Note: This post is a summary of the webinar I held with traders last Monday.
I have been involved in trading in the US stock market since 1977. My professional work with traders began in 2003 and continues to this day. I've seen my share of the markets, and I've seen a lot regarding what goes into trading success.
What I find noteworthy in recent markets is the degree to which more and more money is being put to work, looking for relatively short-term advantages in the market. Quite a number of hedge funds and money management companies around the world have significantly increased their assets under management. They have also expanded their operations across markets and across geographies. When I started performance coaching, it was common for funds to specialize in specific strategies and consist of single portfolio managers, sometimes assisted by assistants. Now, we find many funds trading multiple strategies (“multistrat”) with large teams. This means that each team acts as a mini-fund, building diversified investment portfolios. In the past, my work was largely limited to traders in New York and London; Now it's truly global.
At the same time as business organizations exploded, their ability to take risks declined. In the past, a manager could lose up to 20% in one year before being shut down. Now it is not unusual for this number to reach 5-10%. What happens in practice is that risk managers don't want to see their teams stalled, so they reduce risk before the downside limits are threatened. Once a trader is down a few percent, the risk tolerance is often reduced. So, for example, if my capital was cut in half when I was down 5%, I now have to make 10% of my new capital base just to break even. This is daunting, so – in reality – no one wants to go down more than a very small percentage.
Over the years, I've seen the same dynamic between day traders and proprietary trading firms that are largely involved in short-term trading. They typically do not have large capital bases and therefore need to manage risks tightly. Historically, they have raised their money by leveraging capital, which also ensures that risks are carefully managed. As day trading grows, especially since the “meme stocks” era, we find more and more participants chasing the moves, but with limited ability to lose.
The net effect of these developments is that we have very crowded markets that jump on moves and need to be bailed out when moves don't work out. If a trend appears to be underway, there is a lot of “chasing” of the perceived opportunity, and when the trend reverses, there can be an equally significant abandonment of positions. Overall, this has created more volatile markets. To the degree that this volatility is a result of more and more capital being managed more and more tightly, I expect this volatility to continue.
So where does the spirituality of trading fit into all of this?
My research has found that at market turning points, we see clear shifts in the scope of market movements, as well as changes in relative strength. This happened in late October, when a massive sell-off brought us more than 1,900 one-month lows and more than 1,600 three-month lows among NYSE stocks. Over the next few days, we moved lower by about 2%, yet fewer stocks made new lows. In fact, we are starting to see relative strength emerge in a few market sectors. This led to a flurry of buying (and short-covering!), and by November 2nd, we were suddenly seeing new highs outnumbering new lows. This created a momentum move that has now taken us to new highs in a few parts of the market.
(Interestingly, as we have rallied in the last few days, the widening has stalled and we are seeing shifts in relative strength between sectors. I am watching the market closely for a possible reversal.)
With market participants crowded out and limits on losses allowed, the two most obvious trades are momentum moves (the crowd is chasing the move) and reversal moves (there is an initial rescue from previously popular ideas). The relative breadth and strength metrics I track daily – for the market as a whole and sector by sector – can be found on Barchart.com; StockCharts.com and MarketCharts.com. Momentum backtesting and reversal moves can be found via SentimenTrader.com and QuantifiableEdges.com. Creating a database of market and sector breadth has been invaluable in spotting when there is momentum and when moves stop.
As I assert in my online book Radical Reinvention, our biggest business problems occur when our egos control our activity in the marketplace.. We impose our views on the markets, and we trade – not because of unique opportunities – but because we *need* to be active and make money. Once our egos take over what we do, we become poor listeners to what the markets are actually doing. As a psychologist, if I am preoccupied with my own concerns while talking with a client during therapy, I will likely not be very helpful to that person. I need to listen to them and act on deep understanding. This is the case with markets.
What I refer to as The spirituality of trading It is putting ego aside and training ourselves to be sensitive listeners. If we can master this in the markets, it will be a great exercise for our personal and business relationships. Proper trading makes us better as people. The goal is to trade selectively, from the soul – not reactively, from the ego.
Thanks for your interest–
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