Some Selling Hits the Tape

As I pointed to yesterday, there had yet to be any significant selling hitting the tape. That changed slightly today as the selling into the close sticks out like a sore thumb.

Selling Pressure

While obvious, the significance remains to be seen. An under the surface correction has been the theme over the past month but the waters have been mostly placid. Seeing some selling ripple the surface and a pullback on the indexes would be neither unexpected nor out of the ordinary. Should a series of larger selling days begin to follow in the near term and further distribution hits the tape then reassessment will clearly be in order.

Buying/Selling Pressure

As February comes to a close tomorrow I thought it worth looking over the past month from the perspective of the number of stocks up/down 4% daily. The early part of the month showed two large volume buying days with well over 300 stocks up, but since then the 200 plateau has only been broken once and most days were quite subdued. Additionally during this month there were 5 days where the selling was higher than the buying but not by much as most sell days were less than 100.

Stocks Advancing/Declining 4%

Daily dips and gaps down on the market have been bought and days that look like they may muster a significant break have waned by the close. This has been evident in the Small Caps in particular that are either reversing intraday or failing to follow through the next. Big Cap Tech on the other hand has continued to show strength. Markets need buying to support moves higher but can fall on gravity and their own weight. The current equilibrium of the market is heightening the anticipation of direction and leaves one with the impression a move may be on the horizon.

Weekend Review 02/24/12

Risk awareness is one of my main approaches to trading. It is with purposeful intent that I approach the beginning of each trading week with an assessment of what the market is doing and whether or not the probabilities over the next 5 days will be a conducive market environment for me to trade in or not. Through daily analysis and weekly reviews if there is one aspect where I've experienced the greatest discernible growth it has been in identifying these periods and placing myself in step with the markets direction.

Given that the current correlation of stocks to index is between 75%-80%, being on the correct side of the market is a key component to reducing risk exposure. Rising indexes indicate robust markets and robust markets are simply more forgiving and easier to trade. From December to February this has been the case and then the market simple halted, stopping dead in its tracks. For the past three weeks the Russell hasn't budged and sits half a percent from where it was on 02/03.

Russell 02/24/12

For the past week and a half this became apparent to me and as such I took it upon myself to modify assessment of risk due to the belief that the underlying market breadth had become quite frothy and was beginning to stall out. As such I took ½ risk positions and tightened my profit targets. This was the prudent speculation from my perspective, however it didn't turn out completely as anticipated and in some ways may have increased my exposure to risk.

While I believe I still have the underlying market direction on my side, the relative flatness that has occurred over the month of February introduced a risk I hadn't taken clearly into account –higher propensity of break out failures. The underlying thrust that has propelled this market was waning indicating that the set-ups I trade were now becoming riskier to take due to an increased probability of failure. Avoiding market whiplash means avoiding the market entirely so using this information I can now reassess my plan coming into this week and make a decision to not trade, or further refine my set ups and look for more stringent requirements.

This becomes more apparent when looking at the buying to selling differential and the buying over selling ratio.  The current downward slope is not from an increase in selling as these days have been few and limited in scope, but primarily due to the lack of buying.  A number of days over the past two weeks have shown near equal days of buying to selling resulting in a stagnant range with little upside or downside movement.  Basically we're undergoing a state of stasis.

Buying-Selling Pressure

Breadth Thrust Ratio 

What I'll be looking for first and foremost this week is some indication of increased buying. While there has been a consistent bid to this market, the facts as indicated by the ratios downtrend correlating with the lack of market movement over February indicate a lack of participation driving up prices. When I'm interested in buying it does me little good if there aren't others more interested and it remains to be seen if they'll show up this week.  The signs I'll be looking for are a large buying day with an increase of the ratio above 1.5 to become an interested participant again.

Weekend Review 02/17/12

By nearly every breadth measure the market is currently at extremes. What's noteworthy is that this was the same situation last week, and the week before that, and the week before that and... This clearly embodies the concept of markets being and remaining overbought regardless of which breadth metric is used to slice and dice the current environment. This is also the environment where the temptation of caution be damned begins to manifest because the allure of “It's different this time” kicks in.

