Saturday, August 12, 2017

Capturing Value and Momentum in the Stock Market

In mid-2014 I hit upon an idea for analyzing the strength and weakness of the overall stock market. Suppose we took every stock in the New York Stock Exchange and assessed whether it gave a buy signal, a neutral signal, or a sell signal for a standard technical indicator, such as Bollinger Bands. Such a measure would capture the breadth of strength and weakness for stocks as a whole, not just for the index itself.  Would this be a useful measure?  It turns out that the measure was indeed useful and I began collecting the data daily from the Stock Charts website.

Then I hit upon another idea.  The signals from cumulated stock performance on one indicator (such as Bollinger Bands) were different from the signals from other indicators (such as RSI and Parabolic SAR).  Might it be useful to create an indicator of indicators? This would show occasions when we have strength and weakness across all stocks *and* all indicators.  

The resulting cumulative indicator measure is charted above from 2016 forward (indicator in red; SPY in blue).  Even within the considerable uptrend we've had over that period in SPY, we've seen relative periods of overbought and oversold in the measure.  Note that we currently stand at a significantly oversold level.

Going back to June of 2014, when I first began accumulating these data, next ten day returns in SPY have averaged +.01% when we have been in the top half of the distribution for the cumulative measure.  When we have been in the bottom half of the measure, next ten day returns in SPY have averaged +.63%.  This is a significant value effect.  Returns have been significantly better over a swing period when we've been oversold than when we've been overbought.  If we break down returns by quartiles, the upside returns are even more striking in the weakest (most oversold) quartile, which is where we stand now. Interestingly, when the indicators have been simultaneously strong, we've seen superior upside returns over the same ten day horizon.  

In other words, the cumulative measure is capturing both a value effect (buy when things have gotten weak) and a momentum effect (buy when there is a broad thrust higher). Returns have been subnormal if we are not broadly weak or broadly strong.

This is a nice illustration of the value of "big data" and especially the value of well-conceived unique data sets.  As a discretionary trader, I find it crucial to be quantitatively informed.  I observe that integration of discretionary and quantitative among the great majority of the successful traders and portfolio managers I work with.  Even for longer time frame active investors, timing market entries and exits with shorter-term measures that capture value and momentum can meaningfully enhance returns.

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Monday, August 07, 2017

What I've Learned From My Trading Setbacks

During the summer months, I have made a concerted effort to work on my trading.  My year to date results had been well below my average returns and indeed had turned negative for the first time in recent memory.  I took that as a worthy challenge and engaged in a detailed review of what was working and what wasn't working in my trading.  I'm pleased to say that the results of this work have been quite positive, not only turning the P/L around but also instilling both a consistency of process and a consistency of results.  Below I share a few of the things I have learned in my trading that might be of help to other traders who are adapting to challenging, low volatility markets:

1)  Think in Cycles - This has been one of the two greatest changes I've made in my trading.  I stopped thinking about trends and ranges entirely, I don't focus on chart patterns, and I don't pretend to know what the "big players" are doing apart from noting volume patterns.  Instead, I am identifying dominant cycles in the market at short, medium, and longer time frame and focusing on how those cycles interact with one another.  I am focusing on cycles of volatility in the market, as well as cyclical price action.  This has been a much more effective way to participate in directional market behavior, especially when implemented in event time. The cycle framework has naturally made me more flexible as a trader:  at certain junctures in a cycle, I am a "trend" trader, following the momentum that occurs when cycles line up.  At other cycle junctures, I am a "mean reversion" trader, adjusting to the "choppiness" that occurs when cycles are not aligned.  Most of all, I've become better at focusing on dominant cycles and the ways in which volatility regimes shift the cycles that dominate.

2)  Focus on Execution - A side benefit of the cycle framework is that it allows for simultaneous tracking of short term and longer term cycles.  The short term cycles become extremely useful in entry and exit execution, allowing the trader to extract more from each trade.  I find that the difference between good entries and exits and poor ones in low volatility markets is an important component of making and losing money.  I might be trading a longer term cycle, but I will use a short term cycle to get in near a trough and exit near a peak.  This is a bit counterintuitive, as you're buying when things look worst and selling when they've been recently strong.  By giving execution a short volatility bias, it's helped me participate in directional moves that do occur.

3)  Focus on Trading Spirituality, Not Just Trading Psychology - This is subtle and is a topic not everyone is comfortable with.  Trading just doesn't work when it is *me* focused.  Me making money, me losing, me becoming successful, me working on my state of mind, etc.  Once the ego is the focus, we lose flexibility and perspective.  I of all people should know that: as a psychologist, if therapy ever becomes about me, I lose my effectiveness.  The skill of a therapist is in listening, understanding, and responding to another person.  If I'm concerned about my income, my reputation, or my feelings about the other person, I lose my focus and my impact.  In the past months, I've regrounded myself in my religion and made spiritual readings a daily part of my morning routine. The change in perspective has been dramatic. A turning point occurred when my research yielded a very good trade opportunity.  I didn't feel excitement, conviction, greed, or any of those things.  I felt grateful.  It's a big change.

I'll be doing a free online workshop this week and will be happy to amplify these ideas.  Setbacks occur for a reason; they point the way to new directions we need to take.  I hope you always have setbacks in your trading and I hope they always make you a better trader--and a better person.
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Friday, August 04, 2017

Free Group Coaching on August 9th

I've recently found group coaching sessions to be highly productive.  When a group meets with me for coaching, we can discuss the common challenges members are facing and each person can learn from the experience of others.  In recent sessions, I've outlined specific psychological and trading approaches that address those challenges, so that group members can take away concrete goals and directions for improving their trading.

I'm pleased that Futures.io is hosting a free group coaching session with me at 4:30 PM on Wednesday, August 9th.  The extended "ask me anything" format means that this will *not* be a lecture-style presentation.  Rather, attendees will be part of a group that interacts for group coaching. Participants can ask questions about their personal lives, their trading approaches, psychological challenges they face in trading, how to join trading firms, and much more.

