Thursday, December 08, 2016

Momentum in the Market: Trade It or Fade It?

A trend day is basically a day with momentum on the day time frame.  The buyers or sellers so dominate the market activity that the other side backs off for the remainder of the session.  That is what we saw in yesterday's trade:  once we broke to new highs with significant uptick readings, the buyers remained in control for the session.  I find it useful to track the distribution of NYSE TICK readings during the trading day to identify when we have made significant shifts in buying/selling and when we are extended within a relatively static range.  That shift of distribution often makes the difference between trading strength or weakness versus fading it.

The momentum principle is true on longer time frames as well.  Yesterday's post took a look at the absence of market weakness as an indication of potential future market strength.  Now let's look at the presence of market strength, such as we saw in yesterday's session.  Does that tend to lead to future weakness as an overbought signal, or does it tend to yield further gains as part of momentum?

If we track the number of NYSE stocks closing above their individual Bollinger Bands and those closing below, we find that 412 closed above their bands.  That is a huge number; one of the highest since I began aggregating these data in 2014.  For comparison, since 2014, the median number of stocks closing above their bands each day has been 62 with a standard deviation of 69.  We've had 48 occasions over that period in which more than 200 stocks have closed above their upper bands in a trading session.  Five sessions later, the average price change in SPY has been a loss of -.13%, compared with an average gain of +.15% for the remainder of the sample.  When we look 20 days out, however, the average gain in SPY after the strong session has been +.96% versus an average gain of +.49% for the remainder of the sample.  While it's been normal to have some near-term pullback after extreme strength, it's also been common for the strength to resume.

The market spends much of its time trading in a range.  During that range trade, by definition the moves higher and lower lack the momentum to be sustained.  The best trading strategy is to recognize the loss of momentum and fade the strength or weakness.  Once we expand buying or selling, however, we can get the breakouts from ranges in which strength or weakness leads to further strength or weakness.  We lose flexibility when we identify ourselves as range (mean reversion) traders or trend (momentum) traders.  One of the great challenges of trading markets lies in recognizing shifts in buying and selling regimes.

Further Reading:  Tracking Institutional Participation in the Market

Wednesday, December 07, 2016

A Unique Way of Tracking Market Strength and Weakness

Above we see a cumulative running total of the number of NYSE stocks closing above their upper Bollinger Bands minus the number closing below their lower bands.  (Data from the Stock Charts site).  This is an interesting measure, because it tells us how many issues are distinctively strong versus weak.  The slope of the cumulative line is as important as the direction, as it gives us a sense for the breadth of market strength or weakness.  Note the anemic bounce in the cumulative line since the election lows.  This reflects the very mixed breadth of the market rise--some sectors quite strong, others distinctively weak.  Still, the line has been consistently rising, reflecting relatively little weakness among stocks.  For example, the past two days we've seen 95 and 103 stocks close above their respective bands, but only 5 and 9 stocks close below their lower bands.  In general, to get a sustained market decline, we need to see not just a reduction in market strength, but an expansion of weakness.  

The absence of weakness very often is a useful predictor of future market strength.  For example, when the number of stocks below their Bollinger Bands has been in its lowest quartile since 2004 (little weakness), the next 20 days in SPY average a gain of +.95%.  When the number of stocks below their bands has been in their highest quartile (great weakness), the next 20 days have averaged a gain of +.70%.  All other occasions have averaged a 20-day gain of only +.21%.  It's a nice example of how so much in the way of market returns comes from the relative extremes of momentum and value.

Further Reading:  Momentum, Value, and Short-Term Market Movement

Tuesday, December 06, 2016

What is Your Recovery Plan After Trading?

Many thanks to a savvy portfolio manager who passed along this dramatic account of what professional football players go through to recover from their weekend games.  One of the big points of the article is that the longevity of a professional career is partly a function of the time spent in recovery on Mondays.  Tending to the body after injuries allows for faster healing and prevents those injuries from compounding to the point where they lead to disability.

The principle of recovery is important for all performance professionals, if not so dramatically as in football.  In performance, we push beyond our comfort zones, and that effort taxes us.  A great example is willpower.  When we've focused and made critical decisions under pressure for an extended period, that willpower runs out of power.  We become fatigued, and in the fatigued state we're more likely to make mistakes and fall into old habit patterns that cost us money.

Imagine a person who works nonstop planting grass seed and becomes so exhausted that they fail to water the areas they planted.  We can wind up pushing ourselves to the point where we fail to water ourselves.  We fail to take the time to renew our energy and that takes a toll on performance.

We often hear that traders should plan their trades and trade their plans.  Less appreciated is the importance of plans and routines for recovery.  What are you doing on evenings and weekends that renews you?  Of the four main sources of well-being, which ones are you cultivating in your time away from markets:

Happiness, and doing things that are fun and enjoyable
Satisfaction, and doing things that are meaningful
Energy, and doing things that energize you mentally and physically
Relationships, and doing things that bring you closer to the ones you care about

A good recovery plan should include healthy eating, high quality sleep, and activities that check all four of the boxes above.  

It's the watering you do at night and on weekends and holidays that allows your career to blossom during the work day.

