Saturday, March 28, 2009

Turning Trading Rules Into Commitments

from Dr. Brett:
Saturday's post on following trading plans emphasized that our actions are intimately related to our states of mind. When we undergo state shifts, our perspectives change, and those can alter our priorities. What seemed urgent in one frame of mind becomes lost in another. This most often occurs during trading when profit/loss (P/L) concerns take front and center stage, obscuring our best laid plans for our positions.

The links from the earlier post cover a variety of reasons why traders lose their discipline. There is, however, another reason why traders find it difficult to follow the plans they set: their plans aren't truly plans.

To understand this, consider the difference between plans and intentions. If I tell myself that I need to go to the gym and get into shape, that's an intention. It is not a plan. If I actually join a gym, sign up for classes, set up a schedule for exercise, and create weekly goals for how often I'll exercise and how much weight I'll lose, that is a plan.

Similarly, I might intend to take my wife on a trip that will help her get away from work stress. That is very different from actually planning the trip by discussing it, creating an itinerary, shopping for best airfares, etc.

Intentions are thoughts of future actions, often accompanied by "should". Plans require action--taking steps in the present to achieve the desired end--and they often have a social and motivational component. A business plan, for instance, is much more than intended success; it can be vital in attracting investors and key employees. Because intentions lack committed action, they are generally weaker than plans. We're likely to break a New Year's intention, but less likely to break those vacation plans once they've been formulated with a spouse.

Many traders formulate intentions for their trades and then wonder why they have veered from their "plan". When I ask to see their plan, however, there is nothing written down; nor is there anything specific that has been planned. To be sure, high frequency traders are not going to formulate detailed plans for each trade. In their case, trading rules about such matters as execution, sizing, and risk control would take the place of unique plans for each position. Often, however, I'll hear from "scalpers" that they've violated their discipline. When I ask which rules they've violated, they cannot give a ready answer.

My response is that you can't violate a discipline that isn't there to begin with. The problem is not that an excess of emotion interfered with their plans and rules. Rather, they were never sufficiently planful and rule-governed to begin with.

The single greatest way to build discipline is to turn rules and plans into commitments. That means that you have to give those rules and plans distinct life of their own. The more you think of them, look forward to them, talk them to others, write them down, grade yourself on them, reward yourself for them--the more real they become. You are most likely to abandon rules and plans that haven't been internalized as commitments.

Please check out the comment of reader Adam following the post on learning to think like the herd, but not follow the herd. You'll gain a valuable lesson in turning rules and plans into routines and commitments. Adam's observation regarding the value of checklists in high risk professions is excellent. He explains, "Trading is a matter of repeating over and over again behaviors that trap errors before they are released into the market".

Intentions aren't strong enough to trap errors. To catch the mistakes before they're released, you need the emotional force of commitments and the reliability of routines. Turning intentions into checklists and checklists into commitments is a great way to ground yourself in best trading practices.

Best of Dr. Brett for 2008

Here we have the best of the posts from the third quarter of 2008. Archives can be found for the first two quarters of 2008; 2007; and 2006 via the Trading Coach blog site.

The Limits of Self-Esteem

Emotional IQ and Trading -
Part One; Part Two; Part Three

2007 Performance Posts -
Volume 1, Volume 2, Volume 3, Volume 4

The Psychology of Profitability

The Idiot Wave

Consistent Returns With Small Edges

Adapting to Shifts in Market Regimes

The "Should Have" Syndrome

Distinguishing Trend and Range Days

False Breakouts and Reversals

Trading Success and Teamwork

Where to Place Stops

Position Sizing and Risk Management

Avoiding Overtrading

Trading Stress and Emotion

Mindful and Mindless Trading

Greatness in Life and Trading

Market Communications and Metacommunications

Implicit Learning and Detachment

Implicit Learning and Trading Performance

A Common Coaching Error

The Psychology of Mechanical Trading

Behavioral Finance and Trading

Personality Traits and Trading Success

Risk Taking and Personality

Market Gamblers and Entrepreneurs

Trading and Regret

Best of Dr. Brett for 2007

Here are the top posts from the second quarter of 2007; first quarter can be found here, and 2006 is here:

