Thursday, January 19, 2017

The Foundation of Trading Success: Finding Multiple Ways to Win

Successful traders lay very deep foundations.

What does that mean?

It means that they find multiple ways to win and develop experience and expertise in each of those areas.

Think of any successful company:  a soft drink company, an automobile manufacturer, an electronics maker.  All have many products that they sell.  Each one is a potential profit center, and the combination of multiple profit centers creates a deep foundation for the business.  If one year SUVs don't sell, the auto manufacturer can sell fuel-efficient sedans or sports cars.  Multiple ways to win means that you can win even when some of your strategies don't.

The successful money manager creates a portfolio of relatively independent trades, each of which possesses positive expected value.  One idea might be to be long the US dollar because of interest rate trends and central bank policies in the US versus other countries.  Another idea might be to be long mega-cap stocks and short micro caps because of the anticipated impact of fiscal stimulus and tax credits.  Still another idea might be to buy agricultural commodities because of a change in long range weather forecasts from the best meteorologists.  Such a portfolio has multiple ways to win...if one idea doesn't work out, the others can.

Similarly, the active daytrader may trade a reversal pattern with active stocks near the open and then trade a surprise earnings report later in the day with a single stocks and then trade a trending stock into the close. Over the course of the day, the active trader has placed many trades, each with an edge.  It is the serial pursuit of opportunity that creates diversification each day.  One trade can fail and the day can still be profitable.

What that means is that successful traders must be able to innovate at two levels.  First, they must find new ideas and fresh opportunities.  Second, they must cultivate new sources of ideas and opportunity.  The first involves exploiting the edges we already possess; the second involves identifying additional edges.  The successful trader is never static, never dependent on one type of market condition to make a living.  Just as research and development is the lifeblood of technology and pharmaceutical companies, it is the source of long-term success for traders.

When successful traders aren't trading, they are researching, developing, and innovating.  When unsuccessful traders aren't trading, they're staring at screens and forcing trades.  There is nothing better for trading psychology than being at the cutting edge of a growing business.

What makes a trader successful is discipline:  doing the right thing with fidelity.  What keeps a trader successful is innovation:  doing new things and turning them into disciplines.

Wednesday, January 18, 2017

Turning Goals Into Consistent Actions

Here's an idea to add to your keeping of a trading journal:

Instead of simply recounting what you did right and wrong and what you'd like to do going forward, grade yourself on your consistency.  

Your consistency grade requires a list of your best practices.  These are the things you do when you're at your best.  They can be lifestyle choices, such as how you eat or exercise; they can be best trading practices; they can be best practices in terms of your romantic and family relationships.  In other words, the list consists of the things that define you at your best.

Your consistency grade represents a frequency count of the number of days in the past week in which you have enacted that best practice.

When our two youngest children were very young, we created "sticker charts" for them.  Each day they cleaned their room, played well together, and ate well, they received a sticker.  If they received stickers every day of the week, they could cash those in for a toy or fun thing to shop for over the weekend.  The key to the exercise was the requirement that stickers had to be earned every day.  That rewarded not just good behavior, but consistency in good behavior.  It's that consistency that builds positive habit patterns.

Imagine an adult equivalent of the sticker chart:  If you can check the boxes on your best practices list every day, you arrange a reward experience on the weekend.  Perhaps it's a reward experience with someone you love, giving an extra incentive to achieve consistency.  Most traders are achievement oriented.  If they set up this kind of system and make it public (we hung the sticker charts on the refrigerator), they will want to check the boxes.  They will not want to fall short of a goal they commit to.

The hard part in making changes is getting to that place in which desired behaviors become routine behaviors.  It's easy to fall back into old patterns before the new ones take root.  Structuring your work on yourself--and on your trading--as work on consistency helps you make that transition, building those new, positive habits one day at a time.

