Wednesday, March 31, 2010

Bonus Post: Calculating Price Targets

As I mentioned earlier today, in appreciation of the generous readership, I thought I would share some of my ideas and methods for calculating price targets. If you're new to this topic, it would be helpful to review my prior posts on hidden volatility assumptions and defining effective price targets with the previous day's data.

What we saw in that latter post was that using the previous day's high, low, and average prices provides us with relatively high probability targets for the current trading day.

In my own work, I do not use the average price as defined in the post (H+L/2). Rather, I use (H+L+2C/4). This is the "pivot" level that I post each morning for SPY via Twitter. This overweights the closing price relative to the prior day's high and low, so that--on average--the pivot price will be closer to the current day's open. Going back to late 2002 (N=1894 trading days), my Excel calculations show that we have touched the previous day's pivot on 70% of all trading days.

For this reason, the previous day's high, low, and pivot prices are key near-term price targets for my trading. As I mentioned previously, even closer price targets are the overnight high and low prices from the ES futures.

If I anticipate a slow trading day with a narrow price range and we open in the middle of the overnight and prior day's ranges, I will look for trades to take out the overnight high or low price and then the previous day's high or low. If I anticipate a slow trading day and we open nicely above or below the overnight and prior day's pivot levels (for overnight "pivot" I use the day's VWAP), I look for a move back to VWAP and then the previous day's pivot if buying or selling can't be sustained.

If I anticipate an average or busier trading day, I look toward more distant profit targets. Below is one way of calculating those that builds on the previous post.


* Let us call the difference between yesterday's high and low prices R, for range. That means that the difference between yesterday's average price and yesterday's high is 1/2 R and the difference between yesterday's average price and yesterday's low is 1/2 R. (We're using average price, not the pivot level, for this calculation. More on pivot-based calculations in the next post in the series).

* If we calculate (yesterday's average price + 3/4 R), we will get a price level above yesterday's high that we'll call R1. If we calculate (yesterday's average price - 3/4 R), we will get a price level below yesterday's low that we'll call S1.

* Going back to late 2002, the odds of hitting R1 or S1 during today's trade are 67%. Two-thirds of the time, we'll hit R1 or S1. It's a high probability target if volume is average or better.

* If we calculate (yesterday's average price + R), we will get a price level above R1 that we'll call R2. If we calculate (yesterday's average price - R), we will get a price level below S1 that we'll call S2.

* Going back to late 2002, the odds of hitting R2 or S2 during today's trade are 41%. We want to see above average relative volume (and today's volume > yesterday's volume) to assume that we'll touch R2 or S2.

* If we calculate (yesterday's average price + 5/4R), we will get a price level above R2 that we'll call R3. If we calculate (yesterday's average price - 5/4R), we will get a price level below S2 that we'll call S3.

* Going back to late 2002, the odds of hitting R3 or S3 during today's trade are 26%. We would need to see significantly above average relative volume (and today's volume significantly > yesterday's volume) to assume that we'll touch R3 or S3.


* Instead of using yesterday's average price as a base for calculation, you can use the traditional pivot formula of (H+L+C)/3.

* Instead of using yesterday's average price as a base for calculation, you can use today's open. That is especially helpful when the overnight session leads to an opening price far from yesterday's average price.

* Instead of using R values based on yesterday's trading range, use the average trading range from the prior N days. My research shows some benefit to going out several days, but returns are diminishing out to a five-day lookback.

Regardless of your calculation method, you will find that R increases as the market's volatility increases and decreases as the market's volatility wanes. This automatically adjusts your price targets for the market's most recent volatility.

Going back to late 2002, yesterday's volatility correlates with today's volatility by a whopping .75. That means that we can predict more than half of the variance in today's volatility simply by knowing the prior day's trading range. If we go out to a five-day period, the correlation between the prior five-day's average range and today's range has been .80.

Once you become good at tracking today's volume relative to yesterday's (or the prior five days'), you can make very reasoned estimates as to which levels we're likely to hit during the day. That considerably strengthens our exits and helps us maximize our risk/reward.

This post and the next one (tomorrow) will remain on the blog for a limited time. If the research is of interest, you might want to print out the post or copy the relevant data.

Thanks again for all the interest and support--


Anticipating Slow, Range Trade

You don't get markets much more range bound than this! The low 1170 area has been strong resistance for stocks (ES futures, above), and we've seen support in the 1160 region.

My earlier point regarding defining effective price targets was that using the prior day to estimate today's volatility can be quite useful. In the case of recent trade, seeing the shrinkage of daily trading ranges (and volume) could have helped traders anticipate the limited market moves and place stops and price objectives accordingly.

My next post in the price target and volatility series will offer specific (and new) guidelines for traders.

Top Financial Blogs From 24/7 Wall St.

Well, 24/7 Wall St. is out with an updated list of top 25 financial blogs, and it's very worth a review. It's a great way to discover some sites you might not be familiar with; some of them you'll be familiar with from my previous links.

Many thanks to 24/7 Wall St. for the kind mention as a top blog. Of course, 24/7 is too modest to include themselves in the list, so I'll take it upon myself to point out a few of their interesting features:

* A real-time updated list of the largest U.S. companies;

* An updated list of Warren Buffett's holdings;

* Premarket daytrader alerts;

* Daily best market rumors.

I continue to be amazed by the quantity and quality of information on the Web. The challenge is how to filter it all into usable market views! Maybe that will be a future post...

