, watch TV, get together with other couples, relax at home or on vacation, work in the yard, anything artistic, play sports for reasons other than fitness development. What I often do: read books, research markets, write, travel, go out to eat to new/different places, visit family members, surf the Web for news.

So you get the idea: the unstructured time test shows that I value intellectual and interpersonal activity that is more instrumental than expressive and that is focused on intimate/close relationships rather than purely social ones. If an activity doesn't have a goal/purpose and if it doesn't bring me close to someone I care about, it strikes me as a waste of time.

Other people, of course, structure their free time in very different ways and might value expressive and social activity (sharing with friends, arranging flowers) and pure relaxation (a day at the beach, watching TV of an evening). There's no right or wrong here, just a relatively blank canvas of time that we fill with what we most treasure.

The ultimate blank canvas is retirement. I'm convinced that how people structure their time in retirement is one of the best windows on their souls. With children having left the nest and the end of career work, retirement leaves most time unstructured. How do people use that time? For intellectual stimulation? For productive activity? For social time with family? For travel? All say something about who we are and how we view ourselves and the world.

One retired couple moves to an area to live a country club lifestyle; one couple moves to be closer to their children and grandchildren; still another couple stays in their home community and goes to work building a charitable foundation. By retirement age, when time is not structured by school or work, life itself becomes a grand projective test.

So if you want to know someone, don't ask for their self-descriptions: just look at what they're doing when they don't have to be doing anything.

And if you want to know a trader, don't ask for a self-assessment: just look at what he or she does outside of market hours.

(written during free time of a Sunday morning)


Saturday, October 24, 2009

A Few Good Weekend Reads

* Here's a listing of print and electronic trading magazine resources;

* AMZN and how "surprises" tend to occur in the direction of the market trend;

* More signs of stress in commercial real estate;

* Questioning the value of historical market relationships among asset classes;

* Spotting moves with COT data;

* Very interesting post re: managing the equity curve;

* Views on trading market regimes--great topic;

The Psychology of Position Sizing

To kick off this topic, let's go back to the post on how drama creates trauma: by sizing positions much larger than our norms, we create large swings in dollar P/L, which often translate into large emotional swings--and subsequent emotional damage.

If there is anything more frustrating than being wrong in the markets, it's being right--and then not participating in the actual moves.

Often this occurs because, in our drive to maximize gains, we can size positions so aggressively that we become unable to take normal heat when the market temporarily moves against us.

A great example occurred for me during Friday's trade. I was short from late Thursday and watched the market move against me overnight and then bounce sharply against me on the housing numbers Friday morning. Because I sized the position moderately, I could stand the heat, because I saw that we were not breaking above the multiday trading range. And if we had broken above that range, the loss wouldn't have ruined my week.

Had I been sized much larger, it's much more likely that I would have been spooked out of a good trade. When I'm sized reasonably, I'm willing to risk 5-10 ES points to make 10-20 or more. Sized to the max, I start to translate those 5-10 points into dollar terms--and that leads to scared, reactive decisions.

The purpose of the profit targets that I publish each morning before the market open via Twitter (subscribe here) is to provide a gauge for likely market movement. When I see strong selling pressure (negative NYSE TICK; large volume hitting bids in Market Delta) on enhanced relative volume, I formulate the view that we're likely to hit the S3 price level. My job at that point is to simply sit in the trade, make sure that the market dynamics are not significantly changing, and formulate an exit based on market behavior once my levels are hit.

If I'm processing how much I'm losing (on paper) on countertrend bounces, I'll never sit through the the pain of the gain and earn the reward that justifies my risk.

The ability to sit through a trade is greatly underappreciated. We tend to focus on entries, exits, and the next trade, and the next one--constantly looking for things to do. Sometimes, however, the most profitable strategy is to do nothing and simply let your trades work out. That requires a moderation of sizing/risk--and a kind of inner peace and satisfaction with the positions you have on and the bets you've made.

A Look at Recent Sector Rotation

In recent posts, I've highlighted resources for decision support for traders. One longstanding resource that I've relied upon is Decision Point. The site has the largest collection of indicator charts that I've encountered, with superior coverage of sectors and individual indexes. Flipping through the charts at the end of the week provides an excellent orientation to the market's larger picture.

