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A Look at the Nasdaq Minis as Buyers Test Support

Wondering About Nasdaq Strength Progressing?  These Images Tell the Tale

Above we see the passage of the last five days in the $NQ_F, the mini NASDAQ futures - against a backdrop of the month’s volume. Instead of candlesticks, we are looking at the volume associated with price.  

The NQ_F chart here tells me that I am sitting near solid regions of new higher support holding but I have congestion areas above holds steady as resistance even as we press through to higher levels.  Thin volume below still poses a problem that will surely raise its head in the future as a problem but as it sits right now, pullbacks remain buying opportunities for most participants in the market.

So how did I get this information from the chart we see?

We might notice in these mountainous formations, the peaks and valleys present each day.  What they represent is a participation level in terms of volume.  From these images, we are able to say with quite a bit of surety that if I drift into the regions near the higher peaks, I am likely to stay there for a while.  It will chop or grind through those levels on its way to the next ones.

When traders behave this way, they agree that the instrument is near a price at which traders desire to participate - usually in both directions.  

In the spaces where we see the valleys, we are likely to lift (or fade) through these regions quickly when we approach them.  When traders quickly move away from a price it means that it has created a space where the level of participation becomes one-sided (again, either direction is possible), creating directional motion.  These are my favorite places to identify as a trader as they can give me swift movement in participation.

Knowing these two pieces of information can help you see how to both enter and manage your trades a bit better by realizing what the likelihood of behavior might be with other traders.

A developing trader said something to me a few weeks ago that has stuck in my mind: he said that he has to be careful what websites he reads because negativity can be dangerous; when you live in a constant state of fear, it colors everything you see. Be careful: you are what you eat (and read and think about!)

I think it goes even deeper. Negativity and fear change our perception deeply. When we absorb certain kinds of information, or information placed in emotional contexts, we create blind spots for ourselves. We are not able to see and think rationally if we allow too much emotion, and too much emotional contamination from others, into our thought process. Emotional context changes how think and how we are able to think.

I’d challenge you to take a moment and think about the information you consume on a daily basis. First, major media is not perfectly unbiased. Anyone who works in media wants to engage an audience. We (I’m including myself here because, among other things, I’m a blogger) all know that emotion generates clicks, shares, and reads and negative emotion resonates much more strongly than positive. So, news stories naturally come wrapped in an emotional wrapper with a provocative and emotional headline, and our brains naturally accept the emotion with the facts.

Major media has a mandate to be more or less unbiased, and most major media sources accomplish this fairly well. But what about blogs and newsletters and sources that are intended to be biased? Some of the most popular sites on the internet feature an incredible dose of emotion—fear and hate will provoke and engage an audience and build a core audience very well.

So take a few moments today and do an information inventory. Ask yourself what sites and sources you regularly read and how much emotion is baked into them. (I’m not going to call out any specific sites or authors, but I think you will be able to read between the lines.) For traders, there are a few specific things to watch for:

Do you frequent discussion forums that are filled with frustrated, failed traders and investors? Some of these forums also include a healthy dose of constructive work by traders who are either committed to figuring out the game or helping others, but be sure you can separate out the wheat from the chaff. I’ve been involved in these forums since they were mailing lists, and I can say I’ve rarely seen the degree of anger that comes from failed traders. They are certain the system is rigged, and just throw abuse at anyone and everyone in the forum like a monkey throwing poop at the zoo. You can hang out in these forums, but watch out for the flying poop.

Speaking of flying poop, there’s been a lot of focus lately on fake news, especially politically-driven news on Facebook and other social media feeds. It takes less than a minute to do some basic fact checking, so please do this before you share and get upset about something you read.

Do you read newsletter writers who constantly predict the end of the financial world, World War 3, or who focus on conspiracy theories? If so, you’re probably hurting yourself. There are writers who have built multi-million dollar industries playing on the emotions of the public. These newsletter writers have been constantly predicting THE END for decades, and they’ve been wrong. They will continue to be wrong, but the harm they have done to their readers is almost beyond measure. If you read anyone like this, consider carefully what your world would be like without this influence.