Defining Effective Price Targets With the Previous Day's Data

In my recent post, I emphasized that every trade idea that includes risk and reward necessarily makes assumptions about both market direction and volatility. Traders encounter problems when they are right about market direction, but either underestimate volatility (and leave potential profits on the table) or overestimate it (and see winning trades reverse on them and often become losers).

So how does one define effective price targets that have a reasonable, known probability of getting hit?

The market itself provides us with some valuable targets.

Going back to late 2002 in the S&P 500 Index (SPY), for example, we find that only about 12% of all days are inside days. The odds are quite good that today's market will take out yesterday's high or low price. If we open somewhere within yesterday's trading range, we can then use our readings of evolving market direction (sector behavior, intermarket relationships, sentiment) to handicap the odds of hitting one of those price levels before touching the other one.

The advantage of using yesterday's data to frame today's targets is that we're allowing the most recent estimate of volatility guide our expectations about today's volatility. We can then update today's relative volume as the market is trading to modify those expectations as needed.

For instance, if we define yesterday's average price simply as the average of yesterday's high and low, we find out that, since late 2002, we've traded today at yesterday's average price about 60% of the time. That is useful information for those occasions where we open above or below yesterday's average price, but cannot sustain buying or selling. We can then target a reversion to the average price of the previous day, because we cannot sustain value higher.

Interestingly, the statistics are similar for weekly data, so that we can expect this week's trade to take out either last week's high or low and can expect a high proportion of occasions in which the current week's trade will touch last week's average price. This can be helpful in framing targets for swing trades.

The odds of exceeding highs or lows are even higher when we frame overnight highs and lows as initial targets for futures contracts. Well over 90% of days take out either their overnight high or low, so when we open within the overnight range, a worthwhile initial trade is to play for one of those levels once we see evidence of a directional bias to the day's trade.

The beauty is that, in using these levels, we automatically adjust assumptions regarding volatility based on how the market has traded most recently.

In my next post we'll see how we might build upon that.

Every Trade Idea Includes Hidden Volatility Assumptions

This will begin a series of short posts on price targets, why they're helpful, and how I calculate them.

While many traders pay close attention to their entries, they don't always crystallize their ideas as to how far the market is likely to move in their direction. Without a clear idea of price targets, it's easy to exit positions too quickly or overstay your welcome and see moves in your favor reverse against you.

Price targets incorporate assumptions not only about directionality, but also volatility. This is where most traders get hung up: they focus on market direction, but their assumptions regarding volatility are hidden--and often inaccurate.

This is a very important concept: every trade idea embeds a hypothesis about *both* direction and volatility. When we calculate the risk and reward on a trade, we're making assumptions about how and how far the market could move in our direction. Bad calls on volatility could be as problematic over time as bad directional calls.

My goal, in part, is to make you more aware, more conscious of your volatility projections when you hold a trade toward a chosen objective or place a stop out point away from your expected direction.

So how can we adjust for volatility? There are two ways, and those will be topics for the next posts in this series.

Morning Briefing for March 31st: Shifting Lower

9:13 AM CT - I added the top chart to show how we made fresh morning lows before 9 AM CT, but those lows were accompanied by relatively modest negative TICK readings and a non-confirmation from the Russell 2000 stocks. Seeing the divergence, I bought some IWM and rode a pop higher toward the top of the morning and yesterday afternoon ranges. It's a nice little illustration of how choosing what you're trading (a relative strength leader if you're expecting a rise) is as important as getting your timing right.

We've pulled back into the multiday trading range in early trade today, breaking below the range of the past two trading sessions. I'm now looking to see if we can sustain price and build value below yesterday's low price. Despite the stock weakness, other risk assets are firm: USD is weak vs. euro and we're seeing some strength in gold and oil; rates are a bit lower. Also, we're not yet seeing the Russell 2000 Index or the NASDAQ 100 set up for new lows relative to yesterday; I'll be watching closely to see if those divergences continue. More later this AM--

In Appreciation: A Free Bonus for TraderFeed Readers

I want to thank readers for their continued support of the blog. This month has seen another record number of visitors (above) and page views to the site.

In appreciation, I will be posting the specific proprietary formulas I use to calculate price targets for the S&P 500 Index.

This will include formulas for calculation of levels that I have not shared at all on the blog to this point.

Keep an eye out...I'll be posting later today. I will not keep this information on the blog permanently; it's for current readers only.

Thanks again!!


A Look at Sentiment and Stock Market Strength

As we can see, the CBOE equity put/call ratio has averaged about .60 since the fourth quarter of 2009. We've tended to spike higher than average (showing relative bearishness) near intermediate-term low points and have tended to register below average (showing relative bullishness) readings around intermediate-term peaks. That ratio has been largely below average for a while now, indicating that traders remain relatively bullish following the market's rise to fresh highs.

Although we're trading relatively near those bull highs, the number of stocks registering fresh 20-day highs vs. lows has remained subdued. As I noted in my recent tweet, we saw 969 stocks across the NYSE, NASDAQ, and ASE make fresh 20-day highs on Tuesday and 398 score new lows. Earlier this month, we had over 3000 new 20-day highs.

That being said, the recent movement has suggested more sector rotation than outright correction: of the 40 stocks in my basket (five from eight S&P sectors), fully 32 are trading in uptrends according to my Technical Strength measure. (That indicator is also updated each morning prior to the market open via Twitter). We're also hovering near bull market highs in the advance-decline line specific to NYSE common stocks, as noted by Decision Point. While sentiment could constrain the near-term upside here, we're not seeing the kind of technical deterioration that generally precedes major market selloffs.