Further Reading:  A Personality Questionnaire for Traders

Monday, December 05, 2016

The Path of Persistence

Here's a great exercise:

Review your trading journal and/or your written goals and plans over the past several months.

How many items appear repeatedly, over many days per week and over many weeks?

Change is rarely instantaneous.  Enduring change requires repetition.  Repetition requires persistence.  

If your notes and journal entries don't have items you work on repeatedly, over time, then you're simply logging one good intention after another.  The path of least persistence rarely is the path to success.

And if you're not persisting in keeping a journal, setting goals and plans, and chronicling your progress and learning?

We don't win by persisting at trading.

We win by persisting at working on our trading.

Further Reading:  How Ordinary Traders Become Extraordinary

Sunday, December 04, 2016

This Stock Market is a Market of Stocks

The above chart of sector performance over the past three months from FinViz really is quite remarkable.  There have been big moves during this recent period, but the moves have been very different across the sectors.  If you have been long industrial conglomerates and commodity-related shares, you've likely done well.  If you have been long consumer staples shares, healthcare issues, or utilities, your returns have been significantly negative.

Here's another interesting perspective, courtesy of the excellent Index Indicators site.  As of Friday's close, we had 48% of SPX stocks trading above their three-day moving averages; 43% above their five- and ten-day averages; 58% above their 20-day averages; 60% above their 50-day averages; 54% above their 100-day averages; and 61% above their 200-day averages.  In other words, at every time frame, there have been a large proportion of stocks you could identify as weak or strong purely on a moving average basis.

In short, we've had less of a true stock market than a market of stocks.  

From a cycle perspective this is important, because the bull and bear phases of cycles are characterized by trend and momentum.  When we are in a true bull or bear market move, the tide tends to lift or lower all boats.  When markets spend significant time topping or bottoming, we see a meaningful degree of rotation, with the stronger and weaker sectors diverging in performance.  

It is not clear to me that the moves off the election evening lows represent a fresh bull market in stocks.  Yes, we did see significant share creation in the SPY ETF after the election; this has leveled off and even dipped a bit since mid-November.  And, yes, we did see an expansion of the number of stocks making fresh 52-week highs following the election.  That has leveled off in the past week, but interestingly 100-day new highs minus lows among the SPX stocks only hit 94 at their recent peak, below levels seen off the late June bottom.  Much of the breadth strength in the aggregate market numbers are a reflection of relative strength among small caps and mid caps.

As long as that aggregate breadth stays positive, with few shares actually registering fresh new lows, I don't expect any major near-term corrections or transition to bear market conditions.  When I see all ships not rising, however, I question the tide.  End of year performance dynamics for fast money participants have led markets to price in a significant degree of expectation for the new Presidential administration.  I am watching breadth statistics carefully to handicap the odds of continuation versus consolidation, and I'm carefully tracking the relative performance of the strongest and weakest sectors to determine the staying power of the post-election themes.

Further Reading:  The Momentum Curve

Saturday, December 03, 2016

Three Powerful Measures of Character

Character is more than personality.  Character reflects our deepest values and priorities and our most fundamental commitments.  When someone has a good personality, we might like that person.  When someone has a good character, we're likely to admire that person.

Here are three simple but powerful measures of character:

1)  How does the person spend his or her free time?  Per Ayn Rand's observation above, what does he or she do for enjoyment?  

2)  How does the person respond to your successes?  Many people are willing to commiserate with you when you're down and elevate themselves in the process.  A person of genuine goodwill celebrates your successes and is happy for your happiness.

3)  What strong beliefs does the person voice and live through their actions?  Character means standing for what you believe in and living your beliefs.  Go along and get along might be comfortable, but commitment is what powers effective action in the world.

Now apply the three criteria of character to yourself.  What do you do for enjoyment?  How do you respond to the successes of family members and colleagues?  If someone were to read your writings, hear your speech, and observe your actions, what would they conclude about your beliefs, values, and commitments?

Character is a magnet:  who we are determines who is drawn to us.

Further Reading:  Personality and Character in Trading

Friday, December 02, 2016

A Unique Measure of Stock Market Cycles

A rule that has held up well is that successful traders tend to look at unique data and look at common data in unique ways.  It's pretty difficult to distinguish ourselves from the herd if we're part of what the herd is looking at and listening to each day.  Some of the best traders I know view unique data uniquely.  That means they're looking at things others aren't.

Above we see an indicator created by tracking every stock listed on the NYSE and whether it is giving a buy signal, no signal, or a sell signal on the Parabolic SAR system created by Wilder.  The indicator, in red above, simply cumulates the buy signals minus the sell signals and keeps them as a running total, like an advance-decline line.  I scrape the raw data from the excellent Stock Charts site daily.   

The indicator provides a useful sense of overbought and oversold.  More to the point, when values have been in their strongest quartile since 2014, the next 20 days' return has been superior.  That's a momentum effect.  When the values have been in their weakest quartile, we've also seen a superior average return over a 20-day period.  That's a value effect.  The trajectory of the cumulative measure acts reflects the cyclical nature of market movement, with returns shifting between value and momentum at various phases of market cycles.