Do you frequent blogs that repost or aggregate content like this? Is there a constant flood of posts predicting crashes, talking about why the system is rigged, or drawing great significance from hidden datapoints? Is everything blamed on HFTs? Again, this stuff generates clicks and shares, but it does not help you as a trader and investor.

Once you’ve taken a serious look at the information you consume, then you’re in a position to figure out what do to about it. I suggest trying an information diet: First, cut out virtually everything you read. If you are a news junkie, this may feel uncomfortable. You may feel blind or cut off, but give it a chance. Avoid clicking or reading for a week, and see how your emotional state changes.

Then you can start adding things back, a little at a time, and monitoring your emotional state while you do so. If you find yourself sucked into hours of clicking and sharing emotional and negative articles, first of all congratulate the blog owner on building an engaging blog, but then step away and rethink. You can absorb information, but you need to be careful about the emotion that goes with it.

We have limited time and attention. This is one of the realities that developing traders soon face—no matter how hard you work or how well-intentioned you are, there’s a limit to what you can look at, analyze, and understand. It’s important to filter out the noise so we know where to focus that precious resource of time and attention, but how do we do that?

Another way to ask this question is something like “what’s the most important thing on a chart?” or “where do you start reading a chart?” The answer is simple: you want to pay attention to the big moves.

Why big moves? Because most of what we see on a chart is random. Most of the time, the market moves unpredictably from point to point, and we can’t make money if the market is moving randomly. If we’re going to risk our money (and other resources like time and mental and emotional energy), we need to have some evidence that there’s an edge in the market. Looking around big moves is a good way to start looking for an edge.

So what is a big move? The answer is “it depends”, but that’s not the useless answer it might appear to be! What does it depend on? It depends on how the market usually moves; a more precise way to say the same thing is that it depends on the volatility of the market, and that’s the key: using measures that automatically adjust for the volatility of the market can help us find these big moves we want to focus on.

We can think of “big moves” either as single bars or swings—we can look at large single bars, relative to some measure of “average bar size” on the timeframe we are monitoring, or we can also look at large swings that somehow rise above the average swing length for the

The first is visual inspection. Simply look at the chart and ask yourself which moves jump out as big moves. The problem with this is that this is a purely subjective measure. What stands out to you today might not stand out tomorrow; if you look at the same chart twice you might come up with two different answers. That answer might depend on the charts you look at before, how long you’ve been studying, what you had for breakfast—you get the idea. This certainly doesn’t invalidate this approach, but you do need to realize that it may not be fully reproducible. The chart below highlights some big moves with red arrows, but the orange arrows point to bars that might or might not be considered big moves. We also can’t use this in any kind of backtest because it’s so subjective. Even with those limitations, this is something anyone can start doing today and simplicity is often a good thing.

We can pick out big bars just by looking at the chart, but this raises some questions

If we want to have something more consistent, we can start applying some mathematical measures to charts. One of the tools I use is something I’ve called SigmaSpikes, which is simply each day’s move expressed as a standard deviation of the past 20 trading days. One way to use it is to go through a chart and highlight all the moves that exceed a certain threshold value. (I often use 2.0) The beauty of this measure, to my eye, is that it lines up very well with the points I would pick out subjectively, but it’s an objective measure. I can scan charts for it, create screens that rely on it, look at markets that have made big moves in recent history, and use it in a backtest—all good tools to help me narrow down the universe and to know where to focus my attention.

Big bars measured with sigma spikes

Another useful tool is to put some kind of band on the chart, and to look at the spots where the market engages the bands. Personally, I prefer Keltner Channels, but Bollinger Bands are probably more common. Don’t get too caught up in the search for the perfect tool or perfect parameters; the concept is much more important. The concept here is that we put some volatility-adjusted bands around the market and only look at the point where swings (or single bars) rise to the level of significance by touching the bands. Again, we can look at historical measures of this objective tool and even incorporate it into backtests and systematic approaches.