Here is the link for registration for the event.  Space in the room is limited, so please sign up early.  And start thinking about the best questions you have regarding trading psychology.  It's a great opportunity to learn from each other's experience!

Thanks as always for the interest--

Brett

Sunday, July 30, 2017

Renewing Our Trading And Regaining Our Passion

One of the most striking differences among traders I have encountered is their grounding in a problem-based mindset versus an opportunity-based mindset. The problem-focused trader is chronically frustrated, battling one challenge after another.  The opportunity-focused trader is inspired, finding meaning and direction in setbacks.  It's easy to become problem-focused when losing money and it's easy to perceive opportunity when things are going well.  The successful traders I've known look for problems when things are going well, because they are always looking for opportunities to improve.  They are also looking for what is going well during periods of drawdown, because that is where opportunities may be showing up.

In a recent article, I outline why I believe we could be on the cusp of important market opportunities. Yes, it's been a challenging period for traders in terms of low-volatility market behavior and erratic trends.  But, as I outline in the article, there *are* strategies and approaches that are working; I *do* see people succeeding.  There is opportunity in current difficulty.

What has kept me alive in markets since the late 1970s, besides risk management, has been research.  Every week I update my database, explore ideas, and test out strategies.  Easily 80% of what I look at is either worthless or duplicates what I already have.  Another 10% is promising but ultimately has limited value.  It's that final 10% that opens new doors and yields fresh opportunity.  I could become discouraged about the 90% of research that never finds its way into my trading, or I could be energized by the 10% that moves me forward.  

If I were not innovating, what would keep me interested, driven, optimistic, and energized during periods of drawdown?  Too often, we are mired in problem-based mindsets because our focus is solely on P/L.  So our focus and passion rises and falls with our equity curves.  When we approach markets with intellectual curiosity and a love of sharing ideas with like-minded colleagues, we create whole new sources of motivation.

Trading was fun when it was new.  The challenge is keeping ourselves re-newed.

Further Reading:  Why Trading Has A Future

Saturday, July 22, 2017

Why We Overtrade and Why We Miss Opportunities

So many psychological problems of trading boil down to underaction, failing to act when it is appropriate to do so, and overaction, taking actions that are not warranted.  Undertrading means that we fail to "pull the trigger" on our ideas.  Overtrading means that we trade outside the range of our ideas.

As Gandhi's quote suggests, our actions express our priorities.  The trader who fails to act is very often prioritizing preservation of capital and avoidance of risk and loss.  The trader who acts excessively is prioritizing gain and avoidance of "missing out".

What I find in working with traders is that underaction and overaction occur in a specific context. Very often the trader has figured out the idea that would have them long or short a market or stock. What they have not explicitly outlined is the specific set of conditions that would have them act upon this idea.  In other words, traders have an idea, but not a clear "setup" criterion that would have them execute that idea.

In the absence of a clear entry or exit signal, traders are left with ambiguity.  That ambiguity is the fertile ground in which those psychological priorities--avoidance or risk, fear of missing out--grow and become dominant.  It is necessary to have sound ideas with edge to succeed in trading, but having great ideas is not sufficient to bring success.  One also must know how to implement those ideas.  Without a sound basis for implementation, ideas cannot come to consistent and optimal fruition.

To be sure, we see the opposite problem as well.  Traders will grasp as "setups"--patterns of price movement--as ideas and trade these without any objective verification of having a probabilistic edge in outcomes.  "Selling is holding at the X price level" may be a useful observation, but it is not a plan and in itself confers no edge.  A common problem among daytraders is such eagerness to trade and make money that relatively little time is spent researching ideas that are actually worth trading and that have the potential to make money.

Once we distinguish between the idea we're trading and our plan for executing that plan, we're in a better place to figure out when we need to work on our ideas and research (i.e., trading the wrong ideas) and when we need to work on the trading of those ideas (i.e., faulty execution of our ideas). Very often, we overtrade and fail to act on valid opportunities simply because we have not been explicit about the idea we're expressing and how we are expressing it.

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Saturday, July 15, 2017

Evaluating Yourself as a Trader

Very quickly, evaluate yourself on the following criteria:

1)  Innovation - Researching new sources of edge in your trading, drawing upon different inputs; learning new strategies and markets; finding new opportunities; learning from your experience and the experience of others.

2)  Flexibility - Ability to find opportunity in different market conditions, different markets, and different time frames; ability to move from being aggressive to being patient and back again; ability to trade different strategies and different sides of markets.

3)  Self-Improvement - Always assessing what you could do better and making steady improvements; following through on goals with concrete plans and actions; keeping yourself in peak performance condition.

If I had to identify one flaw affecting struggling traders, it would be stasis.  The static trader does not innovate; is too fixed in doing one thing; and has no consistent process for improvement.  Most important, struggling traders aren't following Elon Musk's advice and questioning themselves.  

Show me what traders are working on outside of market hours, and I will show you the odds of their future success.  A passion for trading in the absence of a passion for innovation and improvement is a sure path to losing money.

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Sunday, July 09, 2017

Reaching the Next Level of Trading Performance

Einstein observed that we cannot solve our problems with the same level of thinking that created them.  In other words, problems exist in our deficiencies of perspective.  Once we reach a next level of perception, thought, and analysis, problems can give way to solutions.  An important contribution of mentors and coaches is to introduce us to next levels of thinking.  If we are locked into our old modes of perception and thought, we will be locked into our level of performance.

On Wednesday, July 19th, I'll be speaking at Stock Twits' second ever Futures Forum in New York City.  We'll be meeting at Slattery's Midtown Pub and enjoying food and drink--and I'll be presenting key ideas regarding getting to the next levels of trading performance. (Registration information for that free event can be found here).