Above, I've taken sector data from Decision Point and charted them in Excel to show how the stocks within each sector are trading relative to their 20-day exponential moving averages.

As noted during the past week, we've been in a multiday trading range. Such range environments are created when sector rotation becomes a greater source of movement than directional index movement. In other words, institutional investors aren't so much pulling money out of stocks or putting cash into them as reallocating their existing holdings.

From the chart above, we can see that energy shares have been the great beneficiary of this reallocation, with formerly strong materials stocks now the laggards of the S&P 500 sectors. We can also see that consumer and industrial shares have also seen favor, responding to improving economic news.

At a broader level, we have 53% of S&P 500 large cap issues trading above their 20-day EMAs, but only 36% of S&P 600 small caps. It may well be that larger international companies that benefit from overseas sales are beginning to take the lead from companies less likely to benefit from a falling U.S. dollar.

Friday, October 23, 2009

Views to Start the Weekend

* Questioning v-shaped recovery;

* Turning defensive on municipal bonds;

* Problems with devaluation of China's currency;

* Seven banks today closed and taken over by FDIC--106 failed banks so far;

* Formula for a housing scam;

* Trade war continuing?

* Dangerous collapse in USD unlikely.

Thoughts on Taking Profits

I took profits on my short position late today; it was definitely one of those gut feel decisions that may or may not come back to haunt me. The stock indexes were weak today; there's no denying that. As we approached the Wednesday and Thursday lows, however, I noticed that we only had a little over 500 NYSE, NASDAQ, and ASE registering 20-day lows. That was about the same as Wednesday's level and below Thursday's.

In addition, as you can see from the Futures Heatmap from Barchart, intermarket themes were not providing as many bearish cues as I would have expected to see if we were going to sustain a break to new weekly lows. We didn't see unusual strength in the U.S. dollar, and we didn't see unusual commodity weakness--particularly from the metals.

In short, we were weak; just not outstandingly so. Discretion the better part of valor, I cashed in my chips.

When we get to the top or bottom of a distinct range, there's always a judgment call to be made for discretionary traders as to whether we trade for a breakout or fade for a move back into the range. And, sometimes, when the evidence is mixed, it's best to take the chips off the table and wait for a clear signal. Success doesn't require being involved in all market moves; it just requires that the market move your way when you do get involved.

Resource for Identifying Significant Price Levels

In recent posts, I've been highlighting resources for journaling and tracking performance. Regular readers know that I use Twitter as a resource for staying on top of the market as part of preparation for the trading day. That includes identifying proprietary daily and weekly profit targets that are adjusted for recent market volatility.

Another nice resource for identifying pivot levels--as well as moving average points, value areas, support/resistance, and much more--is the Pivot Farm site. The levels for stock indexes are provided free of charge and are a great way to review markets and the broader context of trading. Levels are also provided for currencies. It's a useful and well-organized resource.

Creating What-If Scenarios to Frame Trade Ideas

I find it helpful to prepare for the day with "what-if" scenarios. These prime me for action should the market prove able or unable to sustain prices above or below key price levels. An example of such "what-if" thinking was the morning briefing today. Seeing that buying on the existing home sales number at 9 AM CT was unable to sustain prices above the R1 level, I had prepared for a move back to pivot (which happened to be the average trading price for the multiday range). Engaging in such preparation is helpful in acting decisively upon ideas, creating favorable risk/reward once you see that we weren't going to hold above 109.68 in SPY (red line above).

Morning Briefing for October 23rd: A Fresh Look at the Range

The above useful chart from Big Charts shows how volume has been distributed at price (left bars) for SPY over the past ten days. We can see the accumulation of volume around the 109 price, with volume tailing off above and below, consistent with a range market. On the heels of the favorable response to MSFT earnings news, as well as strength overnight in Europe and Asia, I will be watching to see if we can challenge the highs of the trading range. If not, I would expect a rotation back into the range, with that 109 area a likely near-term target.