Further Reading:  Turning Success Into a Habit
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Tuesday, January 17, 2017

Making Sense of the Market's Auction Process

Here's an admittedly unusual chart taken from last week's stock market action.  The red lines represent the amount of total upticks in the market on a one-minute basis.  I use this as a measure of buying pressure.  The blue line represents one-minute closing prices in SPY.  The chart is arranged so that the week's high price for SPY is at the left and moves toward the low price at the right.  Time is not a variable here.  We are looking at buying pressure at each price level of SPY during the past week.

What we see is that buyers were quite active as we crossed the 227 level in SPY.  We also see very low levels of buying and in fact net negative buying from approximately 226.75 to 226.87.

It's a way of smoking out where the buyers and sellers are located.  I've found this to be a very useful way of thinking about "support" and "resistance"--and an especially effective way of identifying points where fresh buying or selling are entering the market.  

It's also an example of how looking at market data in new ways can provide fresh perspectives that aid market understanding.  If a price level has held sellers this past week but cannot hold sellers early this week, it's a very useful indication of a shift in supply vs. demand.

I find my most effective trading captures an understanding of who is in the market and what they've been doing.  Too many traders attempt to forecast what prices *will* do before they truly understand what they've been doing.  The market is an auction, and you're watching the behavior of buyers and sellers to determine whether the price of the goods is likely to rise or fall.  It's amazing what we can see when we place market behavior in proper context.

Further Reading:  The Most Powerful Step We Can Take Toward Becoming Solution Focused
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Monday, January 16, 2017

Turning Information Into Knowledge: 100 Sources of Potential Insight

Traders are typically inundated with information--from charts and data feeds, chat, financial media, social media--but obtaining knowledge (not to mention wisdom!) requires some active filtering.  The challenge is to be open to new sources of perspective, but not so open that everything becomes a blur.  I would much prefer to deeply ponder five excellent sources of knowledge than skim fifty.  Indeed, it's the proliferation of information--and our desire to assimilate it all--that often prevents us from obtaining true knowledge and wisdom.

A recent feature from Feedspot highlights 100 top blogs and websites associated with the stock market.  These have been ranked as a function of site traffic and social media followings.  TraderFeed is on the list, as are a number of news and trading-related sites.  A great exercise would be to scan the list and find one source of information that can truly provide knowledge for your trading.  While not all 100 will be relevant to every trader and investor, the odds are good that at least one can provide new ideas and perspectives.

Creativity begins with new inputs:  we're most likely to achieve new insights when we look at new things and contemplate old things in new ways.  The challenge is finding the information most likely to provide us with actionable knowledge.  The list of 100 sites is a good place to start.  

Further Reading:  Some of My Favorite Financial Websites for Developing Traders
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Sunday, January 15, 2017

Positive Psychology and Trading Psychology: Bloomberg Radio Interview With Brett Steenbarger

I have to say, in the many years in which I've participated in interviews, I've never encountered one as detailed and well-prepared as Barry Ritholtz's recent interview of me on Bloomberg Radio.  He sent me questions in advance, updated those questions before the interview, and then came up with additional questions during the interview that revealed his prior thinking on the topics.  Barry's podcast series, Masters in Business, has become an impressive body of work, including interviews with such authors as Michael Lewis, Daniel Kahneman, and Philip Tetlock.  

One of the major themes of the recent interview was the role and importance of positive psychology for the discipline of trading psychology.  Positive psychology grew out of the early work of Abraham Maslow and the subsequent research of Martin Seligman and others.  It is the study of human strengths and competencies, as opposed to the study of psychological disorders.  An excellent curated list of positive psychology readings can be found here.

In a performance field such as trading and investing in financial markets, it is the leveraging of these positive attributes that distinguishes success.  Solution-focused work turns traditional counseling, therapy, and coaching on its head by intensively studying our successes--and then building upon those.  The Trading Psychology 2.0 that I describe in my recent book is a view of trading performance that highlights such strengths as adaptability, creativity, and the continual evolution of best practices into best processes.  Those topics were barely mentioned in trading books when I first began working with participants in financial markets almost two decades ago. 