One very important idea is that almost always we are already performing at that next level of performance on some occasions.  It is when we are at our best that we can clearly perceive our next level of development.  That is what we are ready for.  That is what we are already capable of.  At times, we are closer to our goals; at times we are more distant.  When we clearly identify what we're doing when we are nearer to our ideas, we start to piece together a roadmap for getting to our next level.

What are you doing well now and how are you doing those things?

Those are some of the most important questions in trading psychology.  Our next level of thinking is the thinking we're doing when we're performing at our best.

Further Reading:  Building Self-Efficacy
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Saturday, July 08, 2017

Beyond Coping: The Inspiration Mindset

Let's consider a key distinction:  Being in a coping mindset versus being in an inspiration mindset.

The coping mindset is problem focused.  It means tackling a difficult, stressful, and/or unpleasant situation and getting through to completion.  The focus of a coping mindset is getting past a negative; getting through a disagreeable challenge.  Coping mindset is what we experience during a subway delay or during an interminable contentious business meeting.  Coping mindset is also what we experience when we have chores to tackle at home, responsibilities with family, and a backlog of demands from work.  

The inspiration mindset is different.  Whereas coping takes energy, inspiration gives energy.  Inspiration is value focused.  It follows from engaging in a meaningful activity, immersing ourselves in a greater vision or purpose.  The focus of an inspiration mindset is appreciating a positive, finding affirmation through our actions and/or experiences.  Inspiration is what we experience when we encounter a breathtaking vista or when we achieve a meaningful goal.  The inspiration mindset is also what we experience when we find closeness in our relationships and a sense of purpose in our work.

Very often the same activities can be undertaken in a coping mindset or in an inspiration mindset.  Performing physical exercise could be experienced as coping with an unpleasant, demanding routine or as a valued development of your capabilities.  Going to work or tackling your trading could be an exercise in coping with threats and frustrations or it could be an opportunity to make a meaningful difference and achieve new and better things.  A marriage can be something we cope with to avoid conflicts, or it could reflect a deep emotional, spiritual, and physical fulfillment.

During periods of flat performance or drawdown in markets, trading can feel like an exercise in coping.  I recognize this when I speak with traders and hear nothing of the excitement, challenge, discovery, and growth that initially attracted them to markets.  It is like speaking to a person who was once in love and now copes with a relationship that has lost its romantic spark.  The trader may choose to work on problem A, B, or C, but it's all just different deck chairs on the Titanic.  The problem is not A,B,or C, but the devolution to the coping level.  The problem is the absence of inspiration:  the way in which trading has become divorced from value, meaning, and purpose.

Traders who sustain an inspiration mindset find value and meaning in markets above and beyond recent performance.  They discover new opportunities through research; they learn new things in their professional networks; they benefit from developing teams and mentoring up and coming talent; they use their trading as a way to develop themselves as people.  To sustain an inspiration mindset means figuring out how to make negative P/L days winning days in process terms.  

Coping and inspiration mindsets are self-reinforcing.  Others respond to the energy we project.  If we come across as inspired, others are attracted to the meaning and fulfillment we radiate.  If we are absorbed in coping, our negative vibe will attract a very different tribe.

What will inspire your day today?  Your week?  Coping is far better than not coping, but there is much more to life than getting through tasks and burdens.  You know you're on the right path when you find meaningful, energizing ways of tackling unpleasant responsibilities and challenges.

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Thursday, July 06, 2017

Self Awareness and State Awareness in Trading

One of the topics I'll be addressing in depth at the upcoming Chicago workshop (July 24-26) is understanding your physical, emotional, and cognitive states and how those contribute to good and bad decision making.  

Much of our behavior--in and out of markets--is state dependent.  How we interact with others, how we take risk, how we tackle challenges:  all of these are impacted by the degree to which we are energized or fatigued; calm or keyed up; fulfilled or frustrated; distracted or focused; etc.  

In the right states, we can access our greatest strengths.

In the wrong states, we fall victim to our greatest weaknesses.

Awareness and management of our states--and the ability to cultivate new states and extend existing ones--is central to peak performance.

One of the great challenges of trading is balancing market awareness and self-awareness.  

You have a trading process: a way of identifying opportunity, defining trades, and managing the risk and reward around positions.

Do you have a self-awareness process?  

We track price action closely; how aware are we of ourselves and whether we are in the right states for peak performance?

This is one of those areas where work on our trading requires work on ourselves: in becoming better traders, we become more self-aware and self-determining human beings.

I look forward to working on that self-development at the workshop.

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Tuesday, July 04, 2017

What Is Making Money Now In Financial Markets

I recently wrote on the topic of how trading has sharply moved in an evidence-based direction.  That has enormous implications for trading process.  Specifically, it means that traders are spending the bulk of their time researching opportunities in markets, not staring at screens and putting on trades.  The successful trader is looking less and less like an intuitive market wizard and more and more like an insightful, disciplined researcher.

Read carefully the recent blog post from The Mathematical Investor describing which hedge funds are outperforming the others--and outperforming the markets.  It's a relative handful of funds that are performing very well and gaining assets.  These funds have several significant advantages:

*  They utilize high frequency algorithms to place trades and manage positions, making trade management a profit center, but also freeing up traders' time from the tasks of execution.  In many situations, it is far more time and cost-effective to systematize execution than to hire a small army of discretionary execution traders.

*  They have the capability of ferreting signals from large, complex data sets, allowing them to generate edges in trading not available to casual inspection and intuitive processing. 

*  They have the bandwidth to develop many models in many markets, creating highly diversified sources of returns and more reliable revenue streams.

These advantages are conferred by superior processing power (supercomputers); superior programming capabilities (capacity to store and access data and automate processes); superior data sets (more information and more unique information); and superior mathematical expertise (better ways to transform and analyze large data sets without overfitting).

The point that The Mathematical Investor is making is not that quant trading is superior to discretionary trading.  It's that mathematically sophisticated trading/investing has been superior to everything else, including lower-level quant that attempts to systematize discretionary insights by applying basic statistics and modeling methods.

