Midday Briefing for August 7th: Shifting Themes

With strong jobs data, we've seen the dollar rally sharply against the euro and stocks rally strongly to new bull highs, led by the financial sector.

Note the inversion of recent themes: here we're seeing strong stock prices on the heels of a strong dollar and weak commodities. Note also the continued relative underperformance of the NASDAQ 100 stocks, as well as commodity-sensitive energy and materials shares. Indeed, the new highs in the S&P 500 Index (ES, above) are not confirmed by several sectors, including XLP, XLV, XLE, XLB, and XLK.

I will be watching closely to see if we can sustain the current strength--and also to see if we're seeing the start of shifting intermarket themes.

Thoughts on Discovering Our Best Trading

Here's a little thought experiment for active traders.

Suppose you could only make two trades per day and you could only trade at a maximum of 2x leverage.

Once you made your two trades, you were done for the day.

What would happen?

You would have to be very selective in your choice of trades. That means you would have to be extremely patient and disciplined.

You would have to concentrate on identifying the largest moves in a day. That means that you would have to be very market focused, emphasizing only the best and most relevant market data.

You would have to ride your winners and frame each trade with very good risk/reward, because you wouldn't have further opportunities to trade during the day.

You would have to trade only when patterns in the market hit you between the eyes, giving you the greatest possible confidence.

It's all supply and demand. If the supply of possible trades is reduced, each trade becomes more valuable to the trader.

Might many of us discover who we are as traders--what we do best--if we strictly limited the number of trades we placed? At that point, we'd have to be the best we could be, because we wouldn't get another shot at markets.

Perhaps it's true of life itself: awareness of our limited time on earth makes us value each day more, prodding us to live it to its fullest.

Without perceived scarcity, any commodity loses value.


Morning Briefing for August 7th: Retreating Into the Range

Please take a look at my post on the narrowing trading range from several days ago. We're seeing that scenario playing out in recent trading, as stocks have retreated from their highs and are back into multiday trading ranges. All of this looks like an extended topping action from my perspective. That doesn't mean we can't get higher prices still, but I suspect any such highs will be accompanied by growing divergences among sectors, indexes, and indicators.

Trading, Entrepreneurship, and Confidence

The recent post emphasized the importance of finding creative trading niches. The great majority of traders I've known who have sustained success have developed their own unique "take" on markets. They either look at unique information, or they assemble existing information in unique ways. This enables them to see patterns that escape the attention of others.

One unusually successful trader patiently explained to me some years ago that he tracked a variety of commodity prices as well as the pricing of commodity options and futures for various expiration months. The relationships among the commodity prices--and the expectations built into the futures and options--told him which sectors of the stock market were most likely to outperform the others. So he bought those sectors and sold the likely underperformers. His trading was always market neutral: the general stock market could go up or down, but he would always make money as long as he was in the sectors that performed best.

He no longer trades that strategy; he felt that the long/short space became too crowded several years ago. Now he tracks completely different economic indicators to accomplish something similar among global stock markets. So, for example, he has been long certain emerging economies and short other, developed ones.

What initially impressed me about this trader was not only his work ethic and ability to view and trade markets in fresh ways, but also his confidence level. He was extremely confident, but not overconfident. His confidence was a direct result of finding his own trading strategies: ones that made sense to him and that he had researched. He could weather drawdowns and add to winning trades, because he knew how his markets performed.

What impressed me most recently about this trader has been his willingness to remake himself as markets changed. He didn't hesitate to replace one strategy with another when he saw opportunity fading.

No business market remains static. Successful businesses always have to remake themselves and adapt to changing economic and demographic conditions. Trading as a business is quite similar. The ability to detect opportunity and see the world through fresh eyes is a virtue of all fine business leaders. They don't come to markets to gamble; they approach markets as entrepreneurs.


Trading Creatively: Finding New Niches as a Trader

A while back I wrote six pieces of advice for new traders. One additional piece of advice that I would offer is to be creative in finding markets and strategies to trade.

If you were starting a new business, you wouldn't necessarily select an area that is loaded with competition. You would find a business niche where demand is not fully met; where there is potential opportunity.

Interestingly, new traders often gravitate to the most common and popular strategies and markets, such as the directional trading of stock indexes. Rarely do traders venture outside their national boundaries (especially in the U.S.), and rarely do they look into strategies at different time frames, non-directional strategies, and strategies across asset classes.

One trader I met recently collected extensive information on world trade and used this (along with other information) to trade calendar spreads in commodities. He has been unusually successful, using reasoning processes that are quite different from the norm.

I encourage traders to never stop exploring markets and strategies. There is always room to grow. Those who develop new opportunities are best positioned for those occasions in which current sources of edge start to go away. It is great to find a niche as a trader; even better is to continually develop fresh niches.