Bands can also be useful to measure big swings

Many of my readers probably already use tools like this, but, if you don’t, think about adding this concept to your toolkit: focus on markets that have made big, sharp moves, as these moves may point to the way to some imbalances in buying and selling pressure that could give opportunities for profits.

I’m sitting here at my desk looking out the window. On my desk is a (perfectly normal and fair) coin that I had been flipping a while. Question: can you tell me how many heads I flipped?

Now, think about that question a few moments. If you had to guess, what would you guess? Maybe I’ve been sitting here watching Netflix for a couple of hours flipping a coin. Maybe I flipped it while I was on the phone for just a few minutes. Maybe I just flipped it once or twice. You probably could figure out some reasonable estimate of how long a (mostly sane) person would sit flipping a coin, add into it an estimate of how many times you could flip each minute, and come up with some kind of answer. You can probably guess that there’s some practical upper limit to how many times I flipped it, and the probability distribution of how long I’ve been flipping probably has a lot of weight near the origin and not much out in the tail.  If this was an interview question for a consulting firm, you could come up with some answer.

Now, here’s another question: how sure are you of that answer? How confident can you be that you’re within 10% of the right number of coin flips? This is the question that really matters. Ok… hold on to that thought.

Let me give you one more piece of information. If I tell you I flipped 67 tails, does that change your answer to how many heads I flipped? It should–now you know if 5, or 65, or 65,000 is a better guess. How confident are you about your guess now?

Here’s the point of this post, and it’s not a math lesson: heads and tails go together. You can’t have one without the other. The same process that generates the tails generates the heads. You might even say that heads and tails “live together” or that “tails live in the land of heads”.

This is such a simple observation that many of my readers probably already clicked away, but I want you to think of this in two ways. First, this lesson generalizes to life. I think you can often tell how successful someone is by asking how many times they have failed. Most big, successful businesses (and individuals) have a string of dramatic failures behind them. In some sense, we learn from those failures and move forward.

But there’s another way to think about this–life and business are really about the odds. Chance and luck do play a part, but you have to put yourself in those situations where chance and luck can work in your favor. The more times you’re at bat, the better the chance you’re going to hear that crack and everyone can just stand and watch the ball sail over the fence. One of the most inspiring quotes I’ve ever heard–and maybe it’s as much for its gritty realism as anything else, comes from Mark Cuban: “it doesn’t matter how many times you fail.It doesn’t matter how many times you almost get it right. No one is going to know or care about your failures, and neither should you… All that matters in business is that you get it right once. Then everyone can tell you how lucky you are.

If you’re a trader, think about your losses in this context. How do you feel about those losses? Do you feel shame? Fear that your next trade might be a loser? Do you do things designed to minimize the size and chance of your losses? (Be aware that those two things work against each other–fearful traders often generate very small, but very certain losses. This is one way to die as a trader.) Or do you welcome your losing trades?

Do you know that all of your winning trades live in the land of loss? Do you realize, wholeheartedly, that your losses and wins are two sides of that same coin? Do you know your losses are essential to your success? The more winning traders you have in the course of your career, the more losing trades you will have–winning lives in the land of losing, just like the heads and tails on that coin I flipped.

When we understand this–and if we are sure that we are trading with an edge–then trading becomes easy. Fear of loss vanishes

To me, this is a simple, but profound truth. It also just happens that this simple thing is one of the keys of approaching trading with a professional mindset, and becoming fully comfortable with probability, risk, and the nature of a trading edge–all essential to your eventual success as a trader or investor.

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I saw this interesting article from Bloomberg last week, with the almost-clickbait title of “Train your brain for trading (No, Really!)” I just happened to click on it, and found that it was actually an interesting perspective on some earlier research. When I wrote my book (which you should check out if you haven’t already!) that particular paper was relatively new, and it had some perspectives that shaped the way I thought about teaching and developing intuition. Key points are that 1) this is a normal aspect of human cognition, just slightly re-tooled to work in the market environment, 2) intuition is normal, and 3) if everyone has it, it’s not a stand-alone source of a market edge.