Stepping back, and by back I mean a decade three things have stood out this week.

Both the NASDAQ-100 and NASDAQ closed at 11 year highs this week. In terms of nearer history the NASDAQ has now cleared the 2007 highs indicating that a change of character is under way as the market shakes off the effects of housing and the Euro-Zone crises.

NASDAQ Monthly

   The second point to stand out this week is the $BPNYA during this same period. Looking back it is very rare to reach the current level. Other than a period in 2006, the only other times this level has been surpassed was in 2011 which was the peak of the move that came off of the 2009 extreme lows. This is something to keep in mind in the near future.

$BPNYA

Third, the primary ratio I keep track of is a very high reading as well and beginning to waver which I associate with instability at this stage.

Primary Ratio as of 02/17/12

Another point to keep in mind is that the NASDAQ has moved nearly 17% during this up let without an “obvious” pullback.

NASDAQ- Current

While much of this suggest an overheated market, it is also noteworthy to observer that the index has moved a mere 1.56% over the past two weeks so under the surface there has been a correction occurring.

NASDAQ Move Since 02/03

Further, this under the surface correction shows up in a number of other scans.  The Secondary Ratio I observe has followed suit and peaked approximately two weeks ago and nearly halved in this time.

Secondary Ratio

The buying pressure over this period has also waned over this time.

Buying Pressure

The $USHL5 further solidifies February 3^rd as a pivotal date since this indicator pulled back on that date and ended the current week on the upside.

$USHL5 02/17/12

Overheated market? Yes.  However, it's my general belief that the market is acting and behaving in accordance to my personal cadence and what I believe to be a healthy market for me to trade in. Metrics aside, sometimes it simply comes down to how stocks are behaving. Recently a number of set ups have broken out as others continue to form solid bases;  also with extended stocks pulling back and a number of stocks breaking out or down based upon earnings, the underlying tone is that it is a stock pickers market right now and focus on vehicle selection is key.  

Reality Based Trading- Balancing What You Want with Who You Are

Breaking down some numbers today it's become abundantly clear that the metrics I'd like to achieve and what I've accomplished are night and day. This is a principled example of cognitive dissonance and the resolution to this is not 100% clear, so I thought it in my best interest to externalize the conundrum in an attempt of ascertaining coherence.

Ideally my benchmark to achieve is a risk/reward ratio of 3-1. This number is not something I've simply pulled out of my ass --it is completely rationale and here is why; Cognitively it has been shown that the human brain reacts approximately 2.5x more to losses than gains which means that for each loss the gains to balance the internal state should be 2.5 or more. Given this, my thoughts were that if I could maintain this ratio the internal balance of my mental state would be more harmonious and would lessen the discomforts I have at times being in a trade.

The problem is that I've latched onto this anchor and continue to hold to this metric as a goal to achieve while in turn completely neglecting the information my trades are telling me. Here in lies the crux of the problem; what I'd like to achieve I have thus far been unable to do with consistency.  In turn I  have ignored the profits achieved consistently resulting in sub-par performance. The result is that this has done anything but appease my internal state and in fact it has simply increased frustration and exasperation.

Currently what I have shown myself capable of is a 58% success rate with an average of 1.17 R/R. I have not shown I am capable under the current market conditions to extract 3-1, let alone 2-1 with consistency so it is to my detriment to hold onto this view any longer. In fact, given that my time frame is 5 days I can simply take the max high over this time compared to entry and note that the average has only been 4.8% to begin with. Couple this with my current average profit extraction of 3.93% and I'm really not missing much profit and in fact causing detriment to my productivity in attempting to extract more.

Given this I can only come to the conclusion that it is time to stop fighting the reality of the situation and to accept fully what my personal performance is indicating to me. Which in turn means I will have to modify my plan for the time being. This isn't to say that I'll completely give up on reaching for 2.5+ R/R, it simply means I'll also have to let my metrics show me when I am capable of that. Once my stats begin to show me I am costing myself by not holding on a little bit longer and maximizing potential profit I'll adapt.  