If you have goals and a vision for yourself, the best way to reach those is to find the ways in which you are already moving toward those ideals in some ways, at some times.  There are patterns connecting your smaller successes that can become the framework for larger successes.  We are already the people we wish to become, but often only occasionally and inconsistently.  It is our moments of best performance that hold the key to the achievement of our greatest dreams.

Thanks again to Barry and the Bloomberg team for the opportunity to exchange ideas.  The podcast series is an invaluable resource for traders and investors.

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Saturday, January 14, 2017

The Power of the Pause

Here's a very simple rule that distinguishes good traders from poor ones:

Good traders trade poorly at times.  When they do, they pause from trading, reassess the market and themselves, and don't return to trading until they're in a different mode.  That different mode could be a different state of understanding; it could be a different emotional, cognitive, and physical mode--often it's all the above.  When good traders trade poorly, they make changes before placing additional capital at risk.  Pausing from trading is an essential part of their success.  It returns them to their best practices.

Poor traders also trade poorly at times.  When they do, they continue trading, and they compound their mistakes.  They never achieve a different mode, because they're so focused on markets that they never observe themselves.  When poor traders trade poorly, they place additional capital at risk before they can make changes.  That further trading is essential to their failure.  It keeps them from implementing best practices.

To determine a trader's skill, watch what they do when they are not trading.  How well do they research and reassess markets?  How deeply do they reflect and observe themselves?  It is in life's pauses that we have an opportunity to change direction.  Without powerful pauses, nothing can change.

Further Reading:  Three Best Practices of Trading
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Friday, January 13, 2017

Be the Person You Want to Become

Here's a very important psychological principle:  When you want to make a change, clearly identify your ideal self--the person you would like to become--and make a conscious effort to be that person in some way, in some measure every single day.

We expand our identity by taking on roles and, over time, having those roles become part of us.  When I met my wife, she had three children by a prior marriage.  I had never been in a father-like role in the past.  By taking on some (but far from all) of those responsibilities day after day, I gradually internalized the sense of being a father.  When we had two more children, I stepped into my responsibilities naturally and gladly.

Identity is something we internalize over time, and the feedback we receive from others when we're in a new role is an important part of that internalization.  Our life experience is constantly mirrored to us in our social interactions and that becomes part of who we are.

One change that many traders want to make is expanding their trading size and risk taking.  They have been trading small and prudently as they develop, but now is the time to take greater risk and pursue meaningful rewards.  How can traders make that transition?

We become bigger traders by gradually trading bigger:  by assuming that role each day.  In gradually bumping up the size of our positions, we gradually internalize the sense of being a bigger trader.  The gradual increases ensure that the resulting volatility of our P/L doesn't throw us for a loop, but are meaningful enough that we experience ourselves as growing.

We never talk ourselves into change.  Change is the internalization of consistent action.  When we assume a role, we potentially expand our identity.  Be the person you want to become in small measure every day, and before long, you'll experience the world as that ideal person.

Further Reading:  Five Keys to Making Life Changes
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Thursday, January 12, 2017

Supercharging Learning and Your Development as a Trader

In a recent post, Adam Grimes offers a number of helpful thoughts and advice for developing traders.  He makes the very valuable point that many of the psychological challenges of trading resolve themselves once basic, fundamental components of trading are properly addressed.

I'd like to add an observation to Adam's excellent list of must-do's for evolving traders.  The observation was inspired by a group coaching exercise I performed yesterday with the developing traders at SMB.  They came to my session probably expecting me to deliver a talk on a psychology-related topic.  Instead, I began by going around the room asking each attendee to name the one goal they were working on in that day's trading.  To their credit, the traders were able to quickly articulate what they were attempting to accomplish.

My observation is that the rate of development in a trader critically hinges upon:  1) keeping score with one's trading; 2) using score-keeping to identify clear aspects of trading to work on; and 3) the manner in which one actually works on those goals.  This third component turns out to be particularly important.