Tuesday, March 30, 2010

Thoughts on Networking and Success

I want to thank the many traders who have responded to the post regarding forming virtual trading groups. My hope is that those who commented to the post can follow through with mutual contacts and explorations of common interests.

It always surprises me that people who otherwise seem to desire success don't follow through on their desires with solid, persistent networking.

Life is a team sport. You learn from others, you benefit from their experience, you develop your thinking by incorporating their perspectives--and they learn, benefit, and develop in their interactions with you.

Never, ever be afraid to make yourself visible. Put yourself out there: your ideas, your experience, your interests. Cold call 20 promising people; it's the one or two that respond meaningfully that will add to your life and career.

No one will cheerlead for you; no one will discover you; no one will take you under their wing if they don't see and hear from you.

Reach out to likeminded traders. Put out enough information that likeminded traders can reach out to you. No matter how inexperienced you might be, don't be afraid to reach out to those who are more accomplished.

It's not about crass self-promotion. It's about recognizing the synergies that are possible in positive working relationships.

Go for it.

For Traders Looking to Form and Join Virtual Trading Groups

In his comment to my recent post, reader Bruce expresses a desire to connect with other traders to form a mutual coaching group. This very much fits with my idea of using virtual trading groups to leverage learning and development.

While my work with trading firms prevents me from actually forming and participating in such groups at this time, I would be pleased and honored to have this blog serve as a place where traders could connect with likeminded peers.

If you have an interest in forming or joining a group, by all means feel free to communicate via comments to this blog post.

My sense is that each experienced trader can both benefit from peer mentorship and can contribute to the mentoring of other traders. If you can gain insight from others and share yours in turn, that sounds like the best winning trade of all.

Succeeding as Your Own Trading Coach: Guiding the Learning Process

"I never teach my pupils," Albert Einstein once remarked. "I only attempt to provide the conditions in which they can learn."

A great number of trading educators attempt to teach their pupils. What they don't necessarily provide are the conditions in which learning can occur.

At one firm that I visited a long time ago, traders were given very small amounts of money to trade and risk was managed very tightly. As soon as the trader lost a couple hundred dollars in a day, they had to stop trading for the day.

The traders were taught some setups and ways to look at markets.

But what they learned was that it was not OK to lose money. They never learned confidence, and they never learned to be aggressive when they were right in their views.

To my knowledge, none of the traders developed into ones that could sustain a living from their trading.

So what are the conditions in which traders can learn?

They have to be conditions in which it is OK to make mistakes, but important to learn from those. They have to be conditions in which traders can count on regular feedback to guide their efforts. They have to be conditions in which clear, attainable goals guide development and learning.

For the many traders that don't belong to trading firms, we have to establish our own learning conditions. That is a central challenge to self-coaching: we not only move forward as students, but as coaches of our own learning processes.

Preparing for False Breakout Moves in the Stock Market

Note how often in recent market action we've seen prices move above or below a recent high or low, only to snap back into the prior trading range. These false breakouts can be challenging for traders, as they assume that we'll see range extension and the beginning of a trending market. Instead, the market simply sustains a longer-term trading range.

By the time the market does experience a catalyst to move it outside the extended range, many traders are so beaten up by getting chopped up on false breakouts that they can't participate in the directional move.

What I find among short-term traders is that they often will presume that breakouts will continue in their direction without actively planning for the possibility of retracement. When we see that stocks have broken to new highs (as we did this morning), but that other asset classes aren't participating significantly and that the number of stocks making new highs has been waning, we want to actively build a scenario for a possible reversion trade. Once the correlated asset classes begin to retreat, stock prices stall out, and we see NYSE TICK pulling back, we're then prepared to act on the scenario we've built.

It is much easier to act on market action if you've visualized and planned for it in advance.

Morning Briefing for March 30th: Continuing the Range Trade

10:35 AM CT - Note the downside break that occurred from the range that had prevailed going into today's open. The inability to hold the move above the pre-opening lows led to selling that has taken us back into the thick of the multiday range. It's a good example of how a breakout move at one time scale is actually a mean reversion move at another. If we persist with a negative bias to NYSE TICK, I would expect a test of the multiday range lows around 1160.

As we can see, we're trading within a multiday range, with prices recently caught within a narrow range inside the larger range. We're also seeing mixed trading among asset classes, with not much movement from gold and oil. There's some strength in AUD vs USD but not much happening with EUR. I'm continuing to watch small cap stocks vs. the large caps and the Cumulative NYSE TICK; those should point the way toward how this range environment will ultimately be resolved directionally. More later this AM.

Municipal Debt and State Budget Woes: Accident Waiting to Happen?

Municipal bonds (TFI; above) have fallen from recent highs and have not exceeded their 2009 peak thus far in 2010. Nonetheless, they remain popular investments, given rising tax burdens for high-income investors and a shift toward taxable debt among municipalities (the Build America Bonds).

At present, 10-year triple-A rated, general obligation municipal debt offers an average yield of 3.23%, up from 2.95% six months ago, according to Bloomberg. The current yield on two-year debt is .69%, down from .75% six months ago. So we've seen some steepening of the muni yield curve. Muni rates overall are attractive relative to Treasury debt, but not screamingly so as they were during the 2008 bear market, when tax free rates were substantially higher than taxable Treasury rates.