In that sense, trading is looking a lot like weather forecasting.  Forecasting was once a wholly discretionary activity based upon the reading of cloud patterns and the feel of the air.  Later, it became possible to quantify such variables as wind speed, air pressure, and humidity and use this information to understand weather patterns and make forecasts.  At present, computer models capture the complexities of interacting weather systems to make forecasts that would be impossible to an individual forecaster looking at a thermometer and barometer.  

Where I am seeing the greatest success of individual traders is in niche strategies and markets, where inefficiencies are most likely to be present.  Many of these exist in strategies and markets where there is limited liquidity and hence limited participation of sophisticated funds.  An example would be certain commodities and companies, where detailed knowledge of the market and industry can still confer an edge in trading.  This is akin to a small business person finding a niche in a community he or she knows well, thus performing well in spite of the presence of large retail firms.  Specialization, uniqueness, and detailed product knowledge are likely to outperform generalist trading strategies as sophisticated market participants continue to claim the most liquid sources of alpha.

Further Reading:  Becoming an Evidence-Based Trader
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Saturday, July 01, 2017

Behavioral Techniques for Mastering Your Trading Psychology: Relaxation

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A recent blog post outlined the process of diagnosing the problems that may be leading to drawdowns and poor performance.  This post will be part of a series for the forthcoming trading psychology online encyclopedia on the specific approaches and techniques for addressing those problems when psychology is at their root.  

Behavioral approaches to the change process involve skills building and especially the formation of new, constructive habit patterns.  When we engage in behavioral methods, we are literally teaching ourselves new action patterns: replacing problem patterns with new, effective ones.

The first behavioral method that I have found to be helpful for trading problems is relaxation training. In relaxation training, you teach yourself skills to calm both mind and body.  My favorite relaxation exercise is to listen to absorbing music--I find instrumental music preferable to music with lyrics--while controlling the rate and depth of your breathing.  You perform this exercise seated in a comfortable position and in a quiet environment, free of distraction.  While focusing on the music, you breathe deeply and slowly from the diaphragm, but not in a strained or exaggerated way.  If you notice your mind wander, you simply refocus on the music, perhaps following a melody line or beat from a specific instrument.  During this time, you stay very still and make your breathing increasingly deep and slow.

It usually takes 15+ minutes for beginners to get themselves "in the zone" with the deep breathing and focus.  As you practice (mornings and evenings are great times for practice), you will find yourself quicker and quicker at entering the calm, focused mode.  It's not unusual for a trader experienced in relaxation methods to completely center themselves with just a few deep breaths.  My experience is that the longer the relaxation session, the deeper the state you can enter.  Sticking with the exercise for 30+ minutes can induce a very focused and clear state of awareness.

A variant of this relaxation method is known as "progressive muscle relaxation."  In this method, you start at one end of your body (your toes, for example) and--while listening to music and slowing and deepening your breathing--you slowly tense and relax those muscles.  So you might curl your toes gradually and tightly and slowly release them.  Once you've done that, you work your way up the body, lifting and releasing your feet, then tightening and releasing your calf muscles, etc.  Eventually you work your way to your head and tensing and relaxing your brow and forehead.  All of this typically takes 15+ minutes.

The progressive muscle relaxation works for two reasons.  It calms and focuses you, but it also turns your conscious awareness to your body and away from day-to-day and trading stresses.  This "gearshift"--the alteration of your state of consciousness--is common to all the major approaches to counseling and psychotherapy.  It's a very important principle: to change a behavior, you first have to shift your state.  Learning a new skill in a new state accelerates the process of internalizing that skill.

The key to success with relaxation methods is practice, practice, practice.  It's like any skill: mastery comes from repetition.

Relaxation methods are valuable as preventive tools.  You can practice getting "in the zone" before you start trading and during breaks in the trading day to ensure that you avoid overconfidence, frustration, and discouragement.  It is difficult to get worked up if mind and body are greatly slowed down.  Doing the muscle relaxation midday is a great way to get into your body and return to markets in a fresh state.

Relaxation methods are also valuable tools when you catch yourself overtrading or anxious and avoiding opportunities.  By temporarily pulling back from the screens, you can center yourself relatively quickly and return to markets far more calm and focused.  I often find myself regulating my breathing during trading, thereby sustaining the state practiced in the relaxation exercises.

Relaxation techniques are a first building block for other, more detailed behavioral skills and so they're a great place to start your skills building.  For more detail on relaxation and other behavioral methods, you can check out the behavioral chapter in The Daily Trading Coach.  In the next post in this series, I will illustrate how relaxation methods can be combined with self-hypnotic suggestion for targeted behavioral change.
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Monday, June 26, 2017

Becoming an Evidence-Based Trader

The recent article I wrote for Forbes is perhaps the most important one I've written.  It is about a trend that is sweeping the trading world.  Yes, we talk about algos and quantitative trading, factor-based investing, and passive index strategies and all of those are helping to reshape the landscape of finance.  The broader revolution, however, is one in which financial decisions are evidence-based.  Those who assume the responsibility for achieving returns on capital are expected to do so in a way that is objectively verifiable.

As the Forbes article points out, this mirrors developments in medicine.  The clinical judgment of the wise, experienced doctor is no longer enough.  Too many studies document the fallibility of such judgment.  Instead, physicians are expected to follow "best practice" guidelines that follow from well-conducted outcome research.  We are rapidly approaching a point at which the alternative to evidence-based medicine is not discretionary medicine, but malpractice.

If you read old texts on technical analysis, you'll encounter generalizations such as "this is a bullish pattern".  No actual evidence is produced to document this.  It is the "clinical judgment" of the practitioner.  Similarly, a fundamental analyst might assert that the price of a stock or index will rise because of increasing consumer spending or a growing GDP.  Once again, no evidence is provided for those links.

The alternative to technical analysis is not fundamental analysis.  The alternative to technical and fundamental analysis is evidence-based decision-making.  