Trading Techniques

Visiting a World Class Trader

When Coaching Works and Doesn't Work

Trading and Poker

Changing Your Self-Talk

Information Processing Biases in Trading

What to Do If You're Losing Money

The Most Dangerous Word in Traders' Vocabulary

Performance Anxiety

Handling Performance Pressures, Part Two

Solution-Focused Linkfest

Finding a Trading Coach

Short-Term Market Transitions

When Coaching Doesn't Work - Part One, Part Two

Assessing Trader Personality

Heroic Dimensions of Trading

Becoming Your Own Coach

Trading Transitional Structures

Trading Discipline

Attribution and Cognitive Bias

Trade Like a Scientist - Part One, Part Two, Part Three

What Makes a Trader's Marriage Work

How Can I Learn Trading?

Assessing Your Strengths

Therapy for the Mentally Well

The First Steps of Brief Change

Becoming the Actor of Your Ideals

Programming Your Experience

Four Qualities of Successful Traders

My Trading Framework

Coaching Yourself to Let Profits Run

Personality and Trading Performance

Personality Questionnaire for Traders

Interpreting the Personality Questionnaire

Subjective Well-Being and Trading

Improving Well-Being

Transforming Stress Into Well-Being

Good Trade Execution

Keys to Trading Success

Tracking Large Traders in the Markets

Identifying and Trading Breakout Moves

Somatic Markers and Trading Decisions

Five Guiding Principles of Trading Psychology

Best Practices in Trading

Resilience and Courage of Your Convictions

Trading Opening Range Breakouts

Psychological Risk Management

The Epistemology of Trading Expertise

Why Traders Self Sabotage

Why Traders Don't Trade Their Plans

Steps Toward Joining a Prop Firm

Underconfidence and Overconfidence in Trading

Using Imagery to Accelerate Behavior Change

Ten Principles of Short-Term Trading

Winning Trades vs. Making Money

Trading and Learning Styles

Assessing the Learning Styles of Traders

One of My Best Market Posts

Trader as Entrepreneur

When Traders Lose Confidence - Part One, Part Two, Part Three

Five Steps Toward Self-Coaching

Very Important Post on Trading and Pain

Life Lessons From Mali

Trading and Emotional Well-Being

Our Moods and Our Trading; Here is a Mood Questionnaire

Our Emotional Style

Coping Strategies; Stress and Coping; Coping and Intuition; Assessing Your Coping Style

Improving Your Coping

Goal Setting for Traders

How Problem Patterns Develop

The Importance of Emotional Experience in Change

Making the Right Decisions Under Conditions of Fear

Using Emotion to Change Emotion

Making Cool Decisions With a Hot Head

Ayn Rand, Objectivism, and Trading

Trading and Worry

Trading With a Philosophy

Somatic Markers During Trading

The Psychology of Losing
Knowing Your Strengths

Emotional Balance in Trading

Identifying Your Edge

The Cognitive Development of Traders

Ten Short-Term Trading Guidelines

Regret and Trading

Keys to Emotional Resilience in Trading

How to Change Yourself

Self-Evaluation and Success

Preparing for the Day's Trade

Four Common Trading Problems

Trade Like a Card Counter

Finding Your Voice as a Trader

Considerations RE: Trading for a Living

Common Stresses Faced by Traders

Stress and Cognitive Regression

The Psychology of Scarcity and Abundance

Self-Confidence and Performance

Six Positive Trading Behaviors

Signs of Burnout

Cultivating Self-Awareness

Trading and Anxiety

Turning Setbacks Into Goals

Trading Myths and Questionable Assumptions

Achieving Emotional Self-Regulation

When Trading Performance Declines

Predictors of Coaching Success

Greatness, Happiness, and Performance

Physical Exercise, Self-Efficacy, and Well-Being

Living a Purposeful Life

The Brain and Trading Performance

Best of Dr. Brett for 2006

It's been a great year, and I want to wish all readers a very happy and prosperous 2007. Below are links to TraderFeed posts from the first half of 2006 that capture a few of my New Year's thoughts--and resolutions! Tomorrow I'll post links to favorite psychology posts from the second half of the year.