A recent New York Times feature highlights the very significant debt burdens of many states. As the article notes, ratings agencies continue to give the states stellar grades despite debt that approaches the levels of troubled eurozone economies. Particularly troubling is the very high debt levels associated with pension obligations. It is difficult to see how states can endlessly kick the debt can down the road, and it is difficult to see how budgets can be balanced in troubled economic times, particularly when tax revenues to the states are down. As Rogoff and Rinehart ominously note in the Times article, "When an accident is waiting to happen, it usually does."

Monday, March 29, 2010

Constructing Experience and Other Good Monday Reads

* The importance of constructing--and reconstructing--our mental maps;

* The experience of discrepancy is what rewires our thinking and feeling;

* Stocks trading cheap relative to junk debt;

* Rising yields could pose challenges; good overview of economy;

* Making sense of the recent rise in yields;

* Canada and California: both in bad financial shape;

* April has been a good month for stocks;

* Subprime mortgage securities on the rise;

* Risk on the rise at AIG;

* Consumer spending continues to rise;

* Top rated stocks from MSN StockScouter;

* The challenge of reforming banks;

* Stocks are where they were in December, 1998.

Goal-Setting, Discipline, and the Emotions of Traders

An important post from last year linked goal setting in trading with emotional well-being--and especially with sound trading discipline.

Discipline problems typically begin with experiences of frustration.

Frustration is a function of not meeting goals and expectations.

Many times, traders try to adopt psychological strategies for combating frustration. These can be helpful, but they don't get at the root of the frustration problem.

If we do not set challenging, but feasible goals, we cannot experience ourselves as effective, successful people. Goals that are perfectionistic cannot be met and thus generate frustration.

The failure to set goals robs us of opportunities for cultivating a sense of purpose and well-being.

Goal-setting is not just essential to mastering markets; it's essential as a tool of psychological management. We shape our experience of ourselves by controlling what we pursue and how we evaluate the pursuit.

The Relevance of VWAP in a Range Market

The volume-weighted average price (VWAP; red line above) is an excellent reference point in range bound markets. In a good range trade, we'll tend to see a narrow value area (volume will be transacted within a narrow price band) and moves away from value will tend to return back to (and usually through) VWAP. In a true range trade, we'll also see little slope to VWAP, as we transact volume relatively evenly above and below that average price.

If you're playing for a range breakout, it often makes sense to track the distribution of NYSE TICK, Cumulative Delta, and intermarket themes. Often we'll see buying or selling unable to pierce VWAP prior to a breakout to the downside or upside. It's the inability of price to trade through VWAP that shows buying or selling drying up--and that emboldens traders to probe lower or higher value levels.

Morning Briefing for March 29th: Pulling Back

9:13 AM CT - I added the top chart to show how we're trading in a range thus far today, with volume building between 1167 and 1169 and the value-weighted average price at 1168. Cumulative Delta is very modestly positive on the day thus far; NYSE TICK is mixed. Note how we continue to see sector rotation: the sectors that have been relatively weak of late (commodity-related sectors, health care) have caught a bid today; the sectors that have been stronger (consumer discretionary, financial) have seen some selling. Overall, that keeps us in a range.

We're seeing stocks trading in a multiday range, with resistance in the 1170 area and support around 1160. We're also seeing a weak USD and firm commodities; I'll be looking to some of these intermarket relationships to handicap the odds of a break from the trading range. Note also that Russell 2000 stocks are continuing to underperform the large caps--another relationship I'll be watching in early trade today. I'll update this post later in the AM.

Indicator Update for March 29th

Last week's indicator review found that we had retreated from a momentum peak, but could likely experience higher prices going forward. Little has changed since that report; upside momentum has waned, but price has corrected only modestly.

We can see from the Technical Strength (a proprietary short-term measure of trending) of the sectors that most of the sectors remain in a bullish mode. The exceptions are the commodity-related sectors, Materials and Energy, and the uncertainty-laden Health Care stocks. Particularly strong are the Consumer Discretionary, Financial, and Technology areas, suggesting that we're responding to themes of strong economic performance. Most important from the vantage point of the sectors is that we seem to be correcting via sector rotation, rather than by wholesale selloff.

Momentum, as measured by the Cumulative Demand/Supply Index (middle chart), has moved toward the zero area. In a bull mode, we can get successively higher price highs on lower Cumulative DSI readings before the market as a whole turns over. New 20-day highs only slightly outnumbered new lows on Friday (bottom chart), with the 20-day lows expanding to over 500. This is a measure I'll be watching for possible further deterioration. As long as new highs outnumber new lows, I consider the intermediate-term trend to be bullish.

While the trend remains higher, I am vigilant for divergences that could show up if we test the bull market highs. Those would have me cautious about chasing the upside, as we could see further rotation and correction before starting any fresh leg higher. As always, I'll be updating indicators daily via Twitter before the market open.

Sunday, March 28, 2010

A Longer-Term Look at Risk Assets: Is Global Growth Intact?

I thought it might be enlightening to take a longer-term look at three markets. All the above are weekly charts.

We can see that the China ETF (FXI; top chart) retraced approximately half of its bear market decline before pulling back late in 2009 and now failing to register new highs in 2010.

The performance of commodities (DBC; middle chart) has been even weaker, only recovering a small proportion of their dramatic bear market decline. They have failed to better their January highs lately.

The stock markets for Europe, the Far East, and Australasia (EFA; bottom chart) have recovered less than half of their bear market losses. Note that they also have failed to beat their January highs in recent trade.

While the recovery from the bear market lows has been impressive in percentage terms, that in part is a reflection of how low we had gotten. At least thus far, it appears that many risk assets are losing strength of late, not exactly what you'd expect if a global recovery were gaining steam.