Interestingly, that 109 area also represents Thursday's pivot price, as noted in the Twitter posting this morning. We have already taken out the R1 level in premarket trading for SPY; if we cannot sustain the R1 level, I would look for a move back to pivot. Should we sustain R1, the R3 level would also represent the highs of the the multiday trading range and would be a target to watch for. Thus far, I'm not seeing a great deal of buying or selling support for stocks from the currency markets, which could keep us range bound. I will update via Twitter to gauge intraday sentiment (follow tweets here).

Keeping Grounded as a Trader: How to Avoid Going on Tilt

Suppose a major league baseball pitcher became excited with each strike that he threw and discouraged with each ball that was out of the strike zone. If he walked a batter or gave up a hit, the pitcher would lose his temper and begin throwing wildly. If he struck a player out, he would become euphoric.

Such a pitcher wouldn't last long in the major leagues. He would be viewed as lacking professionalism. His extreme emotionality would interfere with the straightforward task of throwing good pitches and adjusting to each hitter.

It's the same in poker. If a player were to "go on tilt" after every losing hand, become exasperated with each mucked hand, and get pumped after each win, that would be an easy player to read. Instead of playing the odds, it's likely the player would be making decisions driven by the ups and downs of each hand.

There are many active traders who approach trading like the pitcher or poker player of the above examples. They become emotionally attached to the results of each trade.

For a successful trader, a trade is like a single pitch to a hitter. It is one part of one at bat, which is part of one inning, which is part of one game. The goal is to win the game, not to "win" on each pitch. When a pitcher walks a batter, the focus is on getting out of the inning successfully. When a pitcher has a bad inning, the focus is on finishing the game well. After a losing game, the pitcher reviews with the pitching coach and makes adjustments for the next outing.

There are plenty of games left in the season. The big picture keeps the pitcher emotionally balanced.

That is why, in working with traders, I focus on being profitable for the week and month--not on each trade, or even each day. For the active trader, there are many trades in a day and there are five days in a week. As long as you don't lose too much in a trade, you can turn the day around. As long as you keep daily losses reasonable, you have a chance for a green week. And as long as a week doesn't dig you into a deep hole, you can still be profitable on the month.

There are plenty of trades left in the week, month, and year. The goal is to have a successful season: that view makes it easier to shrug off the pitches that get away from you and focus on what is truly important.


Thursday, October 22, 2009

Two Performance Applications for Traders

My recent post highlighted some journaling programs for traders. Here are two more apps that help traders make the most of performance:

1) Trader DNA - Thanks to Matt for the reminder on this program. Trader DNA analyzes your trade data and spits out a variety of metrics to illustrate how well you are doing across a variety of dimensions. How long are you holding onto winning vs. losing trades? How well are you trading range markets? How much heat are you taking on trades? Trader DNA answers these and many other questions, enabling you to identify areas of trading for improvement.

2) Market System Analyzer - This is a unique program that addresses issues of money management. If you have a trading system, Market System Analyzer will tell you if there's a significant edge, and it will show you how you can benefit from different ways of sizing positions to maximize reward/risk. The program also details extensive performance statistics for trading systems.

Do you use other programs to evaluate and improve trading performance? If so, please feel free to recommend resources in comments to this blog post. Please also note my earlier post on Ninja Trader as a resource for developing traders.

Trading Journal Resources

Keeping trading journals is an excellent way of tracking performance, evaluating strengths and weaknesses, and setting goals for development. Here are a couple of resources that might be helpful for traders looking to become more organized in their quest for the next level of performance:

* StockTickr - This application allows traders to keep a journal, calculate performance, and even automate trading ideas;

* Stock Trade Journal - This application allows traders to enter trades, calculate P/L, keep notes, and track their performance;

* TradePerformance - This application produces extensive performance reports regarding one's trading and also includes templates for business planning and journaling.

It's worth looking into many different journal formats to see what works best for you. Some people keep audio journals by dictating their notes. There is no one best way to keep a journal; the key is keeping entries doable and informative, so that entries can lead to concrete goals and actions to improve trading.