* How I use volume flow information in trading to capture the market's psychology;

* Why I find historical analyses of the markets to be useful;

* Reflections on life and the markets;

* Why having odds in your favor doesn't assure success;

* How the S&P 500 Index behaves on a very short time frame;

* Some defining features of market pros I've worked with;

* VIX as a measure of daytrading opportunity;

* A psychology checklist for traders;

* Lessons that traders have taught me;

* Why scalping the stock indices has become so difficult;

* The opening range and market opportunity;

* A solution-focused framework for working on one's trading;

* How the markets confound human nature.

* The most common trading problem of all.

* Why traders lose their discipline.

* Diagnosing trading problems.

* Playing it safe avoids reward as well as risk. Even for investors.

* Living the heroic life: Part one, two, three, four, five

* What a bodybuilder teaches us about life success.
* Smooth vs. choppy moves and what they mean: Part one, two;

* What it means when there are lots of bears out there;

* What every short-term trader should know; one of my best posts, IMO;

* Why attacking your trading problems can be a mistake;

* Markets and people are wired differently;

* NYSE TICK and stock market momentum;

* Identifying breakout trades;

* Mean reversion as a trading strategy;

* The need for dynamic thinking in trading;

* What a market's opening minutes tell us;

* A framework for looking at markets, short-term;

* Why it's easy to lose money when trading;

* Trading opening gaps, Part One, Two;

* Life lessons from trading;

* What contributes to trader success?

* Shifts in the NYSE TICK and their significance;

* A very simple psychological test;

* What a lack of discipline can teach us;

* The multiple personality of the stock market;

* Learning how to lose at trading;

* Becoming your own trading coach;

* How people make changes;

* Identifying market reversals;

* Lessons from sport psychology;

* An important psychological skill for traders: Part One, Two;

* Figuring out how much opportunity is in the market;

* Finding your niche as a trader: one of the important ideas from my recent book.

* Four facets of market psychology.

* Participation in a market move affects the likelihood of continuation vs. reversal.

* What happens in the brain affects how we trade.

* My advice for new traders.

* How personality traits affect trading discipline.

* More observations on life and markets.

* Market patterns are different from our own thinking patterns.

* Tracking how large traders are behaving in real time and why big traders matter.

* The safest times to trade are the most risky.

* Good example of the value of looking at historical trading patterns.

* The importance of trading the right things, not just the right ways--even for daytraders.

* Do gaps tend to fill?

* Why short-term trading has been so different from investing in recent times: the market is really two different markets.

* Becoming your own trading coach: Part one, two, three.

* More on the solution focus in trading.

* Unappreciated problem: addictive trading. Here's a self assessment.

* What you trade should match how you trade.

* Myths in trading psychology.

* Style cube: one way of thinking about *what* you trade.

* Some trading wisdom.

* What we see on charts is not necessarily what we get in the future: perceptual distortions.

* Success takes a lot more than taming emotions.

* A different way to measure market sentiment with relative data.

* Learning how to lose: a key to winning.

* We can learn a lot from the opening minutes of trade.

* Steps we can take to develop ourselves as traders.

* Devon's post: an important principle.

A Quick Note on Trading Psychology

from Dr. Brett:
I just finished an email to someone at a trading firm in which I tried to summarize the essence of trading psychology in a single post. Here's the gist of what I had to say:

Under conditions of perceived risk and uncertainty (after all, what we react to is what we perceive) we no longer process information in our accustomed ways. At a brain level, regional cerebral blood flow shifts from the frontal cortex (our executive center) to motor centers that facilitate those famous flight or fight responses. This denies us access to our usual good planning, judgment, and decision making. As a result, we can end up making decisions that we look back upon in amazement: "What was I thinking?!" The answer, of course, is that we *weren't* thinking at the time. We were reacting: managing our perceptions of threat rather than the objective trades in front of us. Effective brief therapy for traders enables them to reprocess perceptions of risk and uncertainty, so that the blood shifts--and the associated state shifts that generate anxiety, frustration, and impulsive behavior--cannot occur.