The Value of Keeping Score Religiously

What does the distribution of your trading returns reveal about your trading?

Are you aware of the distribution of your returns?

I recently wrote about some of the factors that separate successful traders from their less profitable counterparts.

I can think of several very successful intraday traders I know well. All keep score meticulously. All are on top of when they're doing well and when they're not.

When they're trading well, they identify what's working and aren't afraid to push on the accelerator. When they're trading poorly, they're quick to pull in their risk and figure out what's going wrong.

They have the ego to get big and take risk and the humility to get small and acknowledge weaknesses.

And what helps them do both is keep score.


Keys to Daytrading Success and Why So Few Traders Get There

Thanks to several alert readers for sending me this insightful New York Times article on daytrading and the challenge of daytraders.

A while back, I posted on the topic of research concerning individual daytraders and how many of them are truly successful. That is worth reading or re-reading: it clearly indicates that most active trading is hazardous to traders' wealth, but that a small group of participants are able to sustain success.

This is not like most career fields, where an average teacher, middle manager, or sales person can sustain a living. An average performance in trading is one in which the trader does not make money at all. The Times article cites research suggesting support for the often-cited statistic that 80% of daytraders lose money.

I'm in an interesting position, because--as a trading coach--I see the actual trading of actual traders, not the performance claims of wannabee gurus. I also see which traders have been able to sustain meaningful livings from their trading and which have not.

Here is a post outlining what I see among the consistently successful traders. The links at the bottom of the post will also help you focus on what helps traders sustain solid performance.

Ultimately, the most important contributors to trading success are twofold:

1) The development of concrete trading skills: pattern recognition, ability to execute sound trade ideas to create a positive expectancy, sound risk management;

2) The cultivation of the mental toughness, continuous learning, and discipline that enable you to adapt to new, challenging market conditions.

Sitting at a computer each day, not having a concrete strategy for the day, and relying on a vague sense of intuition to get you through is not going to cut it.

Success is something the great traders do, not just something they have. They work on building skills, they work on building themselves, and they have routines in place for accomplishing both.

Do you?

Saturday, March 27, 2010

Mental Toughness, Psychological Resilience, and Trading

* Resilience and courage in trading;

* What we can learn from NCAA upsets;

* Nice outline of what goes into mental toughness;

* Mental toughness and winning in sports;

* Top basketball coaches build mental toughness through drills;

* Factors underlying psychological resilience;

* Does physical challenge contribute to emotional resilience?

* Many ideas for building resilience in the military apply to trading;

A Fresh Look at Demand/Supply Momentum

An older book that I'm rereading--and finding useful--is Constance Brown's text on Technical Analysis for the Trading Professional. She emphasizes unconventional ways to construct and interpret conventional indicators, many of which are quite creative and useful.

I used ideas generated by her work to configure a momentum indicator based upon the Demand and Supply data that I post each morning via Twitter. The scale is different, so that we get more uniform peaks and valleys in the data, with momentum frequently leading price change.

Note that we've been seeing higher prices with successive pullbacks in momentum, the hallmark of a bull market. Price has held up well during the recent momentum retreat, leading me to believe that the bull market has not yet given up. That being said, we're not quite at momentum lows that have characterized recent intermediate-term buying opportunities.

Behavioral Finance and Other Good Reading to Start the Week

* Ten defining features of successful traders;

* The P/L ups and downs of trading successfully;

* Thanks to a sharp reader for this link to a study on how people can learn to identify real vs. random charts;

* Thanks also to a savvy trader for the link to this useful slideshow overview of behavioral finance;

* What money managers are expecting: a look at consensus;

* Federal government getting deeper into the housing market;

* Government can't create artificial demand for housing that was artificially inflated to begin with;

* A fresh look at new high/new lows data;

* The problems of trying to get out of debt by taking on more debt;

* Data not suggesting a double-dip recession.

Friday, March 26, 2010

Midday Briefing for March 26th: In the Range

We've moved back into the day's trading range, and indeed are within a multiday trading range. Chartists will be tempted to see a head and shoulders pattern developing, as we see both momentum and strength waning even as we hover near bull market highs. I'm watching closely for relative performance of commodities and other risk assets, as well as small caps, to handicap the odds of that head and shoulders scenario playing out.

I'll be returning to Chicago today and will have more to say about markets and indicators when I return. Stay tuned!

Divergences in New Highs and Lows

Note the deterioration in new 20-day highs minus lows in the last two weeks (pink line above), even as the S&P 500 Index (blue line) has been making bull market highs.

I noted earlier that there were significant divergences occurring within and across stock markets. Those are showing up in the new high/low figures.

At this juncture, we're not yet seeing a significant expansion of stocks registering fresh 20-day lows. Rather, we're seeing a narrowing of the rally, such that fewer stocks are making new highs.

An expansion of lows would suggest a more serious potential breakdown of the market uptrend.

Friday Thoughts and Perspectives

* Two killer words in the trader lexicon: "should have";

* The power of embracing frustration and turning it into opportunity;

* Thanks to a sharp reader for the link to this article on taking pressure out of trading;

* Hiring boom on the near horizon?

* New home sales still look weak;

* EU uncertainty over Greece weighing on the euro;

* Bank bonds face best of all worlds;

* How the market trades after being down on Fridays;

* Don't take time off when you're trading well!

Thursday, March 25, 2010

NYSE TICK as a Gauge of Intraday Swings

Here we see a four-hour moving average of NYSE TICK (pink line) plotted against SPY (blue line) from March 17th through today's session.

