Link: Overconfidence and Underconfidence

Jul 5, 2007: 8:29 PM CST

Dr. Steenbarger recently posted a source entitled Overconfidence & Underconfidence in Trading: Biases in Processing Emotions.

In the post, Dr. Brett discusses objectivity and how we process and recall experiences which lead to performance issues (usually hindrances) in the present. He shares a personal story of how he ‘felt’ relieved/good when he traded poorly and counteracts that with discussing the notion of feeling bad while trading well.

Read the post and see how it incorporates into your own trading and observations. Keeping a journal can help you, and it is important to have other activities outside of trading so that ‘trading is not life’.

At the end of the article, Dr. Brett provides three bonus links to previous posts that you should definitely read.

Also, Dr. Steenbarger recently compiled resources regarding Intuition in Trading. 

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Mid-Week Index Views

Jul 4, 2007: 6:39 AM CST

Happy 4th of July!

The markets are setting up interesting swing patterns and are exhibiting both consolidation (which makes sense) and momentum divergences. Neither bulls nor bears are making significant headway in the last few weeks of trading, and little – except some shock – is likely move investors either way soon.

dow-july-3.jpg

The Russell and S&P look most similar (technically) to the Dow recently – all are showing range contraction and (buying) momentum divergences. The indexes are clearly carving out support and resistance zones and traders are becoming aware of these zones (which means they should break when everyone believes they are firmly established).

The only majorly individual chart is that of the Nasdaq, which is making new price highs despite the lag in the other major US indexes. This tends to be good news for the overall market because so much of the Nasdaq is in ‘volatile’ technology stocks. Observe:

nas-july-3.jpg

I also could not resist pointing out that we are upon a so-called “Bollinger Band Fade Trade” or for those with a little Irish leaning, it’s a “Top ‘O the Bollinger” Fade Trade. It goes without saying that the expected play occurs when price is exhibiting rangebound characteristics and reaches the upper Bollinger Band (20 period look-back at 2 standard deviations). This would indicate a possible 90% chance of price returning to the mean (20 period moving average) soon. A corresponding stop would be placed a safe distance (you decide how close) above the upper Bollinger Band in the low-probability event price continues through it.

Three of these such trade setups have worked since May in the Nasdaq (QQQQ for the ETF).

Also, take the ‘low volume’ rise in stride, meaning this is a holiday week and thus does not constitute a technical analysis volume deterioration signal. Overlook this reading for now.

Enjoy the holiday, be safe, and come back refreshed!

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Link: What Makes a Good Trading System

Jul 3, 2007: 9:05 AM CST

JMOT’s Blog is offering a series of free articles for trading beginners, and the most recent post is entitled “What Makes a Good Trading System?”

For those just starting out in the world of trading, or those gripped by greed or fear, a personally developed trading system can help reduce the effects of these emotions, especially if you judge the results of trading as a function of your system and your ability to execute it, rather than your personal decisions regarding when to buy or sell.

A system is – at its core – a written set of rules based on observations/experiences you have gathered while trading/studying. It simply tells you what to buy, when to buy it, how much to buy (risk), when to sell it, and how to record progress (of course, there are many other aspects, but this makes a good start).

JMOT offers a description of emotions, and why a trading system can help reduce their effects:

Trading systems try to take the emotions out of trading. When we are trading, we are always plagued by fear and greed. When the stock price is moving up, you keep asking yourself if you want to take profits now because you are afraid that you will lose out on more profits if the stock price continues to move up – This is greed.

The next thing you know, the stock price come tumbling down and you lose whatever profits that you had in the first place. When the stock price is moving down, you keep asking yourself if you want to exit the trade and cut losses now because you are hoping that the stock price may move up the next minute and turn your losses into profits – This is fear. The next thing you know, the stock price fall even lower and you regretted not exiting your trade eariler to savage whatever that is remaining.

Trading is both a mind and emotions game. Trading systems help to contain our fear and greed.

Check out the post for more information and seek other resources if you have yet to develop your own personal trading plan/system. There’s no time like the present, and having a plan/system will significantly increase your confidence if you do experience ‘trade entry phobia.’