Think of it this way:  the emerging perspective says that if less research rigor goes into your trading and investment decisions than your decision to buy a new car, something is very wrong. 

So how can discretionary traders become more evidence-based?

It starts with what Victor Niederhoffer calls "counting".  When we see a pattern that we believe has some implications for non-random forward returns, we look back in time and see if that pattern indeed has led to those anticipated results.  Cherry-picked examples supporting our inference does not constitute an evidence-basis.  Rather, we look back over a meaningful sample and count the times when the pattern has and has not led to expected returns.

Mike Bellafiore's text The Playbook is a great example of nudging traders in an evidence-based direction.  When a daytrader identifies a "setup" for an anticipated market move, that setup becomes part of a playbook and the trader tracks his or her simulated (and then actual) trading of that setup.  Only setups that empirically demonstrate profitability become an enduring part of one's playbook.  The professional trader is one who sticks to their playbook and tests out new plays before adding them to the playbook.

Once a trader begins to count, the development of many skills follows:  data management skills with spreadsheets; statistical skills to determine when returns are truly significant; and programming skills to acquire and transform large data sets.  With the advent of online education through such sites as Coursera, it is easier than ever to upgrade one's skills.  At most of the firms where I consult as a trading coach, there has been a movement toward the development of team-based trading to bring those skills to discretionary traders.

If you are a developing trader, I encourage you to check out the article on the evidence-based revolution and reflect upon how you will be part of the future of finance and not one trapped in its past.  There still is a role for intuition, pattern recognition, and judgment in the world of medicine, and there will be that role in trading.  Those subjective hunches are the sources of hypotheses, however, not conclusions. Great things can happen when we are fertile in our generation of hypotheses and rigorous in our establishment of conclusions.

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Sunday, June 25, 2017

Who Is Your Trading Coach?

It's difficult to find a performance field, whether it's Olympic sports or performing arts, where people don't grow through coaching.  Coaches guide development; they provide the feedback that enables performers to set and achieve the right goals.  If we always viewed ourselves accurately and were always 100% accountable to ourselves, perhaps we wouldn't need coaches.  Very often, however, coaches see what we don't see and push us to be more than we are comfortable with now.

If you check out my recent Bloomberg interview with the Odd Lots team of Joe and Tracy, you'll see that they compare my role as a trading coach to that of Wendy Rhoades, the fictional coach of the hedge fund portrayed in the show Billions.  There is overlap, but--as I point out in the interview--there are important differences as well.  Unlike counselors or therapists, coaches don't just help solve people's problems.  They also build on strengths.  They might help a team with conflicts among members, but even more often they're helping teams become more creative and generate more and better ideas.

One thing I love about Alcoholics Anonymous is that there is no coach running the meetings, but everyone is a coach--and a student.  In A.A., coach is a verb, not a noun.  It is what people do with one another.  Part of working on yourself is helping others.  In seeing others succeed, we acquire insights and tools for our own success.  In observing the challenges of others, we gain awareness of our own challenges.  

Back when I was a community psychologist in Cortland, NY, we used to challenge clients with alcohol problems to attend 90 meetings in 90 days.  Bring the body and the mind will come.  Over the course of 90 meetings, the group becomes your team and you find many coaches.  Most specially, you find that you can coach others.  With the consistency of 90 meetings in 90 days, the coaching lessons are internalized and become new, positive habit patterns.  You don't want to backslide, because you have a responsibility to your team, not just to yourself.

I'm not sure change can be optimally achieved without coaching.  But I'm also not sure that one needs a single, dedicated trading coach.  Imagine creating your own "Traders Anonymous", where a group meets regularly, shares challenges and successes, and supports each other's development.  Would we fall into the same patterns if we had a group around us who gave us correction without arousing resentment?  Might we advance further if we pooled our efforts and observations and stimulated each other's thinking?

Who is your trading coach?  It could be someone in your personal or online network.  Once you think of coach in verb terms and not as a noun, then coaching is something you can do and others can do with you.  It is no accident that I am seeing groups of traders coalesce with mentors, meeting frequently online, and learning about trading and trading mistakes.  There is power in teamwork--power that few traders are maximizing.  To get better, FIND. YOUR.  TEAM.

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Saturday, June 24, 2017

Trading Psychology Diagnosis: Identifying the Root of Trading Problems

Every trained physician knows that diagnosis precedes treatment.  We have to understand what is going wrong before we attempt any kind of solution.  Auto mechanics engage in the same process: they listen to the engine, look under the hood, and run tests before they identify problems and begin to fix them.  

Too often, traders attempt solutions for their trading problems before they've truly understood the sources of those problems.  Equally often, mentors and coaches of traders offer their solutions without actually going through a thorough diagnostic process.  In this post, I will model for you a way of thinking that can help you identify what might be going wrong with your trading.  This way of thinking is anchored by several important questions.

Question #1:  Is there actually a problem here?

This may seem like a strange question.  You've just drawn down; you've been frustrated in your trading.  Of course there's a problem!  The issue, however, is a bit more subtle.  Any successful trading is still a probabilistic enterprise.  Hit rates and Sharpe Ratios don't grow to the sky; people are fallible and markets embed a fair amount of uncertainty.  As a result, losing periods are inevitable and frustrations will be encountered.  Just as we expect baseball hitters to strike out every so often and football quarterbacks to throw incomplete passes on occasion, we can expect losing trades.  A trading approach with a 60% hit rate could be phenomenally profitable, but it will still encounter strings of losing trades with regularity.

What this means is that we begin the diagnosis by examining a meaningful sample of past trading, not just the last few days or trades.  A frequent day trader making many trades a day might look at the month's results and compare with results from the past year.  A longer term trader might need to assemble data over a year or more before confidently identifying a problem.  In other words, to identify a problem, it's necessary to see that recent results fall short of past ones and that recent drawdowns are not similar to past ones.  That requires a proper historical view.