Midday Briefing for October 22nd: Intermarket Correlations

We can see the strong correlation between the Aussie dollar vs. U.S. dollar (top chart) and the S&P 500 Index (ES futures; bottom chart) in today's trade. In both cases, a breakout above the morning highs have led to nice upmoves. The ES futures have returned to their multiday range, and the Aussie dollar has moved back into its range dating back to 10/19. The resolution of these ranges is likely to set up the next meaningful trending leg among risk assets.

Morning Briefing for October 22nd: Consolidating After the Selloff

Note how the ES futures (above) have been trading overnight after yesterday's late afternoon selloff. We have traded in a relatively narrow range, attempted to break below yesterday's low (failed) and then attempted to break to overnight highs before the 7:30 AM CT numbers (and failed). As a result, we are trading solidly in the overnight range, with the overnight highs and lows defining important near-term levels. The longer we spend in this range, the more business we transact at the lower end of yesterday's range, and the lower we accept value. For the day session, I would expect a nice bounce higher if we can hold above yesterday's lows on early selling. Inability to take out the overnight highs in early buying would target those recent lows.

Three Creative Ideas From Quant Bloggers and Researchers

* Jeff Pietsch at Market Rewind illustrates two ways of generating superior performance by rotating each week into the asset class that shows the greatest relative strength. A second illustration shows superior returns by rotating into the top two relative strength currencies from among an ETF group. By taking advantage of relative strength, the systems tracked by Market Rewind are able to capture momentum effects across markets. Very interesting idea for swing traders, as well as active, aggressive investors.

* Rob Hanna at Quantifiable Edges shows how a mechanical trading system can be built by examining different historical studies of trading patterns and synthesizing them into single trading signals. By aggregating different historical patterns, the system is able to find occasions in which edges in one are confirmed by others, providing high probability trade opportunities. Excellent extension of historical research.

* Rennie Yang of Market Tells has introduced an "intraday relative cumulative TICK" measure that compares where today's cumulative NYSE TICK stands relative to the average reading of the past 30 sessions. By comparing, say, 10 AM numbers today with the 10 AM numbers from the past 30 days, we can see if today's market is trading with greater or lesser buying and selling interest than recent sessions. In a recent post, Rennie shows how a pullback in the relative cumulative TICK preceded yesterday afternoon's selloff. Nice sentiment gauge.

Wednesday, October 21, 2009

Fresh Market Views

* Thanks to a savvy reader for this article on the value of getting things wrong;

* Was today a key reversal day?

* Combining information to make intraday trades;

* Sign of the times: One product flying off the shelves these days is hand santizer;

* Gold sensitive to inflation concerns;

* Props to a reader for this interesting lecture on the role of randomness in life;

* Concerns over home lending and retail sales weigh on market;

* Housing continues to look weak;

* Rethinking our decision making.

Price Levels and Market Breakouts

My recent post noted a "multiday trading range". There's nothing mysterious about such ranges; the relative highs and lows within those ranges are pretty much on the radar for most traders and portfolio managers. The more times we touch a relative high or low in a range, the more important those "levels" become for traders. Breaking those levels can lead to a surge in buying or selling, as stops placed at obvious levels are taken out. Knowing where those levels are at--and where stops are likely to be placed--can lead to profitable short-term trades.

A nice example occurred this afternoon as part of the market's selloff. We saw expanded volume on the selloff (top chart), which told us that large traders were participating to the downside. As that continued, I began looking at the 1076 area as an important level, as it defined the lower end of the multiday range (bottom chart). Knowing that selling momentum/volume was sustained and knowing that stops were likely to be placed just below that level led to a nice trade where sellers could hold their positions through that stop point.

Observe (top chart; blue arrow) how volume swelled tremendously as we broke the support level. A canny trader can anticipate such "puking" and craft short-term breakout trades around those levels.

Going forward, whether we can sustain prices back above the 1076 region vs. see that support area now become resistance will frame the issue of whether today's selloff is the start of a trend reversal. Traders who believe that might be the case can hold onto positions (or portions of positions) through the short-term breakout to hit more distant profit targets.