I recently wrote an article for the Trading Markets web site that described why so many short-term traders were struggling in the S&P 500 E-mini market. Going back 40 years, I investigated the proportion of twoday periods during a moving 250-day window that were either both up in price or both down in price. In other words, I was looking at the number of times a one-day move in the market carried over to a second day. This was a very simple measure of trending behavior.
If we assume that the market has a 50 percent probability of rising and a 50 percent probability of declining, then we should see approximately 125 occasions out of 250 in which the market is either up or down for two consecutive days. In the late 1960s and early 1970s, however, the number of trending occasions out of 250 was consistently above 140. This proportion steadily declined into 2006, where it has been hovering in the low 100s as I write. In other words, we have gone from market conditions in which markets were more likely to follow rises with rises and declines with declines to a situation in which rises are more likely to be followed by declines, and vice versa.
Moreover, I found evidence that this was occurring over multiple time frames. The Barchart.com web site has an interesting feature for subscribers that tracks the performance of each stock vis-à-vis a number of technical trading systems. These are trend following in nature, assuming, for example, purchase at moves above a moving average and sales below the average. Some of the systems are short term, covering trades and patterns lasting a few days on average, and some are longer term: up to 60 days. Looking back over a three-year performance period, Google (GOOG), a stock that had been strong during that period, was profitable on each of the systems. The S&P 500 exchange-traded fund SPY, however, was a loser on every system. In other words, Google was trending across multiple time frames and the broad market was not.
With the rise of automated trading and the increased program trading and arbitrage that it facilitates, trending movements in the broad market have become less common. Because this is occurring in very short time frames (intraday) as well as longer-term, it affects scalpers as well as active investors. Momentum trading (buying short-term market strength; selling short-term market weakness) and longer-term trend following have simply not worked in the S&P 500 market—and the proof is in the many proprietary stock index traders who used to make a living scalping that market and found dwindling opportunity.
It is interesting that some traders gravitate toward being momentum traders, while others are patient trend followers, and still others trade in a countertrend style, fading market movements. I’ve also noticed that many traders have a persistent bias, either to the long or to the short side. No doubt personality plays a role in such preferences. While I strongly suspect that flexibility of trading styles has advantages over such biases, I’ve seen traders succeed with a variety of idiosyncratic preferences. When that success has been present, however, it is always because market opportunity has lined up with those biases. Trend followers make money in trending markets; momentum traders profit when short-term moves continue into the next time period. Once market opportunity shifts, as I found, those biases leave traders at risk.
At that point, either they need to move to new markets (that accommodate their biases) or they need to cultivate a new trading style. Neither is an easy adjustment, and yet they are the kinds of adjustments required by markets that regularly shift their trending patterns. While it is important to match one’s cognitive and emotional styles to one’s style of trading, none of that will be helpful if there is not objective opportunity in the marketplace. Simple analyses like the ones I performed, such as looking across time frames and determining how often rises are followed by rises and declines by declines, will tell you quite a bit about a market’s personality—and whether it matches your trading style.
Another facet of the market’s personality is volatility. Some markets offer more movement than others, and this translates into greater potential risk and reward. I recently completed an analysis for my TraderFeed blog that looked at five-day periods of weakness in the market. The market forecast for the following five days was significantly bullish for both the S&P 500 Index (SPY) and the Russell 2000 Index (IWM) of small-cap issues.
While the number of historical winning and losing trades was similar across the two indices, the Russell offered a 50 percent greater return on average. This was because of the greater volatility of the small stocks during the period covered by the study. One’s profitability, in this case—as in most cases I’ve studied—was thus just as much a function of the market they traded as the pattern being traded. Once again, we can see that matching trading style to markets becomes key to trading performance.
Markets, like people, have their personalities; our relationships with markets will profit to the extent that there is compatibility.
One of the trickiest aspects of trading is that volatility varies on an intraday basis, as well as longer-term. Just as bear markets tend to be more volatile than rising markets, we typically see greater volatility when markets open and close than during their midday hours. Currencies, for instance, will trade greater volume and display enhanced volatility around the London and New York opens than during the period in between or during the New York afternoon. A short-term trading style that makes money in the morning can struggle mightily at midday. The fit between trading style and market personality that was there at one time period is no longer present later on. Opportunity thus becomes a moving target for the active trader.
These are the three legs of the performance stool: (1) your talents and interests, (2) your trading style, and (3) markets and their personalities. The meshing of your qualities with your trading style will help determine your ability to trade that style with consistency and discipline. The meshing of your trading style and the features of markets will determine the degree to which you have a performance edge in the marketplace. The ever-shifting features of markets ensure that traders who are adaptable will be most likely to sustain expert performance over the course of a trading career.
Read More : Market Opportunity: The Other Half Of The Equation