When traders assume that a problem exists without a sufficient historical analysis, they run the risk of tinkering with methods that work and making those methods worse.  This is very true when traders begin to trade systems.  They become discouraged when the system has a (normal and expectable) drawdown, so they begin to change the system, front run the system, etc.--only to turn the setbacks into protracted slumps.

Sometimes traders are taking too much risk--trading position sizes too large for their actual loss tolerance--and those strings of expectable losing trades create a "risk of ruin" situation.  In such a case, the trader can look at hit rates and average win/loss statistics and determine whether the problem is in risk taking or if the actual performance of the trading methods has changed.

All of this is a strong argument for keeping detailed performance metrics on your trading.  Only by comparing recent performance to past performance can you understand if you truly are improving in your trading or having an actual problem.  If you're a beginning trader, then you would compare your recent returns to the returns you achieved in simulation mode.  (For more on trading metrics, see this post; also this post.  A detailed treatment of trading metrics can be found in Chapter 8 of The Daily Trading Coach). 

Question #2:  If there is a problem present, is it associated with a change in the market(s) you're trading?

My first hypothesis when I encounter a trading problem (my own or that of an experienced trader) is that the problem has occurred for a reason, and that reason is related to a change in how markets have been trading.  Because of those changes, the methods that had been working no longer command the same edge.  

A great example of this has been the recent decline of volatility in the stock market.  Many, many traders who made money from momentum and trend trading have suffered during this low volatility period because moves no longer extend and, indeed, tend to reverse.  That, in turn, leads to frustration and discouragement.

The key tell for when trading problems are related to changes in markets is that people trading similar strategies are also experiencing performance difficulties.  This is one reason it's important to have a broad network of trading colleagues, even if you trade independently.  If the great majority of traders trading similar styles are also experiencing drawdowns, you can safely assume that not everyone has turned into an emotional basket case at the same time.  

Performance indexes for various hedge fund and CTA strategies are available from industry sources and can help identify when certain approaches are winning and losing.  For example, the Barclay's short term trading index (STTI on Bloomberg) tracks the returns of professional money managers trading short term momentum and trends.  The performance of those managers over the past year or two has been dismal, again related to the collapsed volatility of markets in the wake of low interest rates around the globe.  

If your trading problems are widely shared and can be linked to shifts in how your markets have been trading, no psychological exercises in and of themselves will solve the problem.  Nor is it a solution to put one's head in the sand and hope that markets will "turn around".  Rather, the answer to the trading problems is to adapt to the new environment and search for fresh sources of edge that can complement one's traditional trading.  For example, one might find mean reversion or relative value strategies that nicely complement one's directional/trend/momentum trading.  The combination of trading approaches truly diversifies returns and produces a smoother P/L curve.  (See Trading Psychology 2.0 for a detailed presentation of adapting to changing markets).

Question #3:  If there is a personal problem present, is it--or has it been--present in non-trading parts of your life?

Here is a very, very important issue.  Many personal issues, such as anxiety, anger, depression, attention deficits, and impulsivity, show up in trading, but not exclusively within trading.  For example, a person might have trouble with patience and frustration in personal relationships, and those same problems crop up in his relationship with markets.  Similarly, a person might have self-esteem problems in life that then show up as negative thinking patterns during periods of market losses.  When the emotional patterns, thought patterns, and behavior patterns that interfere with trading are also occurring and interfering with other aspects of life, that is a strong indication that simply working on trading will not be sufficient.  It makes sense to seek professional help.

The great majority of psychological challenges can be dealt with via short-term approaches to counseling and therapy.  Research suggests that problems such as relationship difficulties, depression, anxiety, and anger can benefit significantly from cognitive, behavioral, psychodynamic, interpersonal, and solution-focused approaches. (A thorough review of research and practice in this area can be found in the textbook that I have co-edited.  A new edition will be coming out late this year).  The key to brief approaches to therapy is that they are highly targeted and make active use of exercises and experiences during and between sessions.  

In situations in which the psychological problems have been longstanding, when there has been a family history of similar problems, when those problems have been severe (significantly impairing important areas of life), and when those problems have been complex (impacting many areas of life, as in drug or alcohol abuse), longer-term approaches to helping are generally indicated.  Attempting short-term approaches to help for more significant problems runs the risk of relapse.  When problems have been longer standing, severe, and complex, it often is the case that more than one form of help is required, such as medication help in addition to therapy or group sessions (as in A.A.) in addition to counseling.  In such instances, it is very helpful to have a thorough assessment from a qualified mental health professional.  If there is meaningful depression and/or anxiety, a workup from an experienced psychiatrist is helpful, as safe and non-habit forming medications often can play an important role in addressing the problems.

Depression, anxiety, attention deficits, addictions, bipolar disorder, relationship problems--these impact a high percentage of people in the general population.  Traders are not exempt from these general problems.  Assuming that an emotional issue impacting trading is necessarily a trading issue may prevent you from getting the right kind of help.  No amount of writing in a trading journal will rebalance neurotransmitters in your brain or solve the conflicts you bring to your marriage.  When you see the problems affecting your trading also affecting other areas of your life, it's a strong indication that a more general approach to change will be needed.

Question #4:  If the problem you're facing occurs uniquely in trading settings, do you need psychological coaching or do you need further mentoring of your trading?

Here again is an important distinction.  Especially for newer traders, frustrations and other emotional problems arise in trading simply because they are still young on their learning curves.  What they need is not simply emotional coaching, but guidance from experienced mentors who can help them correct trading errors and more consistently apply trading skills.  Even experienced traders can encounter drawdowns and frustrations because they are making trading mistakes that a mentor can pick up.  I recently worked with a trader who was very discouraged because of a drawdown that occurred simply because he was not closely monitoring correlations among his positions.  What he thought were several independent trades turned out to be versions of the same trade once the central bank indicated a possible policy shift.  He lost money because he was too concentrated in that one, converged trade.