Another compelling thought is that most new/retail traders do not have a written/developed system. It is no wonder why such a large percentage fail when they have no set course of direction to guide their decision making in such an uncertain environment as the market. Put yourself ahead of the crowd and develop a system, or continuously test and modify your existing system for greater profitability.

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Martin Pring – The Investor’s Guide to Active Asset Allocation (Sector Rotation)

Jul 2, 2007: 8:03 AM CST

Martin Pring’s recent (2006) book The Investor’s Guide to Active Asset Allocation details one of the most complete explanations I have seen so far (in easy to understand format) regarding sector rotation, the business cycle, stock market cycle, money/portfolio management, intermarket relationships and many other concepts. Not only is the text a virtual reference manual for these concepts, Pring provides specific easy to follow strategies for proper asset allocation and targeted diversification to maximize returns using Exchange Traded Funds and other vehicles.

In the book, Pring details his proprietary Six Stages of the Business Cycle and how to identify them (hint: It deals with bonds, commodities, and the S&P 500). He further describes his new research including detailed charts of how certain sectors/industries have performed during each of the six specific stages he outlines and provides strategies to take advantage of specific strength and weakness of under- or over-performing sectors at key times.

It’s not enough to recognize what has happened in the past, but to recognize conditions/relationships occuring now, as well as position long-term portfolios to take advantage of these developments. Swing traders can also benefit by active trading of larger key themes with individual stocks or broader ETFs.

The following bulleted points are from the official description at Amazon.com:

The Investor’s Guide to Active Asset Allocation provides you with proven investing expertise on:

 

  • Basic Principles of Money Management
  • How the Business Cycle Drives the Prices of Bonds, Stocks, and Commodities
  • The Pring Six Business Cycle Stages
  • Technical Tools that Help to Identify Trend Reversals
  • Putting Things into a Long-Term Perspective
  • Recognizing Stages Using Easy-to-Follow Indicators as well as Models
  • How the Ten Market Sectors Fit into the Rotation Process
  • How Individual Sectors and Groups Performed in Each of the Six Stages
  • Asset Allocation for Specific Stages
  • I highly recommend any trader/investor to read Pring’s work to learn sector rotation or economic/business cycles at a deeper level that provides actionable strategies for profit. Martin Pring is recognized as one of the Masters of Technical Analysis, and is often referenced as “The Technician’s Technician.” I have heard Pring speak at two conferences and enjoyed the material and his depth of knowledge regarding the topics discussed.

    Pring wrote an earlier guide in 1996 entitled The All-Season Investor: Successful Strategies for Every Stage in the Business Cycle which details these concepts. I have not read this work yet, but wanted to highlight it as well as one of Pring’s reference guides.

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    Intermarket Relationships Chart Update

    Jul 1, 2007: 3:20 PM CST

    The major story over the last month has been the impact of rising bond yields and their effect on the overall market.  This updated chart from StockCharts.com provides a graphical representation of what has transpired over the month of June in terms of major market relationships:

    intmkt-rel-july-1.jpg

    Interpretation:

    The Yield on the 10 Year Treasury Bond (Note) has indeed taken a toll on the overall market and on interest rate sensitive areas.  The 3.18% rise during July resulted in a stock market (S&P 500) correction of 1.76% (and a few major distribution days) as well as the Financial (and Banking) sector being taken down 4.81% and 3.96% respectively.

    Housing and Real Estate Investment Trusts were hit hardest in June for a variety of reasons, suffering 9.62% and a major 11.56% respectively.  Utilities – a sector that is very sensitive to interest rate increases – was not hit as hard as it could have been.

    What this signals for the overall market is that continued upward pressure on bond yields, or some extraneous market dislocation could send already skiddish investors to cash out their positions and move to safer positions, which would undoubtedly put large negative pressure on US equities.

    Problem areas remain the sub-prime mortgage/lending areas, as well as global interest rates and economic conditions.

    Always view the larger picture when considering swing trading or position trading candidates.

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