Note that we've shifted downward from a peak in the measure recently and have been heading lower, though are not yet near oversold territory.

Thinking of market movement in cycles has helped me frame when I expect prices to trend and when I expect mean reversion.  Tracking cyclical behavior over time has been useful in identifying longer-term market strength and weakness.  Perhaps most of all, having a cycle framework means understanding that no market move will last forever.  "This, too, shall pass" helps place many things in a useful life perspective.

Further Reading:  Volatility and the Dynamics of Market Cycles

Thursday, December 01, 2016

Developing Your Trading Playbook

Here's one you can take to the bank:  

The most successful traders can talk in detail about the patterns that they perceive in markets and how they have traded those patterns.  The patterns make sense to them and represent some manner in which markets are "offsides" and thus offer a favorable reward relative to risk.  

The least successful traders talk about catching moves in markets and are not focused on particular patterns or setups.  They let market movement define opportunity, rather than allow their definition of opportunity guide their involvement in the market.

In other words, the best traders, to use Mike Bellafiore's phrase, develop a playbook just like any football or basketball team.  The plays they practice are ones that make use of their strengths and that exploit weaknesses in the opponent.  The playbook defines opportunity set.

As a trading coach for developing traders, I can readily identify the traders on the right track.  The ones who are progressing talk about their playbook trades and how well they are exploiting their opportunity set.  They are getting better and better at running their plays and, every so often, they develop new plays as they see new patterns and fresh opportunity.  The ones who aren't progressing talk about their feelings, how they missed the last move, whether the market will go up or down, etc.  

What is your playbook:  the patterns that you see setting up and that make particular sense to you?  How well are you recognizing those patterns in real time and running your plays?  How well are you exploiting those patterns once you get into the plays?  What factors help you make the most of your plays?  Which interfere with pattern recognition and acting on your areas of opportunity?

Before you ever get good at trading, you'll become good with specific trades.  Grade yourself on how well you ran *your* plays.  Get better and better with your playbook and gradually add to it.  If your trading journal doesn't reflect your playbook, is it really going to help you play the game better?

Further Reading:  Training Yourself in Pattern Recognition

Wednesday, November 30, 2016

Trading Model and Market Update

Here's an update of the multivariate trading model I keep for SPY.  A number of variables go into the ensemble model, including buying pressure, selling pressure, breadth, sentiment, and volatility.  Readings of +3 or greater and -3 or less have had particularly good track records in and out of sample, anticipating price change 5-10 days out.  Note that we hit a -3 reading on Friday; prior to that we saw +3 readings shortly before and after the election.

Thus far, we are not seeing significant breadth deterioration in stocks.  For ten consecutive sessions, we have had fewer than 200 stocks across all exchanges register fresh monthly low prices.  This breadth strength generally occurs in momentum markets; weakening of breadth--particularly an expansion in the number of issues making fresh lows--tends to precede market corrections.  It is not at all unusual for momentum markets to correct more in time than price.  We've seen selling pressure the past two sessions, but not significant price deterioration.  This dynamic allows momentum markets to stay "overbought" for a prolonged period as price consolidates and often grinds higher.

Further Reading:  Previous Model Update

Tuesday, November 29, 2016

Working on Our Trading by Working on Ourselves

The recent post emphasized pattern recognition as a core trading skill.  That same skill is key to trading psychology.

One of Freud's central insights was that of the "repetition compulsion":  the idea that we unconsciously repeat patterns in our lives, often with negative consequences.  Change in therapy occurs when we become aware of our patterns and are able to interrupt and change those.  The different approaches to helping--psychoanalytic, behavioral, cognitive, family systems, solution-focused--are simply different ways of understanding and changing the patterns we unwittingly relive.

One trader I worked with never felt fully accepted and valued by his parents.  He was compared with his brothers and often found wanting.  He latched onto trading as a way of making a name for himself and becoming wealthy and successful.  Each time he lost money in the market, he experienced the loss as something more than the dollars and cents.  The losses felt like confirmation that he really was inadequate.  With his self-esteem riding on each trade, he found it difficult to make sound decisions.  He took profits quickly to regain the feeling of winning and took losses very reluctantly, unwittingly repeating those mistakes.

When we track our trading mistakes--and our trading psychology--in journals, we can often detect patterns that sabotage our profitability.  This is particularly the case when the same emotions crop up in trading situations, such as frustration, depression, or overconfidence.  Once we become aware of those patterns, we can begin to identify triggers that set us off.  That enables us to anticipate the patterns and rechannel our emotions and actions.  The trader I worked with learned to take breaks after losses and process his self-talk at those times.  Gradually he learned to separate his self-worth talk from his trading talk, allowing him to accept losses without experiencing himself as a loser.

It all starts with self-awareness.  We can't change a pattern if we're not aware of it.  When we become observers to our patterns, we are no longer immersed in those patterns.  As observers we can control those patterns and ensure they don't control us.  If you're experiencing repeated emotions and self-talk during your trading, the chances are great that there's a life pattern controlling you.  Market mastery and self mastery go hand in hand; working on ourselves can be the best way of working on our trading.

Further Reading:  How to Break Negative Trading Patterns