This is yet another reason why it's very helpful to be connected to networks of peer traders.  Many times such relationships offer mutual mentoring that can address situational problems and mistakes in trading. 

When drawdowns and disruptions of trading are more psychological and situational, several psychological approaches can be helpful, including behavioral methods (exposure therapy) for anxiety and performance pressure; cognitive restructuring techniques for perfectionism, overconfidence, and negative thought patterns; and solution-focused approaches to identify and expand one's own best practices.  (Specific applications of these methods can be found in The Daily Trading Coach; the creation of best practices is a major topic within Trading Psychology 2.0; an overview of cognitive and behavioral techniques for improving trading performance can be found in Enhancing Trader Performance).

Behavioral techniques are skills-building methods that you practice in real time, during problem situations.  You literally are teaching yourself new skills and new habit patterns.  For example, a very simple behavioral technique would be to take a break during trading whenever you feel anxious, frustrated, bored, or discouraged.  You quickly recognize that you're not in the right mindset for trading and you take a break from the screens.  During that break, you might engage in other skills-building activities, such as relaxation training to slow oneself down and reduce tension.  Behavioral methods are typically practiced outside of trading hours so that the skills become automatic in real time, when problems crop up.  

Cognitive restructuring methods are techniques that you use to identify and challenge patterns of negative thinking that can distort your emotions and interfere with sound decision making.  Many traders, for example, become highly self-critical when they miss a trade or when they take a loss.  This can interfere with their focus on the next opportunities.  In cognitive restructuring, keeping a journal helps the trader become more aware of his or her thinking and challenge that thinking when it's harsh and negative--or when it's overconfident!  

Solution focused techniques are ones that examine what you are doing during your best trading, both in terms of trading practices/processes and psychological self-management.  The goal of solution focused work is to "do more of what works" and become more consistent so that best practices can turn into repeatable best processes.  Trading Psychology 2.0 contains 57 best practices contributed by myself and other traders; the chapter on Building Strengths also embraces a solution-focused approach to identifying what you do best and building your trading around it.

The bottom line is that how you work on your trading should reflect the diagnosis you make of your trading challenges.  Sometimes we encounter challenges because of tricky markets; sometimes because of our psychology; and sometimes those challenges are just a normal part of risk and uncertainty in markets.  In this post, there are quite a few ideas tossed out.  For more information on those, you can simply Google the relevant topic by entering "Traderfeed" and the topic of interest.  Thus, enter into the search engine "Traderfeed solution focused" and you'll see quite a few posts relevant to that topic.  If you want even more depth and detail, the above book references will be useful.

In an upcoming series of posts, I will identify 20 top challenges that traders face and highlight specific approaches to work on each of those.  Yet another series will look more into detail into evidence-based techniques that help traders and when to use those.  All of this is part of a grander plan to eventually link all the posts into a free, user-friendly, comprehensive online encyclopedia of trading psychology.  

Thanks, as always, for your interest and support--

Brett

Friday, June 23, 2017

Online Encyclopedia of Trading Psychology

Image result for greatest enemy of knowledge is not ignorance

In the coming days and weeks, I will be transforming TraderFeed into an online encyclopedia of trading psychology.  Since 2006, there have been over 4700 TraderFeed posts, as well as the four books on trading psychology that I've written.  I just finished editing a third edition of a textbook on brief therapy that highlights new research and techniques relevant to helping people make changes. There are huge applications of these methods for traders.  Much of what we think we know in psychology (and in applying psychology to trading) is just not true.  By collating the top posts, creating new posts that include fresh perspectives, and indexing posts by topics for easy reference, I hope to create a lasting resource for traders.

Stay tuned, and thanks for all the interest and support!

Brett
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Sunday, June 18, 2017

When Discipline Works--And When It Doesn't

Trader A has a preferred trading style.  It might be a momentum style; it might be a directional style.  It's a style that fits Trader A's personality and that has made money in the past, so Trader A sticks to that style.  In sticking to what fits his or her personality, Trader A demonstrates discipline.

Trader B has preferred trading "setups".  These are patterns in the market that make the most sense to Trader B.  Those patterns might be breakout patterns; they might be patterns of mean reversion.  Trader B has seen these patterns work out, so Trader B sticks to trading those setups.  In sticking to what fits his or her understanding of the market, Trader B demonstrates discipline.

Trader C studies the kind of market we're currently experiencing.  Trader C has used some basic dimension reduction methods to boil markets down into a few categories, such as price change and volatility.  Once Trader C figures out the kind of market we're in, Trader C studies the edges present in that type of market.  In trading only the edges present in the current market, Trader C demonstrates discipline.

Three traders, three forms of discipline.

Two of those traders are losing money.

Are you trading what you subjectively prefer, or are you trading what is objectively present in the market?

I submit that the answer to that question accounts for much of the success and failure we're currently seeing among traders and trading firms.

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Friday, June 16, 2017

Four Ways to Read the Psychology of the Markets

In the recent webinar (here is a link to the recording of the event), I touched upon two themes that will be part of my program at the upcoming Chicago workshop.  The first theme is using our emotional responses to markets as market-relevant information.  Very often, we first notice changes in market regimes--shifts in volatility, in trend, in patterns of correlation--experientially.  When we reasonably expect a market to do one thing and it begins to do something else, we experience confusion, frustration, and concern.  The emotionally intelligent trader uses emotion to take a second, objective look at that market and reevaluate ideas and positions.  The less emotionally intelligent trader becomes caught up in that emotion and responds reactively, often with impulsive and ill-considered actions.

The second theme is that we can read the psychology of other market participants and thereby gain a sense for when their buying and selling intentions are waxing and waning.  The ways in which markets transact provide us with important clues as to the leaning of large participants, giving us early identification signals on breakouts, failures of moves, and momentum.

There are four ways that I've used to gauge the psychology of the markets:

1)  Market Profile - The profile is a tool for identifying where markets are setting value and how volume is behaving relative to value areas.  Are we breaking out of a value area and accepting value higher or lower?  Are we oscillating within a value range?  Viewing profiles on multiple time frames can help us understand market behavior in a multidimensional way.