My book The Psychology of Trading was an effort to explain this process and provide basic tools and techniques for traders to use under conditions of heightened risk and uncertainty. In the new book I'm currently writing, I will provide actual "therapy manuals" to help traders become their own therapists.

Anticipating market movements from historical studies provides a valuable edge in trading, but any edge is worthless if our states of mind prevent us from acting upon the information effectively. My hope is that the articles on my personal site, as well as the book, provide traders with some help on that front.

10 Lessons From Working With Traders

by Brett N. Steenbarger, Ph.D.

When I sat down to write this article, I thought it would be challenging—but useful—to distill over 20 years of trading experience—and 25 years of specializing in brief therapy—into ten lessons that I have learned while working with traders (including myself!). In that time, I’ve written two books on trading and worked with dozens of professional traders at a proprietary trading firm. What has this taught me? Let’s break it down:

1. Trading affects psychology as much as psychology affects trading – This was really the motivating factor behind my writing the new book. Many traders experience stress and frustration because they are trading poorly and lack a true edge in the marketplace. Working on your emotions will be of limited help if you are putting your money at risk and don’t truly have an edge.

2. Emotional disruption is present even among the most successful traders – A trading method that produces 60% winners will experience four consecutive losses 2-3% of the time and as much time in flat performance as in an uptrending P/L curve. Strings of events (including losers) occur more often by chance than traders are prepared for.

3. Winning disrupts the trader’s emotions as much as losing – We are disrupted when we experience events outside our expectation. The method that is 60% accurate will experience four consecutive winners about 13% of the time. Traders are just as susceptible to overconfidence during profitable runs as underconfidence during strings of losers.

4. Size kills – The surest path toward emotional damage is to trade size that is too large for one’s portfolio. We experience P/L in relation to our portfolio value. When we trade too large, we create exaggerated swings of winning and losing, which in turn create exaggerated emotional swings.

5. Training is the path to expertise – Think of every performance field out there—sports, music, chess, acting—and you will find that practice builds skills. Trading, in some ways, is harder than other performance fields because there are no college teams or minor leagues for development. From day one, we’re up against the pros. Without training and practice, we will lack the skills to survive such competition.

6. Successful traders possess rich mental maps - All successful trading boils down to pattern recognition and the development of mental maps that help us translate our perceptions of patterns into concrete trading behaviors. Without such mental maps, traders become lost in complexity.

7. Markets change – Patterns of volatility and trending are always shifting, and they change across multiple time frames. Because of this, no single trading method will be successful across the board for a given market. The successful trader not only masters markets, but masters the changes in those markets.

8. Even the best traders have periods of drawdown – As markets change, the best traders go through a process of relearning. The ones who succeed are the ones who save their money during the good times so that they can financially survive the lean periods.

9. The market you’re in counts as much toward performance as your trading method – Some markets are more volatile and trendy than others; some have more distinct patterns than others. Finding the right fit between trader, trading method, and market is key.

10. Execution and trade management count – A surprising degree of long-term trading success comes from getting good prices on entry and exit. The single best predictor of trading failure is when the average P/L of losing trades exceeds the average P/L of winners.

Well, I’ve already hit ten and I have at least ten more I could jot down. Number 11 would be that successful performance mentors have content expertise in their particular domain. What I mean by that is that teachers of concert musicians themselves have experience as musicians; basketball coaches invariably have played the sport themselves. You learn trading by seeing your mentor trade and by having your mentor observe your trading. The right mentorship goes a long way toward shortening learning curves.

Figure it out: what proportion of baseball players, golfers, actresses, chess players, singers, or bicyclists can make a consistent living from their performance activities? Is trading really so much easier than those activities? The stark reality is that expertise in any performance field is the exception, not the rule, requiring dedicated practice and training. If you are emotionally prepared for the learning curve—and excited by the challenge—you are well ahead of the game. Start with finding the Three M’s: right methods, markets, and mentors. Those are the foundation of success, upon which you build skills and experience. Enjoy the journey!