Such a moving average of TICK acts as a short-term overbought-oversold measure. It also highlights when stocks might be making new lows and new highs when selling and buying pressure are waning--nice indications of potential reversals.

Underperforming Commodities and Commodity Stocks

While the U.S. dollar is on an upward path and Treasury rates have been moving higher, commodities (DBC; top chart) and commodity-related sectors (XLB; middle chart and XLE; bottom chart) have been lagging. Those sectors have also been relative strength laggards during today's session.

I don't think it's a coincidence that emerging market stocks (EEM) have also been lagging during 2010, in the wake of tightening economic conditions in China. Commodities have been, in part, an emerging markets growth story. Lately, traders have been betting on low inflation growth in the U.S., but not raging bull markets overseas.

Will slower growth abroad catch up to the U.S. and lead to a turnaround in U.S. stocks? Or will China seek to avoid a hard landing and resume breakneck growth, spurring commodities and further stock market gains?

I will be watching the relationships among overseas markets, commodities, and U.S. stocks to sort this important issue out.

Markets Responding to Economic Strength

Just a quick update to yesterday's post, observing important market dynamics, as the dollar (top chart) and 10-year Treasury rates (bottom chart) continue to march higher, as we continue to make fresh bull highs in stocks.

Strong dollar, strong stocks, rising rates: looks like markets are responding to economic strength.

I look forward to the indignant comments of permabears. :-)

NYXE TICK: Catching Shifts in Intraday Sentiment

Here's a nice illustration of how diminished selling pressure (NYSE TICK, bottom chart) and positive sentiment (Cumulative TICK staying above zero) led to an upside break of the morning range on enhanced volume (top chart). The shift in the distribution of TICK was a nice tell for the coming move.

Morning Briefing for March 25th: Watching a Breakout

9:58 AM CT - With strength in financial shares, but many sectors trading below their opening prices, we're getting a mixed, range performance thus far in the session. The NYSE TICK has been positive on balance, with only one significant selling reading to this point in the day. Volume is running a bit light relative to recent sessions, contributing to the rangy trade. We would need to see a downshift among financial shares and NYSE TICK to sustain a retreat from the morning breakout highs; I'd need to see greater relative strength among small caps to buy into a continuation move to the upside.

We're seeing breakout highs in the ES and NQ futures going into the opening. Note that the Russell 2000 Index, which had been a leader to the upside, is not poised to open at new highs. We're also a decent distance from fresh peaks in the new high/new low indicator. All of that has me looking closely this morning for signs of a false breakout in the day structure, particularly given a lack of bull peaks among other risk assets. Let's see if the small caps can confirm or contradict the early ES strength. More later this AM.

Behavioral Finance and Other Interesting Research

* What research tells us about elite performance;

* How common actually is elite trading success?

* Thanks to a savvy portfolio manager for this article on how relaxed minds may learn better;

* Also big thanks to a sharp reader for this post on making training effective with multiple trainers;

* Stress and lack of activity linked to obesity;

* Measuring one's addiction to work!

* The behavioral mistakes made by Chinese investors.

* "We find that investors who think that they are above average in terms of investment skills or past performance (but who did not have above average performance in the past) trade more."

Wednesday, March 24, 2010

A Look at the U.S. Dollar and Treasury Rates

Note today's upside break in the U.S. dollar (UUP; top chart) and in 10-year Treasury rates ($TNX; bottom chart).

During the market decline of 2008 and 2009, we generally saw a rising dollar accompany falling stocks and falling interest rates (rising Treasury note prices). The dollar and Treasury debt acted as relative safe havens during the rout of stocks.

Now, however, we have been seeing a stronger dollar since late 2009 along with stronger stocks. Treasury rates have also been on the rise since that time.

Rising rates do not seem to be signaling inflation, as long as we have a firm U.S. dollar. Indeed, commodity prices have stayed relatively tame and were down sharply today. Rather, buying of Treasuries from abroad may be slowing down and traders may be betting that the Fed will tighten credit conditions before inflation becomes a problem.

Finding Opportunity in Choppy Markets

My experience for much of the past year is that intraday traders, both independent and at proprietary trading firms, have been struggling to make money. This is because of two reasons:

1) The general drop in daily volatility, creating slow market conditions;

2) The increased choppiness of markets, some of which is attributable to algorithmic trading.

But can traders turn these challenges into opportunity?

David Aferiat of Trade Ideas has recently posted on the topic of finding opportunity in the market's traps. He offers a strategy that relies on mean reversion as a trading opportunity and shows the recent backtested results for the strategy. The post is worth a thoughtful read, because it illustrates the kind of thinking that can succeed in current market conditions.

The general idea is to find points in the market in which bulls or bears are trapped: they have committed to positions, but can no longer move the market their way. It's when they have to scurry out of their positions that the market reversals provide a trading opportunity. Note that this is the foundation for the transition pattern that I recently posted.

Midday Briefing for March 24th: Pulling Back

As you can see, we've been oscillating around the day session's opening price of 1165 in the ES futures, with about 882 more declining stocks than advancing. In my basket of 40 stocks that is evenly divided among eight S&P 500 sectors, 15 stocks are up from their open, 25 down. This weakness is also reflected in continued pressure on risk assets, including oil, gold, and euro and Aussie dollar vs. USD. Interestingly, small caps are not relatively weak from their open, which is one reason we're not seeing a more lopsided ratio of declining stocks to advancers.