2)  Upticks/Downticks - The NYSE TICK (and related measures) is a tool I have used for years to assess real time sentiment in the stock market.  It measures the number of stocks trading on upticks minus the number trading on downticks every 10 seconds or so.  When large market participants are actively buying or selling, we see TICK values jump to extreme positive or negative levels.  Shifts in the distribution of TICK readings over time commonly accompany market turning points.  

3)  Market Delta Footprint - Whereas the NYSE TICK assesses upticks and downticks across all stocks in the NYSE Index, the Market Delta footprint tracks each transaction in a particular instrument, such as the ES futures.  It identifies when a transaction is occurring at the current bid price or offer price and cumulates that information over a variety of time periods.  As a result, we can see when volume is dominantly lifting offers (buyers are aggressive), hitting bids (sellers are aggressive), or relatively balanced.  Shifts in the footprint very often accompany changes in market direction.

4)  Event Flow - As described in the recent post, event flow divides the volume in any instrument into many thin slices and examines price behavior within each slice to infer the relative dominance of buyers or sellers.  That information is cumulated across slices to depict changes in buying and selling dominance.  Unlike upticks/downticks and the footprint, event flow does not rely upon aggressive behavior of buyers and sellers to infer the intentions of participants.  This is particularly helpful in markets where sophisticated market making can disguise those intentions.

These are multiple lenses through which traders can read the psychology of other participants, much as a skilled poker player in Las Vegas can read the tells of players around the table.  The ability to see markets through multiple lenses enables traders to develop ideas and--most importantly--revise those ideas based upon real data.  I look forward to elaborating on the reading of market psychology at the Chicago event
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Wednesday, June 14, 2017

Turning Emotional Trading Into Informed Trading

Apparently there were some sound quality issues during the latter portion of my webinar presentation yesterday.  For those who missed some of the ideas that I will be covering in the summer workshop in Chicago, I'll sketch those out in two posts.  

The first idea is that many of our patterns of poor trading are themselves triggered by shifts in emotional state.  Among the more common emotional triggers are:
  • Overeagerness and overconfidence - Winning can skew our subsequent decision making;
  • Frustration and anger - When we lose, our frustration can lead to impulsive decisions;
  • Anxiety and uncertainty - Fear of losing can interfere with proper risk taking;
  • Negativity and depression - Losing can begin to feel like being a loser 
An important principle is that many, many of these emotional triggers are themselves set off by changes in the marketplace.  When markets change their volatility, trend, etc., the trading patterns that worked at one time no longer work.  Patterns that had not worked now suddenly seem to come to life.  The wise trader entertains the hypothesis that emotional state shifts are potential indications of changing market regimes.  The emotions we feel are information that tell us to step back and reassess market behavior.  

In other words, we can use our emotional awareness to become more emotionally intelligent.  Once we shift states and recognize that a trigger has occurred, we step back from trading and reevaluate our expectations and ideas.  Emotions become a tool for flexibility and adaptability--not a trigger for rigid behavior and poor trading. 

Too often, we treat emotional responses as things to overcome or avoid.  If we are closely attuned to the markets we're trading, how we feel can often provide the first clues as to something different in those markets that we need to pay attention to.

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Tuesday, June 13, 2017

Tracking the Psychology of the Market with Event Flow

When we think of trading psychology, we typically think of the psychology of the trader and the factors that either contribute to or distract from a peak performance mindset.  Another facet of trading psychology is reading the intentions of other market players.  This is very similar to psychology in poker.  The mindset of the poker player is important, and it is also important to read the psychology of the other players at the table.  The skilled poker player reads those tells from other players to infer if they are bluffing or if they might be holding the nuts.  When short-term trading/market making occurred on the trading floor, reading the other participants in a market truly was more like reading other poker players.  With most market activity being electronic, we need other ways of inferring the intentions of market participants.

Above we see a chart of what I refer to as Event Flow for yesterday's session in the ES futures (6/12/17).  I will be discussing this measure during this afternoon's free webinar and in particular detail at this summer's workshop in Chicago.  (Here are details regarding the webinar and workshop).  In a nutshell, what I'm doing with event flow is breaking down the day's action into volume-based events, where each bar represents the price action of each 1000 contracts traded.  What I'm interested in is the price behavior *within* each bar.  If price closes more toward the high end of the bar, I will categorize that bar as a "buying" bar and vice versa.  The chart depicts a cumulative running total of buying and selling bars, in the manner of an advance-decline line.  

Most of the time the Event Flow line will follow price relatively faithfully.  It is the divergences that are of particular interest.  Notice, for example, how sellers were dominating in the afternoon, but ultimately were unable to push prices below their morning (and below their previous day's) low.  The inability of sellers to move price lower (or vice versa) creates a situation where those participants will be forced to cover when flows and prices turn.  Note the nice rally in ES (blue line) after sellers are trapped in the afternoon.

Event Flow is a complement to other ways of inferring the psychology of market participants, such as upticks/downticks (NYSE TICK) and Market Delta.  Event flow is easily constructed for any instrument trading centralized volume.  It is also relatively robust with regard to the participation of optimal execution algorithms, as noted in quant research (see here and here).  Algos may be buying bids and selling offers in an efficient manner.  This would not necessarily show up in measures of upticks/downticks but would be reflected in price behavior within thin volume slices.  Event Flow can be aggregated over longer time frames to provide bigger picture views of market participant bullish/bearish psychology.

I've generally found traders much more interested in focusing on their psychology, rather than the psychology of the markets they're trading.  That's a big mistake.  Typical price charts are far too blunt as tools for assessing the psychology of the marketplace.  With Event Flow, we don't have to track the market transaction by transaction but can still obtain a relatively finely grained assessment of how those close to the market are behaving.

I look forward to sharing more at the webinar this afternoon and the workshop in July.

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