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Archive for August, 2009

Remembering Socrates and disciplined dialogue

August 18, 2009 3 comments

i was remembering his analogy of the ship at sea in a storm, and that democracy is not well suited (his conclusion not mine)for voting in the right person to take the wheel, that what we really want is the best captain at that moment of storm, regardless of whatever other short comings he may have personally beyond the immediate needs of the moment. So what if he is a bigot, he will get us safely to shore where we will re-educate him in proper thinking what makes rhetoric so potentially insidious is how easily the mob can be swayed into thinking that we are in times of crisis.

Of course, there are times when we actually are, but the language is the same and only critical thinking can distinguish between real crisis and manufactured for political or other purposes. “S” like his Roman counterpart Cincinnatus, served his term honorably, and then left it all behind, selflessly.

And yet Socrates had a soft spot in his heart for Alcibiades, who represented one of the gravest threats to the young democracy until Sparta won. Selfless service is an ideal of our Army, an explicit value, and one we recognize and honor in others. who give the last full measure of devotion. i think we can rise to that upon peak occasions, and some exemplify it routinely to a greater degree than others, but i think it has the same problems as pure objectivity, in that both represent, in their purest form, an absolute that seems almost inhuman, unsustainable and not something you can base an entire profession on without checks and balances

Even those who act most selflessly by sacrificing themselves for others, in war for example or in fire & rescue, have not set aside their self-hood. i believe rather, that they sacrifice the self in full knowledge of what it means to give that up for the selfhood of others.

If critical times are moments when the old ways are passiong but not yet fully given way to a new order, then perhaps the chaos around us is a time when we need critical thinking more than ever? A touchstone in rimes of crisis, and a guard against complacency and unwarranted assumptions/complacency by the majority in times of comfort?

ever watchful, onward

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Traders Roundtable: the eight “P’s” of trading success

August 16, 2009 1 comment

At a recent weekend traders roundtable discussion, the topic of the keys to trading success came up.

Experienced traders with different styles and different favorite markets and techniques identified what they thought were their best pieces of advice for novice traders.

It was late in the day and adult beverages may have been served and so our creativity was perhaps in full force.

What finally emerged from our freewheeling discussion was the idea of the 8 “P’s” of trading success.

After we discussed each of these concepts, ourinsight was that your trading results were probably shaped by the concept you were least effective with. At least, that is our working idea. Here are the eight keys that we identified:

  1. persistence: there have been a lot of studies that suggest the most important component of success is grit. You’ve heard the saying that showing up is 90% of the battle. Trading is so complex and uncertain that persistence is crucial. It’s the willpower to keep going in the face of obstacles.
  2. preparation: there’s no substitute for having a detailed trading plan to help guide you through complexity.
  3. participation: you can’t make money  in the market by being on the sidelines.
  4. practice: repetition breeds muscle memory and for traders, mental memory.
  5. performance: trading is a bottom-line business and at the end of the day, month, year you have to to make money.
  6. perception: this ranges from how you perceive the market, how you perceive a system working, and how you perceive yourself.
  7. position sizing: this ensures that you stay in the game even when you get the direction wrong. Position sizing allows you to achieve your financial objectives.
  8. preservation: you have to take care of yourself, your family, your capital, your sanity, your sense of humor, and your profound sense of self.

In future essays we will go deeper into each concept, but the short discussion will get you started.

Traders roundtable: the three phases of new system innovation

August 16, 2009 Leave a comment

At a recent traders roundtable discussion, we started to review the procedures and practices that each of us followed for coming up with new ideas to trade the market. While each trader have their own specific routines and follow, there were some aspects of their practice that were in common with each other. Here are the three phases that each trader went through in one form or another when developing new systems ideas:

Phase 1: Saturation. in this phase the trader is hungry for knowledge and reads everything he can get his hands on. Searching YouTube for different trading ideas is now feasible and reasonable as people will give you their best ideas online in a way that is very accessible and time efficient. In this phase you’re trying to cram your mindful of facts, ideas, concepts, themes without regard for trying to make sense of it yet. Think of it as filling your hard drive with data.

Phase 2: Incubation. In this phase, the trader allows the subconscious mind to stew on facts and assumptions below the level of consciousness. You can think of this as churning butter or slow cooking a stew. It’s not unusual to have trouble sleeping or to feel distracted from day to day events in this phase, because you can sense something is happening at a deep level that you can’t put a name to get. It is often helpful to distract the conscious mind with strenuous physical activity or listen to classical music, especially Baroque music like Bach which seems to have a generative effect.this phase continues until your moment of breakthrough.