The Challenge of Mean Reversion Reversals in the Stock Market

Note how often price in the ES futures has popped to a new high or low, only to return to the prior trading range (blue arrows above).

I explained a major reason why this "mean reversion" occurs in my recent post on algorithmic trading.

This has proven to be a major challenge for short-term traders, who find themselves faked out on seeming moves that reverse.

The first step toward adapting is recognizing that a jump to a new high or low may be a trap. We then need criteria that help us differentiate the traps from the genuine directional moves.

More on that topic of criteria soon to come.

Morning Briefing for March 24th: Facing Pressure

9:28 AM CT - I've added the top chart to show how we're trading both within the overnight trading range and within the range defined by yesterday's highs and lows. While we've seen pressure on risk assets, the ability of stocks to hold up above yesterday's value area has been impressive. The distribution of NYSE TICK is relatively mixed, contributing to the range trade picture.

We're seeing pressure among risk assets going into today's open, with a weak euro, strong USD, and weak commodity prices. That has weighed on stocks, as we've retraced much of yesterday afternoon's breakout move. Recall that we were in a range market with VWAP around 1162. Selling pressure could not take us below VWAP and we got the breakout move late in the day, taking us to new bull highs across most major indexes. Despite that, we saw fewer stocks register 20-day new highs than last week. Now we're looking to see if stocks can sustain their breakout move or will return to yesterday's value area. Should we see additional pressure on risk assets and relative weakness among small caps and NASDAQ issues, I'd expect the retracement to yesterday's value area and a setting of a fresh trading range.

More later this AM.

The Most Common Problem I See Among Active Traders

The recent post on listening to market communications highlights one of the most common problems I see among active traders, particularly those that trade on a day time frame.

We've all known people who seem to talk at you rather than with you. It seems as if they're uninterested in anything you have to say. They just want to get things off their minds. Indeed, even as you're talking, you can see that they can't wait to blurt out whatever is in their heads.

Can you imagine a psychologist who interacted like that? You're trying to describe your problems, and the shrink is talking right over you with whatever psychobabble he happens to be espousing at the time. That would be quite frustrating.

Well, that is how many traders approach markets. They don't listen to what the market has to say. Instead, they're looking for the next setup, the next trade to put on.

When you sit in front of the screen, the goal should be similar to the psychologist's: to understand what is going on before you take action. If you're approaching markets with your own opinions and your own need to put on trades, you'll miss the market's communications--its evolving patterns--and any hope of getting a gut feel for the action will be gone.

I often wondered why I tended to trade well after taking a break from markets. The reason, I discovered, was that I was following markets during the break, but not trying to put on trades. That freed me up to simply hear what the markets had to say.

If you have a *need* to talk, chances are you'll be a poor conversationalist because you'll be a poor listener.

And if you have a *need* to trade, odds are you'll be tone deaf with respect to what markets are actually telling you.


Tuesday, March 23, 2010

Learning to Listen to Market Communications

My recent post on gaining access to our inner expertise stressed that what we know is, in part, a function of our state of consciousness.

If all knowledge was explicit and continuously available to us, then we would be able to make excellent trading decisions regardless of our mind frames. It is because much of our knowing is encoded implicitly, as a function of "gut feel", that access to that intuition is important.

No one knows this better than psychologists.

If I am focused on the person I'm meeting with, I can pick up subtle nuances in their use of language, the tone of their voice, the sequencing of their topics, the changes in their posture and rate of speaking, etc. That level of being attuned to people not only helps me understand them; it also helps them feel understood.

If, however, I go into a meeting preoccupied with my own concerns, I become emotionally tone deaf. The subtle cues of conversation and interaction become lost and I miss the communications behind the communications.

The same thing happens in intimate relationships: how attuned we are to our partners affects how well we interact with them. If I'm busy talking and not listening, I become tone deaf as a spouse.

The markets are continuously communicating with us; the challenge, like in social interactions, is reading the communications behind the communications. These manifest themselves in patterns, not dissimilar from the patterns of tone of voice and gesture than we see in social conversation.

This is why listening is a core trading skill.

And it's why sustaining a frame of mind that is conducive to listening is paramount for active traders.


Emotionally Intelligent Trading (also see links to first two posts in the series)

Following the Market Like a Psychologist

Midday Briefing for March 23rd: Tracking a Range Market

We've remained in a range all day long, but if we can hold the VWAP level on selling, we should be able to mount a decent test of the day's highs, particularly if small caps can outperform and if we can sustain firmness among other risk assets. As a rule, I'll play potential range breakouts in the direction of the larger time-frame trend.

Note that I have an oscillator at the bottom of the chart. In a range environment, these can give relative orientation to potential buy and sell levels; in anything other than a range environment, I don't find traditional oscillators to be of much use.

Gaining Access to Inner Expertise

As I emphasized in this important post, traders know more than they know they know. This is the result of internalizing patterns in markets over time. The resulting "gut feel" for markets provides an intuitive level of recognizing when those patterns are occurring in real time.

A key challenge for traders is that they are often in frames of mind that deny them access to this intuitive, implicit level of knowing. Among the states of mind that interfere with one's gut feel for markets are:

* Fear and anxiety;
* Anger and frustration;
* Boredom;
* Overconfidence;
* Pessimism and depression;
* Excitement and thrill-seeking.

As a rule, the more we are focused on profits, losses, and self-related thoughts, the less focused we are on the patterns playing themselves out in markets. It's that focus, in part, that provides us with access to the gut.

Biofeedback is a useful tool for training ourselves to enter and stay in the state needed to access our implicit knowledge. (See this post for a summary). By sustaining a state of calm focus, we can recognize hunches and insights as they materialize.