If you want to read the original paper, “Exploring the Nature of ‘Trader Intuition'”, you can find it here, but here’s a little excerpt from pp. 361-362 of my book that hits some of the important points for traders. For developing traders, many of the tools and techniques we use are designed to nurture and to refine this intuitive sense of market action:

There have been many studies in the social sciences and in psychology that have established the reality of human intuition. Focusing specifically on trading and market-related intuition, Bruguier, Quartz, and Bossaerts (2010) structured a set of experiments designed to “better define what is meant by ‘trader intuition,’ and to understand why some traders are better than others.” They did this by creating a number of scenarios representing markets that both had and did not have trading by informed insiders, with the goal of seeing if novice traders could intuit the intentions of these informed insiders through price movements. Perhaps surprisingly, they found that uninformed traders with no experience in financial markets were quickly able to discern the intentions of these informed insiders, based on nothing more than information contained in price changes themselves.

The logical question, of course, is how did they do that? Bruguier et al. postulated a connection between traders’ intuition in market situations and a specific ability known in the literature as theory of mind (ToM). ToM is the human ability (perhaps shared with some other primates) to read benevolence or malevolence through the patterns in one’s surroundings—for instance, the ability to read another person’s intentions through eye expression or through moves in a strategic game. Since markets with insiders represent an environment that may be deliberately manipulated against the uninformed trader, ToM becomes a potentially relevant skill. Not only did Bruguier et al. find that trader intuition in their market simulations was strongly correlated with tests for broader ToM-based abilities, but it was specifically uncorrelated with ability on mathematical or logical tests. Last, they confirmed in brain scans that subjects were activating areas of the brain that have been associated with ToM in previous tests and experiments. It appears that subjects were using highly evolved portions of their brains in new contexts and applications to drive market intuition.

This paper is one of many that confirm the reality of intuition, but these results are particularly interesting because they suggest a fairly mundane explanation for the phenomenon. Intuition is not some mystical skill that only supertraders have; it is a retooling and reapplication of normal human abilities built from our social interactions. However, the most important point is that intuition is not special. Even inexperienced, uninformed traders quickly begin to develop intuition about market patterns (a fact that has been confirmed in many other experiments.) If everyone has it, intuition cannot, in itself, be a source of a trading edge.

An interesting debate emerged in the comments to one of my posts. In the post, I had suggested the discipline was the most important thing; a reader countered that patience was more important. Now, I could (and did) argue that patience is a subset of discipline, but the discussion could quickly devolve into an argument over the exact meaning of words–all of this could so easily miss the point: patience is absolutely essential for success in trading. And learning to have patience… well… it sucks!

The patience to wait for an entry

People who haven’t traded often have trouble understanding the psychological stresses of trading. I can remember my early days: I’d have a plan and I would know exactly what I would/could/should do and which markets I would trade. I would review this plan, write it down on paper so it was “real”, and then resolve to follow it exactly. Then, when the hoped for entry didn’t develop, I found myself almost magically in another trade in an unrelated market. I wish I could tell you this only happened once, but it was a part of my struggle several times, and then again when I switched markets and asset classes.

From a logical perspective, this is baffling. It’s beyond stupid. But nearly all traders do it, and some never get over it. The simple patience to wait for the right entry to develop is truly an essential skill in trading, and, if you can’t manage to do this, I don’t think you can be a trader.

We can come up with whatever powerful and correct imagery we wish: for instance, a hawk sitting motionless on a pole, watching the grass below for the telltale whisper of lunch. That hawk will sit for hours if need be, and then pounce at exactly the right moment. Far more often than not, things work out well for the hawk and badly for the “lunch animal”. Ideas like this should be compelling to a developing trader, but we can rehearse and pound the ideas into our heads, only to do something stupid in a I MUST TRADE NOW moment the next day. What to do about it? Hold on, we’ll get to that, but let’s look at a few other ways patience is important.

The patience to be sure you have an edge

This one seems obvious too: It shouldn’t be too hard for me to convince you that the markets are a difficult place and that you don’t stand a chance without an edge. It’s also not terribly hard for someone to learn how to develop and verify an edge. Knowing this, it would seem to be logical that any trader should carefully do the work to be sure he has a reason to risk money in the market, right? Of course, this doesn’t always happen.