Morning Briefing for August 6th: Probing New Highs

Here we see that we're trading at the upper end of yesterday's range. Note that, once again, corrections have been relatively short and shallow, helping to preserve the uptrend. We have support at the Tuesday and Wednesday lows; failure to sustain new highs would target the midpoint of the range since Tuesday. Continued stimulus in the UK is helping support prices; we're seeing stronger gold prices and higher Treasury rates so far, with 10-year rates nearing 3.8%.

Connect-123: Volunteer Work and Internship Experiences in Emerging Markets

Well, it's going on 9 AM here in Cape Town and I'm sitting in the offices of Connect-123, overlooking Table Mountain and the Central Business District. Just a lovely city, and everyone has been more than hospitable.

Connect-123 started as our oldest son's unique idea after he had participated in social venture capital work in Cape Town. From that experience, and from his lovely wife who is native to South Africa, they developed a number of valuable business contacts. This enabled them to begin offering students and early career professionals customized volunteer and internship work experiences in an emerging economy.

Most recently, Connect-123 has expanded to Buenos Aires, another beautiful city, to offer internship and volunteer work experiences there.

The customization of the internships has meant that students can gain experience in the fields of their choice, while enjoying a peer group of interns and sampling a new culture. If readers are interested, they can check out the Facebook page for Connect-123 and see what's going on.

Panic Rarely Pays

I was noticing today that anyone who sold the stock market late in 2008 and early in 2009 when thousands of stocks were making fresh lows for the year would now be losing significant money if they had held their short positions.

Selling into panicky markets may profit short-term from downside momentum, but overall it's a losing strategy at any time frame.

When markets get panicky, pretty much all the bears have gone all in. When there isn't further selling pressure to push markets lower, those bears have to cover their positions. That can lead to vicious rallies.

I went back to September, 2002, when I first began collecting new 20-day high and low data, and examined all occasions in which new 20-day lows exceeded 1500 across the NYSE, NASDAQ, and ASE. Five days later, the S&P 500 Index averaged a gain of .43% (107 up, 90 down). That compares with an average five-day gain of .02% for the remainder of the sample (841 up, 688 down).

Interestingly, it's not that markets are more likely to go up following extreme weakness; rather, it's that their gains tend to be much larger than their losses.

Because there are indeed fat tails of negative returns in which weak results can lead to much further weakness, the best execution of trades when weakness hits is to wait for evidence that selling is drying up--i.e., one of those transition patterns I've written about.

Good trading doesn't mean automatically following the herd or fading it. Rather, it means standing above the herd and recognizing when the herd is likely to head off a cliff.

More on transition patterns here and here.

Midday Briefing for August 4th: Narrowing Range

Quick update from the airport: The major indexes are making higher price lows day over day, keeping us in an uptrend mode, but note the difficulty surmounting the 7/30 highs in NQ (above), as well as selling we've been seeing in the 1000 area for ES. It would not surprise me to see this resolve into a longer-term range/consolidation, with price moving back into the 7/30-8/2 range and perhaps testing the lower portion of that range.

Identifying the NYSE TICK Environment and Stock Market Sentiment

Here we see the distribution of one-minute NYSE TICK readings thus far this morning. Recent posts have focused on TICK as a way of gauging intraday buying and selling sentiment.

A quick and dirty way of assessing buying and selling pressure is to consider positive and negative TICK readings as separate distributions. Count the number of one-minute readings that exceed +800 and count the number that fall below -800.

For TICK to read more than +800 or less than -800, institutions have to be executing baskets of stocks that will either uptick or downtick simultaneously. Comparing the number of +800 and -800 readings gives a rough idea of whether institutions are leaning to the buying or selling sides.

(Why plus or minus 800 as the figure? That roughly corresponds to a "significant" TICK reading: approximately two standard deviations above or below the median reading).

In environments in which we have very few +800 or -800 readings, we can infer that institutions are not active on either the buy or sell side. Those are often range markets. That is the case so far in today's trade (though buying sentiment is overall ahead of selling, with several near- 800 readings).

In environments in which we have many more +800 than -800 readings, we can infer an upside trending market. A downtrending market is one in which the -800 readings handily exceed those that are +800.

And how about environments in which we see many +800 *and* many -800 readings. Those "two sided markets" are often ones in which algorithmic/program trading is active, running markets up and down. They often are range markets, but volatile, choppy ones.

Knowing the TICK environment you're in can be very helpful in framing how you want to be trading, as it enables you to align yourself with the sentiment of large traders that move markets.

Morning Briefing for August 4th: In Yesterday’s Range

Going into today's trade, I'm still watching that ES 994 level from 7/30 to see if we stay above the prior several day trading range. I'm also watching to see if we can stay above the lows from yesterday's early trade. Thus far we're trading well back into yesterday's range; after the recent strength, which saw us register nearly 3000 fresh 20-day highs across the NYSE, NASDAQ, and ASE, some consolidation would not be surprising. I see that gold and oil are off their overnight lows and the U.S. dollar is off its highs. Those markets have been well correlated with stocks lately, so I'll be tracking their movement closely. Given recent market strength, I have to stay big picture bullish until the market can at least show that it can start accepting value at lower price levels. That's not happening as of yet. Sustaining prices below that 994 level in ES would be a start. If we cannot take out the overnight highs in ES during morning selling, I'd be looking for a return to the prior day's pivot and an eventual test of yesterday's highs.