A good, diligent trader will keep track of P/L of trades, identify good and bad trades, and perhaps write in a journal what they did right and wrong and how they want to improve.  That is great.  Consider, however, the trader that takes the following additional steps:

a)  Discusses good and bad trades with a coach, mentor, or colleague and gathers additional perspectives re: things to work on;

b)  Films the trading session and actively reviews each trading day, focusing on specific areas where decisions were made and could have been made and noting what to look for in the future to take the right actions;

c)  Uses results to improve screening for trade selection, including writing scripts that automate screens and identify stocks trading with similar patterns.

Those additional steps accomplish two things.  First, they allow the trader to process learning lessons more deeply, because those lessons are processed via multiple modalities:  through discussion, active observation, and automated analysis.  When we learn something in multiple ways--think of learning to drive a car by reading and memorizing road signs and rules; practicing on a driving simulator; and going out on the road with a driving instructor--our learning is most likely to stick.

The second benefit of these added steps is that they place the trader in a very active learning mode.  The trader who films the session is then reviewing the film, pausing it at key points, writing down observations, and cementing patterns to be acted upon--no different from athletes who watch game film as preparation for practice and upcoming games.  The active and interactive learning keeps the trader highly engaged and focused and thus more likely to take in the lessons learned.

Learning more deeply in multiple modalities; learning more actively by doing and not just observing--these enrich the development process and accelerate the learning curve.  One or more traders in my meeting engaged in one or more of these best learning practices.  Imagine being in a community of traders, each of whom is learning deeply and actively.  

The process of learning is every bit as important to development as the lessons being learned.

Further Reading:  Learning How We Learn
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Wednesday, January 11, 2017

Trading Market Cycles

In the previous post, I proposed a scheme for reading market cycles, by breaking those cycles into phases based upon market activity.  Trading market cycles requires a kind of creative opportunism described by Gehry.  The materials on the table are characteristics of market behavior.  When trading well, we are arranging those in a fashion that enables us to capture solid reward-to-risk relationships.

A cycle-based site for stock and ETF trading that quantifies market cycles and makes buy and sell recommendations is StockSpotter.  The site makes many recommendations--more than the average trader would take in a day.  So they simulate performance by taking very many random groups of four recommendations (Monte Carlo simulation) to show the range of likely trading outcomes from following those picks.  It's one of the more elegant demonstrations of edge that I've seen from a market service.  The opportunism comes when we take other criteria for buying or selling, such as our fundamental analysis of a company or our view of the entire market, and marry those to the site's recommendations.  What we're trying to do with this kind of opportunism is join two or more independent sources of edge, so as to maximize the probability of success.

A different kind of opportunism might look at separate overbought/oversold measures on two or more different time frames.  For example, I'll look at the upticks/downticks in the market as a very short-term measure of overbought/oversold and an oscillator of price change to capture a medium time frame.  When we are topping and dropping, we'll see the measures peak at equal or successively lower price levels: the buyers still move the market, but cannot move it higher over time.  When we are bottoming and rising, we'll see the measures trough at equal or successively higher price levels.  In opportunistically aligning the time frames and market behavior, we can find solid risk/reward ways to exploit market cycles.

Still another form of opportunism for daytraders involves tracking order flow--seeing when bids or offers are holding particular levels--and joining that information to a broader view on trend/direction.  For instance, if we see recurring bids being hit at a given price level where that level holds, we might join the offer if we see that the bigger picture for the stock is higher.  

It is this lining up of market behavior that creates some of the best trades.  Waiting for the lining up requires patience and perspective.  A great deal of productive trading time is spent not trading, but actively watching for those occasions when one source of edge falls into place with another--and then pouncing on those opportunities with meaningful risk-taking.