Again, the solutions I’m going to offer will help here, but it’s also worth spending a few moments on the intellectual side of this. Whether you are trading or investing, you don’t have any reason to risk money or time until you are sure you have an edge. If you got a system idea from a chatroom, are trading some indicator or candle pattern, or just think you can figure out what companies make really cool products, you don’t have an edge. I would argue you can’t be reasonably certain you have an edge until you have some good data (ideally back and forward tested) that shows an edge, so consider this carefully before you risk money. Solutions in a few lines, but let’s look at one more kind of patience we need.

The patience to become a trader

Now, I know this borders on New Agey-touchy feely stuff, but there’s truth here: if you want to do this well, you don’t trade, you must become a trader. I think this is true whether you develop computer trading systems, actively trade technical patterns, or invest in longer-term stocks based on fundamental criteria–no matter how you are involved in the market, you aren’t likely to be successful until you have become a trader. This journey can be long and frustrating; it takes time and conviction. You’ll probably want to give up along the way, but just know that this is really the only way to succeed.

Many disciplines have clear apprenticeship paths, so the developing cook/shoemaker/architect is more or less assured of putting in the time needed. This process is also designed to slow things down so that the student doesn’t feel the need to push through and work too fast. While learning, growing, and developing skills, an apprenticeship program virtually forces patience. Yes, you can find someone selling you programs for trading that claim to do this, but the true apprenticeship path probably lasts 3-5 years. Does your two month course do the same thing? Of course not. You must be patient with yourself and give yourself time to grow into being and becoming a trader–there’s no other way. (Despite the already brewing arguments from the quants who think it might be different if we’re coding. Even here, there’s a long path to actually being able to effectively implement these ideas in the market.)

What to do about it

I can remember, as a very young boy, my grandmother telling me to never pray for patience because that was a lesson usually taught in miserable ways! Know this: if you have decided to be a trader, you’ve already committed to accepting the brutal lessons of developing patience, and the market god is a ruthless teacher! Though the market will certainly teach you these lessons if you stay in the game long enough, let me share a few thoughts that might help:

None of this makes rational sense. Accept that from the beginning, and don’t expect that you can rationalize your way around these issues. Here, we are confronting behavioral and emotional factors that are, to a large degree, outside the umbrella of rational control. Fixing behavioral problems requires a different tool set, and you be careful of emotions (e.g., anger, frustration, despair) that can make the process harder. Be kind and… um… patient with yourself as you work through these issues.

It is a discipline problem. At the same time you are being kind to yourself, inject a healthy component of “tough love.” If you can’t solve these issues, you’re probably going to eventually lose every dollar you risk in the market. This stuff matters, and you have to hold yourself to the highest standards. Demand perfect compliance to your rules.

Rules and accountability help. If you don’t know what you’re supposed to do, then it’s pretty hard to do it. Even with those rules, most of us will discover that it’s still harder than we might expect. Setting up some kind of accountability–to a mentor, to a family member, to a community, or even to yourself–is a good idea. Get some rules and then get some accountability.

It just takes time. Back to my grandmother’s point–developing patience sucks because there’s a lot of this that just takes time. The new trader is too hungry for action, and hands will often seem to make trades without conscious control. The new trader is a swirling mass of emotions and energy; we can try to channel those, but a pressure cooker needs a vent–otherwise we have a bomb.

Limit the damage while you learn. If there’s one truth I’ve learned about learning to trade, it’s this: you’re going to make mistakes. As a new trader, you’re going to make a lot of them, and you may make them for years. Make yourself earn the right to trade bigger. Monitor your growth and performance, and be smart about it. Don’t plan on supporting yourself from your trading income, perhaps for a very long time. All of this is designed to give yourself the time and space you need to grow and develop as a trader.

Just a few thoughts here that may help someone to take a few more steps along their path. Be prepared for how hard this is and how long it can take, and limit the damage while you learn–simple stuff, but powerful solutions.