Overtrading and Our Unrealistic Expectations

Many, many times, overtrading a market (i.e., placing trades when you lack an objective edge in the trade) begins with unrealistic expectations of the market.

The most common mistake I see active traders making in the current market is that they are expecting moves to extend much more than they actually end up extending. In short, they are not factoring current volatility into their expectations.

"I think we could go way above 1000," a trader told me yesterday. His scenario was that the round number would bring lots of bulls late to the party into the market in a panicky rush. Maybe that will happen over time, but his scenario called for stocks to move 3% or more on an open-to-close basis. How many times has that occurred in the last two months? Just once.

Not exactly a scenario to hang your hat on.

When you find yourself anticipating a big market move, ask yourself whether the market is actually moving in that way, or whether you are simply hoping for such a move. The average volatility (average high-low daily trading range) for the S&P 500 Index (see above) is less than one-third what it was earlier in the year. In the last 10 trading days, only one has moved more than 2% intraday. In January and February we saw a number of ten-day periods in which *every* day had a range of more than 2%.

If a move isn't going to extend, it will reverse.

That means being proactive in booking profits when ranges are small.

It also means that placing many trades to catch a big move is a great way to get chopped up and lose money.

Smart trading begins with realistic expectations.

For more, check out posts on Learning When to Not Trade and Pressing Too Hard to Win.

Evening Briefing For August 3rd

* MARKET THEMES FROM MONDAY: Stocks opened strong, with the risk themes in gear: weak U.S. dollar, strong commodities, rising Treasury rates. After consolidating near Thursday's price highs, consistent buying pressure led to a slow rise through most of the session. New 65-day highs hit a fresh peak for the market rally, indicating that the rally has retained significant strength. Once again, we're seeing that dips are short-lived and shallow, as money managers are afraid of missing the bull move.

* OVERSEAS/OVERNIGHT NUMBERS: Monday 11:30 PM CT - Australia, Reserve Bank (central bank) announcement; 4:00 AM CT - EU, PPI; 8:30 PM CT - Australia, imports, exports.



-- Thanks to a very astute reader for this article on the secret to world-class performance;

-- A wise trader calls attention to this article on one crucial secret to success;

-- Valuable life lessons from Irwin Yamamoto;

-- Beijing concerned about overheated stock market;

-- Asia on the rise in early trade;

-- Race to debase world currencies.

NYSE TICK and Buying Sentiment: An Alternate View

The recent post took a look at today's Cumulative TICK, which takes each one-minute average TICK reading and creates a cumulative sum, like an advance-decline line.

Above we see a different view of TICK, based on a 10-minute moving average of TICK readings. Note how we detect underlying buying pressure based on how little time the moving average spends below the zero line.

In strong buying days, pullbacks of the short-term moving average of TICK toward that zero line offer potential buying points. In actual trend days to the upside, those pullbacks of the moving average will occur at successively higher price lows, often providing nice short-term entries.

As the chart above suggests, it is difficult to sell the market for anything more than a scalp when buying pressure is steady through the day. Trading in the direction of the TICK distribution generally puts the sentiment wind at your back.

For more on this topic, check out this post on TICK during uptrends and this basic explanation of TICK.

Stock Market Sentiment and Cumulative NYSE TICK

With the weak U.S. dollar, strong commodities, and firmness in Treasury yields, there has been a persistent bid to stocks through the day. Nearly 2000 more issues are advancing than declining, but for me one of the best sentiment tells has been the Cumulative TICK (red line), which has been positive all day. That tells us that, consistently, stocks have been more likely to trade on upticks than downticks. When we see successive price lows in ES accompanied by higher readings in Cumulative TICK, it tells us that selling pressure in the broad universe of NYSE shares is minimal. We have not registered a single TICK reading below -800 all day so far, an indication of the relative absence of institutional sellers.

Midday Update: Market Crosscurrents

Note how we've been trading in a range in ES (top chart), oscillating above and below the 994 level that represents the high from 7/30 and the high from the prior multiday range. While the weak dollar and rising commodities, as well as rising yields, are supporting stocks, we're seeing profit taking across a number of sectors and non-confirmations of the morning high prices from NQ (bottom chart) and the Russell 2000 Index.

If you think about it, most range markets involve cross-currents: some sectors and themes lean one way, others give a different picture. One of the best ways to trade those cross-currents is to simply observe them and not make large bets until you achieve clarity regarding day structure and how that fits into the market's larger picture.