Further Reading:  Some Great Rules for Life and Trading
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Tuesday, January 10, 2017

How to Read Market Cycles

I find it helpful to think in terms of market cycles, rather than trends.  A cycle consists of both trending and non-trending components.  Understanding where we're at in cycles helps us identify whether we want to be going with strength or weakness or whether we want to fade these.  Once we think in cycles, it's silly to identify ourselves as trend traders or counter-trend traders.  Our job is to profit from the various phases of market cycles, not try to make market activity fit our predetermined trading preference.

Cycles are like snowflakes:  no two are identical and yet all have a similar structure.  Let's review the phases of a market cycle:

1)  Market Momentum Bottom - Here is where we wash out on elevated volume, with a maximum number of stocks registering fresh new lows.  Volatility is high and correlation is high, as the great majority of stocks and sectors are participating in the decline.  An example of a market momentum low was January 20, 2016, when we dropped on high volume with over 2600 stocks across all exchanges registering fresh three-month lows.

2)  Market Bottoming - The extreme selling brings in value buyers and we get a sharp bounce from the market lows, followed by further attempts at selling.  At major market lows, this bottoming process can occur over a period of weeks or more; at intermediate lows, it may occur over subsequent days.  An example of a bottoming process was the bounce into the beginning of February, 2016 followed by a decline to new closing price lows on February 11th.  Only 1353 stocks made fresh three-month lows at that time, showing that selling pressure was having difficulty moving the great majority of shares lower.

3)  Bull Momentum Phase - With the inability of sellers to move the majority of stocks lower, value buyers return with a vengeance aided by short-covering and that moves the market steadily higher.  Volume and volatility are still high, with the vast majority of stocks lifted off their lows.  In this phase, we often look for pullbacks but get none of great magnitude, as momentum enables strength to follow from strength.  A good example of a momentum phase was the sharp move of stocks higher from mid-February, 2016 through much of March and early April.

4)  Bull Topping Phase - Here is where higher prices get to the point where the market is no longer attractive to value participants and bulls are relatively loaded up.  This results in a drop of volume and relatively low levels of volatility.  Correlations move lower as some sectors and stocks continue strong, while others begin to lag.  Late in a topping phase, we can see the number of stocks making fresh short-term lows expand, even as the overall market averages are near their highs.  A short topping phase occurred from mid-April, 2016 through early June.  Over that time, price moved higher, but new three-month highs dropped from 1113 to 818.

5)  Bear Momentum Phase - The inability of buyers to push the market to new highs attracts the participation of sellers and volume and volatility once again pick up.  The market can remain oversold for a while, as bulls exit their positions and shorts are emboldened.  Correlations rise, and we move toward a market momentum bottom.  The market demonstrated an intermediate bear momentum phase from early June, 2016 to late June.  At that bottom, we did not see an elaborated bottoming process.  When a pullback occurred, it was from a higher price point and resulted in a higher price low.  This led to a quick rally higher into August.

As a rule, the longer the bear market phase and bottoming processes, the longer the subsequent rally.  The longer the bull topping phase, the more extreme the subsequent bear phase.  When more market participants are trapped short or long, the unwinds tend to be greater.

Cycle structure can provide us with a road map for gauging where we stand with respect to "overbought" and "oversold" markets and the likelihood that strength or weakness will continue or reverse.  I use cycles less for predicting markets than understanding them.  Knowing where we're at in a market cycle helps us avoid chasing markets at the wrong time and also helps us avoid standing aside during the market's periods of momentum.  Most of the indicators I track are ways of gauging day to day strength and weakness and updating where we stand in terms of cycle structure.

At present, we see volume and volatility at relatively low levels and small cap shares underperforming large caps.  That has contributed to a rise in the number of stocks registering fresh short-term lows.  For example, on Monday we had 520 stocks across all exchanges make new monthly highs, but 694 register fresh monthly lows.  Technology shares have made new highs, but many sectors remain below their peaks.  All of that raises the odds that we're at a relatively late, topping period in the recent bull cycle.

Further Reading:  Relative Volume and Links to the Indicators I Follow
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