Breaking it all down trading in it's essence is simply a game of numbers and probabilities. Each trade increases our sample size and inches us closer to truths about who we are as traders at any given time. One of my priorities written in my trading plan this year was to become more aware of how my numbers speak to me; and given the number of trades I've taken thus far the outline is starting to become a story and it's time for me to start listening.

In keeping with the theme, here are some key formulas to be aware of for trading:

Risk of Ruin is a gambling concept and an important calculation to understand.  This is the ultimate calculation a trading strategy is measured against for if ruin is reached that's it --no mas.  While a near 0 risk of ruin is not a guarantee that one will not blow up their account, it is important to be aware of as an indication of how well one is trading. If this number begins to increase somewhat significantly it is a good clue that one is not in cadence with the market or that ones strategy is not currently working or worse, one is not trading well at all regardless of the market or the method.

There are two caveats to consider in this calculation.  The first being that it requires gains to be larger than losses.  Obviously a 50% success rate where losses are twice as large as gains will lead to ruin but it is also important to acknowledge that trading is not a zero sum game.  While it is true for every winner there is a loser, it is also true the house wins.  A series of ten flat trades can still burn 1% of an account.

Risk of Ruin

Expected Value is another important concept to understand. If you don't know the expected value of each trade you are doing yourself a disservice.  In conjunction with a near zero risk of ruin this is the second factor that must be taken into consideration: a +EV system.  Knowing these correlations will greatly assist in understanding the risk that is being taken.  If the system is not positive and there is an 8% risk or ruin why is the system being traded at all?  If it is marginally positive, where can things be tweaked to improve performance or reduce risk? 

Expected Value

If the first two are positive, then the tweaking comes in the form of personal performance statistics. Figure out what stats are important. I trade with a 5 day time stop so I keep track of how the trades I take perform on this time frame whether I get stopped out or exit before then. Additionally what has been critical information for me to know is if the days close is higher than entry and if the second day has a follow through. A secondary piece of information I watch is the max high over the 5 day period which further heightens the discrepancy between what the stocks over my time frame were capable of moving from my personal desires. You're numbers won't lie to you so deducing this information is absolute imperative.

Did the Ghost of Burroughs Play William Tell?

AAPL a Day

Without a doubt the tremor that shook the market today was the action of AAPL which after a parabolic run to the upside looks to have put in a climax top with the highest volume since earnings in January '11. Given the weight of AAPL in many indexes it comes as no surprise they should buckle and cling to AAPL like a magnet and feel the pull of its gravity. The significance of it's move is evident in the only index showing any signs of an upside move over the past two weeks has been the NDX. Also evident is that the laggard declining into today has clearly been the Russell while the others have been fairly flat.

Index %Gain from 02/03

Taking the SP, the sideways move becomes clearer when looking at the move the past 9 days.

SP 500

Additional support is the lack of new 52-Week highs since February 03 which coincided with the sideways move in the index.

$USHL5 02/15/12

Taking all this information into context today really should not have come as a surprise. It is still jolting however because until today it was the anticipation of the event and now it is the reality of the event which results in differing psychological paradigms. The action of expectation and the reaction to event is often suffixed with: “It wasn't so bad after all.” Now that this has happened will the response be muted or will there be aftershocks?

During the past 9 sessions there has been a lack of significant selling –today inclusive. Even under the duress of AAPL selling off there were only a handful of stocks that showed 4% declines on $100M dollar volume. Distribution takes time and given the persistent bid over the past 6 weeks and the relatively light selling of the past two weeks the signs are not there. Tomorrow's action will give further clues but thus far it looks like a sideways pullback has been occurring and the potential for a deeper correction is on the horizon and probable, but further evidence is needed.