Phase 3: Illumination: this phase begins with the shock of an “A Ha!” moment. the nervous energy released by the shock of recognition of a new insight can be almost overwhelming. I can remember times having to pull my car over on the highway in order to let the new thought fully develop. the energy will run its course while you visualize and or here are the first full manifestation of the idea and its implications. It’s a good idea to have pencil and paper with you at all times or a digital voice recorder so that you can capture the full stream of consciousness insights while it is still fresh.

I strongly recommend that at least once a month you set aside some time to go through these three steps and make them part of your trading research ritual.

Profitable ETF trading strategies: cooperating with the voice of the future

August 16, 2009 Leave a comment

Trading is by its very nature a crapshoot, filled with uncertainty.

People find trading so difficult because it rewards the ability to maintain an open mind with respect to performance and uncertainty, whereas our pattern matching brain desires to create order out of chaos no matter what the cost.

We like to believe that there is order in the universe and that things can be known. Based on this belief we seek to improve our pattern matching capabilities in order to better understand the world around us.

This leads us to believe that our performance is attributable to our own skills as the primary cause of our results.

Trading can be frustrating for people seeking certainty and deep explanations that are robust and reliable, precisely because it is a complex adaptive system that seems to have an irreducible complexity that resists complete explanation.

Even very reliable systems go through periods of time when they underperform random entries. This is because no single system can be as complex as the market in the act of simplification creates conditions in which the system will under perform. Humans being what we are, we interpret these periods of underperformance as the system being broken or ourselves to blame when all that is happening is that the market conditions no longer favor a particular rule set.

It is a normal response after a losing streak of some length, to doubt yourself and begin to anticipate that every decision you make will lead to failure.

It’s normal to start hearing a judgmental voice in your head that tells you in the moment of decision just how wrong are going to be in the future. The voice reminds you that it will be there then in order to say “I told you so”.

Typical human bias will cause us to remember only those times when the voice is right and not all the times when the voice was wrong and we will begin to reinforce our emotion-based belief in ourselves in a harmful way.

I call this voice, the voice of the future.

I recommend that you listen carefully to that voice and find out the name of the character who is doing the talking.

Conduct some deep reflection and inner theater to find out the source of this character and the emotional events in your past that give rise to this judgment of character.

This character can be very helpful to you in many life circumstances.

It may not be necessarily helpful however when you’re trying to trade the markets under conditions of uncertainty.

Psychological work can help you reconcile yourself with that voice in the function it performs and help you come to an agreement on how this naysayer can actually be helpful to you.

For instance, if you set this naysayer onto observing you following your rules and alerting you to those times when you take shortcuts, this critical observer can be immensely powerful.

When it crosses the boundaries into judging you for being wrong than it has overstepped its boundaries and is no longer being helpful.

Understanding and appreciating this deep part of yourself can have a powerful impact on your trading at times when it gets difficult.

Profitable ETF trading strategies: a thought experiment with relative strength

August 16, 2009 Leave a comment

Typically, traders will apply various technical analysis indicators to the behavior of price of an instrument in order to find moments of advantage. Many times these are combined in systems of ever-increasing complexity and apparent sophistication. All of these concepts however are based off of direct behavior of price. That’s not the only way that technical analysis can be used however.

Here is an example of using technical analysis in a nontraditional way to quickly and consistently assess the relationship between a broad index and one of its underlying components.

Begin by calculating the relative strength of an instrument against its index. Perform this calculation over a look back. That makes sense based on the timeframe you intend to hold the instrument. As an example, you may have the belief that swing trading large-cap stocks in the Dow 30 industrials offers an advantage to the agile trader who cannot afford to watch the market throughout the day.

You might take the Dow 30 industrials is a reasonable set of ultra-large-cap stocks which are not likely to go bankrupt overnight and which behave in a conservative fashion compared to some small-cap and overseas stocks based on the wealth of analysis and broad ownership by institutional money. It is rare for these stocks to be wildly mispriced and their stock performance is characterized by relatively smooth changes in price from day to day.

At any given time, one or more of these stocks will exhibit leadership qualities in that it will be outperforming the broad index and its peers for one to four weeks. At the same time there will be a set of these stocks that are underperforming for the same time.

There comes a moment when the individual leaders and laggards can no longer maintain their extreme behavior and they begin to revert to the mean of the index itself. By calculating the relative strength of each of the stocks on a daily basis and plotting that performance on a standardized scale of 0 to 100 for each stock, you may be able to find moments when the extreme condition begins to stabilize and reverse.

In the case of the laggards, this may alert you to a possibility to buy value just as it is beginning to revert to the mean.

In the case of the leaders, this may alert you to the possibility of the outperformance period coming to an end.

By applying these relative strength performance curves on a channel-based technical indicator like Williams %R, you might treat the upper 20 and lower 20 percentiles as the regions of extreme behavior and thus ready yourself for a reversion of the previous trend.