This may be one reason why we can trade like pros on certain occasions and like rookies on others: the state we're in may provide or deny us access to the pattern recognition skills underlying most active trading. We cannot access our internal expert if our attention is drawn elsewhere and our thoughts and emotions are drowning out our intuitions.

More on this topic soon to come

Thinking Like the Computers

One thing I've learned from observing the actual trading of prop traders--those who are trading actively in and out of the market through the day--is that, as a rule, they are drawn to movement and momentum. They like to trade breakouts from ranges, and they like to see clear signs of strength or weakness before they buy or sell.

Many algorithmic (automated) programs that trade actively take advantage of these tendencies by selling strength and buying weakness. If you imagine hundreds of computers, each programmed to work offers at X period highs and work bids at X period lows--and if you imagine X as scalable across time frames--you get a sense for what drives markets on the short time frame when directional, institutional traders are not active.

Traders can benefit from thinking like the computers.

This morning we broke the overnight lows in the ES futures, but small caps were not making morning lows; nor were other risk assets.

If you were looking only at the S&P index, you wanted to be a seller and catch the downside breakout.

If you were thinking like the computer, you were working a bid and profiting from the move back to the average price in a range environment.

Much short-term trading success comes from doing what doesn't come naturally.


Morning Briefing for March 23rd: Forming a Range

9:56 AM CT - I've added the top chart to show the continued range trade in the ES futures. We have moved below the overnight range and ticked above it, each time returning back into the range. Getting day structure right and fading those moves away from value is how intraday traders can mint some coin during otherwise slow, trendless markets.

We can see that the market is setting up in a trading range during the overnight session, oscillating around the volume-weighted average price around 1162. As I alluded yesterday, I like to look at the overnight range as an "opening range" and play for a breakout of that range as an early trade idea. Very often, the early distribution of NYSE TICK readings will give a clue as to that breakout move--and also to whether the break can be sustained. I also like to look at the Cumulative Delta (volume transacted at offer minus volume transacted at market bid) to provide a gauge as to whether we're likely to sustain a breakout or stay rangebound.

Thus far, we're not seeing decisive moves among the majority of risk assets, which keeps me in range trading mode to start the day. I'll update later this AM.

Useful Cheat Sheet From

This is an unsolicited shout-out to one of my favorite sites, The site is my source for the 20-day new high/new low data that I frequently refer to; it also features useful coverage of stock and futures markets--including heat maps that I've posted about.

Above is an interesting feature for subscribers that they call their "cheat sheet". I thought I would point it out for technically-oriented traders. If you click on the sheet above, you'll see key price levels for SPY going into today's market. Those levels include their calculations of pivot and resistance levels, as well as key levels from technical indicators.

You can get these levels for any stock or ETF, which can be useful for framing price targets and alerts; seeing where we're trading relative to overbought/oversold levels; etc.

Monday, March 22, 2010

Monday Evening News and Views

* Five core principles of trading psychology;

* Thanks to some alert readers for this article on testosterone and risk;

* Underemployment hits 20%;

* What's strong and weak among ETFs;

* Stalemate over aid to Greece;

* Frontier markets finding favor;

* Private company debt trading cheaper than U.S. debt;

* Continued economic growth, with modest housing recovery;

* Red flags for bubble in China.

Divergences Within and Across Stock Markets

What do Materials shares (XLB; top chart) have in common with Energy stocks (XLE; second chart from top), Technology issues (XLK; second chart from bottom), and Health Care stocks (XLV; bottom chart)?

All have failed to better their January highs despite new bull market highs in the major stock market indexes.

This might just be a sign of large cap underperformance, given the solid bull highs seen among midcap ($MID) and small cap ($SML) shares, as well as the new highs seen in the advance-decline line for common stocks on the NYSE and the number of stocks making fresh 52-week highs.

What gives me pause is that many international equity indexes have also failed to exceed their January highs. Those include EFA (stocks from Europe, Far East, and Australasia) and EEM (emerging market stocks).

As long as the indicators plow to new highs and we see small cap and NASDAQ stocks outperforming the S&P 500 Index, I continue to lean to the bull side per the recent indicator update. Should we see those smaller cap and more speculative issues roll over, however, and generate deterioration in the indicators alongside lagging in these sectors and international indexes, then I would become more aggressive in looking to the downside for stocks.

Midday Briefing for March 22nd: Risk Appetite Remains

Just as we sharply rejected weakness on 3/15, sending stocks higher, we're seeing a similar move today. After opening lower, we have sharply rejected price below the 1150 area and now have traded back into last week's range. As long as we continue to see pullbacks at successively higher prices, this bull market is intact.

Note that small cap stocks have regained their leadership today and the NQ futures are trading at bull market highs. Crude oil has also turned positive on the day. This is an indication that risk appetite remains alive in the markets.

Catching Market Sentiment Shifts With Cumulative NYSE TICK

Note how we opened the day lower, with more stocks ticking down than up in the first minutes of trading. Within a short period, however, we bounced to positive NYSE TICK readings and stayed above the (blue) zero line. When sellers finally did come into the market, we could not get TICK readings below -500 and could not get the Cumulative TICK back to negative. Unable to sustain selling pressure, we saw buyers come into the market with a vengeance.

I find that it rarely pays to bet against the Cumulative TICK line. When TICK readings are mostly staying above zero and cannot reach significant negative levels (-800 or lower), it's difficult for prices to sustain any retreat.