As I like to cajole myself at times, “I might be stupid, but I ain't dumb.” It's clear that there is increased risk in the market from my perspective as a swing trader. As a smaller player in the scheme of things it's easy for me to get out of the market with a few mouse clicks, and sometimes easier then that. Ultimately it's my money management that takes precedence above my opinions and the simplest way to remain reality based is to see how many stops got hit today and how much profit decayed. Nothing else really matters.

Developing Process Loops Part 1

In its simplest form, a process loop is a set of instructions or a task broken down into units to be completed. One of the earliest process loops I recall learning was putting together a puzzle: Find all the edges and separate them. Find all the the like colors and divide them. Build out the frame. Piece together the like colors and build from the fame inward. In theory a trading process should be just as simple.

Although trading is akin to solving a puzzle, in the initial stages of learning there are no easily identifiable edge pieces and the color tends to be varying shades of gray. What I began to realize early on in developing a process was that I was suffering information overload and didn't have the ability to discern what was useful from what was not. It was further complicated because I had not yet developed my trading persona, so my loop consisted of things I thought I should be doing and it was quickly evident there were severe efficiency issues to tackle. This is not going to be an uncommon plight as there are hundreds of nuances in developing a trading methodology and setups that can be explored. I was feeling stuck and I was spinning my wheels. This is a huge problem as it hindered the overall development and progress of my trading because I wasn't focusing on the pertinent issues.

The irony is that a process loop's intent is to resolve efficiency issues and make task automatic –not unlike breathing. However, I began to realize that there were severe difficulties I needed to address in a number of areas and not knowing which direction to proceed I realized I needed to build a process loop in order to design a process loop. Thus began my quest to understand as thoroughly as possible how to design a process loop that would assist me and keep me focused on important tasks at hand even though I did not have full understanding of what I was trying to achieve in the first place.

For this I received a helpful suggestion from a StockBee member to look at Mind Maps.  Mind Maps is a technique to visualize information and process flows using images. One of the advantages of using this technique is that through images and color a process flow stands out much more sharply then if it were merely typed up document in a monotone color. Certain flows stand out much more clearly when perusing notes.

Additionally by using a more whole-thinking (for lack of a better term) and using multiple parts of the brain along with physically writing down words and drawings, mind maps become more meaningful. The use of images along can speak volumes about what is being expressed and trying to be understood. By using personal imagery my notes took on a personality that conversed with me.

As an example, here are two of the maps I made in trying to clarify a process loop I was trying to develop.  I'm not exactly the most creative when it comes to my doodles but through this process I opened up avenues of creativity I would not have normally explored and I had to get over my ego during this exercise and simply draw no matter how goofy I thought my pictures were. This was a second valuable lesson I received from this exercise that I was not expecting.

Mind Map

Mind Map

For further reading, The Mind Map Book by Tony Buzan and The Back of the Napkin by Dan Roam.

Weekend Review 02/10/12

NASDAQ 02/10/12

On the surface everything looks calm and the persistence of this swing that started in December is clearly visible with the up days out numbering down by 2-1.  Under the surface however, one of the breadth indicators I pay keen attention to is showing the move stalling here.

$USHL5 02/10/12

On 02/03/12 the $USHL5 peaked at 2238 and finished this week at 1399.  If we measure the move of the NASDAQ over this time the change is .06% which is in keeping with a market of stocks that are no longer making new highs.

Corrections don't always have to pull back x%; sometimes they can occur through sector rotation which will not be obvious when looking at the indexes but is clearer through the action of individual stocks, and sometimes the move unwinds sideways which may be witnessing here.

Individual stock action is showing the break outs are working in this market and 52-Week Highs are in play again.  In addition stocks are breaking out from solid set ups and new set ups are continuing to emerge on a daily basis.

Ideally I'd like to see some pause for a few more days so bases can continue to form, but every time I've been on the alert for some pullback it has failed to materialize.  I won't be holding my breath for it to occur this week either.  My focus  this week is on buying break outs and selling when they become extended with the belief that this is the safer means to navigate these waters.  Should a pullback commence extended stocks are the most vulnerable to getting tagged first so selling strength involves less risk under these conditions.