I have not subjected to this idea to rigorous back testing yet, but the concept is intuitively appealing. The insight comes from inductive reasoning based on years of observation and may be worthy of closer study.

Profitable ETF trading strategies: the power of focus

August 12, 2009 3 comments

I have a good friend who has been struggling for years to become a professional trader in the stock market. He is well-capitalized, smart, a quick learner, humble, energetic, self disciplined and passionate about his desire to be a full-time trader. And yet, after years and years of trial and error he has not made enough progress towards his goal to feel confident that his goal is realistic.

I told him that I was willing to be his coach provided he put in the effort and was willing to go beyond his beliefs which may have been the source of his limitations.

The good news is that in a matter of weeks through rigorous self-examination and brutal honesty and a great deal of personal work, he has made major strides after all these years in realizing his goals.

After several weeks of observing his trading patterns in real time, together we concluded that his curiosity and eagerness were not really strengths at all in the way he was  applying them.

He was more than willing to pull the trigger on ideas that seemed to make sense in the moment, but what he lacked was disciplined focus to master and implement a strategy that was most suited for his personality and strengths.

Once we had enough trades to establish a statistically significant population to examine, we focused on the patterns and targets where he had performed to the highest levels with the least amount of effort.

In his case, it turned out that the best thing that he was doing was trading Coca-Cola on an intraday basis, because he found himself able to tune into its normal price patterns and find price levels of support and resistance that gave him favorable reward to risk ratios when traded at his level of capitalization.

By sticking to a couple patterns that were simple and robust, he was able to develop new levels of mastery in a remarkably short period of time on his favorite target. His performance statistics were so outstanding that there is every reason to believe that he could trade just that symbol for living forever.

Coca-Cola is a marvelous company and its stock behaves in a way that makes short-term trading and swing trading very accessible to the beginning trader.

It is liquid, smooth and orderly, and  sufficiently volatile to allow outsized gains for measured risks. Because it is a large-cap US stock, it must be owned by large-cap mutual funds so there is always a population of people who are ready to buy Coca-Cola, which as a certain degree of fundamental safety to the stock.

Human nature being what it is though, it is a daily task of management to keep my friend focused on what’s working for him because the very success he experiences in Coca-Cola encourages him to go back to his old ways and try on other new ideas. If those don’t work, the negative emotions he feels find their way back into the way he trades Coca-Cola.

This is the insidious nature of human emotions in the trading arena. It must be monitored and guarded against daily basis. Each new day brings its own new challenges and you cannot let down your guard.

The results though speak for themselves. If my friend has the will to do it, he already has the skill to be a full-time professional trader Coca-Cola.

Maybe the most important quality in a coaches the ability to remind us to remember and apply the things that we already know.

Profitable ETF trading strategies: reflection theory and its implications on back testing

August 12, 2009 Leave a comment

A simple explanation of reflection theory comes from the mathematical field of set theory and statistics. The theory can be made as complex as you want it to be, based on your interest in statistics and math, but the essence of it is intuitive and has some interesting insights for back testing your systems in the stock market.

To begin with, the reason we conduct back testing is to ensure that our intuitive insights, which are triggered by enthusiasm and emotion in our pattern matching brain, may actually have some objective truth to them when subjected to rigorous analytical confirmation.

The manner in which we conduct back testing and the assumptions that we used to drive the analytical engine are all important when it comes to having reliability and confidence in the results. If you start with a bad set of assumptions, then even the most perfectly applied back testing technique will come up with invalid and unsupportable conclusions.

Back testing is like logic and deduction in that sense. If you start with bad information, you can be perfectly logical but come up with conclusions that are logically sound and don’t work in the real world.

Reflection theory suggests that in normally distributed populations, that for a sufficiently large population there will be subsets which have the same characteristics as the larger population from which they are drawn. This leads you to conclude that the inferences you draw on samples can be applied with great degrees of confidence to the behavior of the population at large.

At the simplest level, if you believe that the market returns are normally distributed, then you can take samples at will and data mine them for relationships between variables of your choosing and then apply any edges that you find to the broader population with great confidence.

Everything we know about the distribution of stock market returns, though, is that they are not normally distributed and that therefore great care must be taken in your sampling technique and in your out of sample testing for validation for any rule set that you propose to put real money on.

There are proponents of the idea that the market is so abnormally distributed that there is ian irreducible chaotic nature about the market which should put an upper limit on any risk you propose to take, no matter what the statistical evidence from back testing suggests.

The short answer to this is: place your confidence wisely and always have an out. Never be the first mouse, unless you have to be, and remember that there are no old, bold mountain climbers.