5 Things You Should Know About Trading Psychology

from Dr. Brett:

The overlap between trading and psychology is complex. Psychological factors, such as performance anxiety, can interfere with clear-headed decision-making about markets. Similarly, poor trading practices--such as taking on too much risk with excessive size--can magnify the normal stresses of the marketplace. Sometimes it is difficult to separate chicken and egg. Many traders put their money at risk without a demonstrable edge. It is difficult to imagine such trading *not* generating frustration over time. Other traders ground themselves in solid methods, but these may not fit their talents, skills, or personalities. A very short-term, aggressive method of scalping markets, for instance, may work fine on paper, but prove completely unworkable--and stressful--for a highly analytical, risk-averse trader.

Sometimes, however, trading psychology problems have nothing to do with trading. They are the results of pre-existing problems that will not be solved by different trading methods. Nor will they go away with simple coaching advice to control emotions and build discipline. If you have considered getting help for trading psychology concerns, here are five things you should know before deciding upon the kind of help that is right for you:

1) Psychological problems are more prevalent in the population than most people realize - The prevalence of clinically significant depression in the population is about 5-6%. There is a similar prevalence among such anxiety disorders as phobias, obsessive-compulsive disorder, and generalized anxiety. There is a prevalence rate of over 5% for substance use disorders; 1% for bipolar disorder; 2-3% for eating disorders; and 1% for post-traumatic stress disorder. That suggests that well over one in ten people--including over one in ten traders--has a diagnosable emotional disorder at any point in time. If, say, 20% of traders are experiencing emotional disruptions of their trading, it is not unlikely that fully half of these are dealing with treatable psychological problems.

2) Psychological problems can benefit from therapy - A wide range of controlled outcome studies suggest that the average effect size across various therapies is close to 1.0. That means that people improve their functioning (lower their symptoms, report less interference with their work and relationships) by close to a full standard deviation. Some problems benefit more than others from therapy or require longer-term treatment. Many anxiety problems, for instance, can be successfully aided with brief therapies. Other problems, such as major depressive disorder and substance use problems, have higher rates of relapse and may require more extended assistance.

3) Psychological problems can benefit from medications - Medications, such as selective serotonin reuptake inhibitors (SSRIs) for depression and many forms of anxiety, can be quite helpful in situations where symptoms are so debilitating that it is difficult to fully engage in therapy and/or where symptoms are impairing functioning at home and work. There are some conditions, such as bipolar disorder and attention deficit hyperactivity disorder (ADHD), for which medications are typical treatments of choice. Some research for depression, for instance, suggests that intervention is most effective when combining medications and therapy.

4) Some psychological problems can benefit from very brief therapy - In general, if a problem is not severe (i.e., it is not impairing wide areas of a person's life) and if it is not chronic (present throughout a person's lifespan), it will probably be amenable to brief forms of therapy. This is particularly the case when problems are the result of situational life stresses. When problems are chronic--and especially when there is a family history of emotional disorders--it is much more likely that longer-term therapy and/or medication assistance will be needed.

5) Some psychological problems can result from purely medical/physiological causes - Fatigue from sleep apnea, high blood sugar, or a host of other medical conditions can be mistaken for depression. Endocrine disorders may manifest as signs of anxiety or depression. There are seasonal forms of depression and depression related to hormonal changes in pregnancy and menstrual periods that have a purely medical basis. Many addictive problems have roots in underlying attention-deficit/hyperactivity and resulting loss of impulse control. Such conditions are not likely to go away with therapy alone and require competent medical evaluation.

How do you know if your trading psychology problem is really just about trading or is a sign of larger problems? Here is a quick checklist:

A) Does your problem occur outside of trading? For instance, do you have temper and self-control problems at home or in other areas of life, such as gambling or excessive spending?

B) Has your problem predated your trading? Did you have similar emotional symptoms when you were young or before you began your trading career?

C) Does your problem spill over to other areas of your life? Does it affect your feelings about yourself, your overall motivation and happiness in life, and your effectiveness in your work and social lives?

D) Does your problem affect other people? Do you feel as though others with whom you work or live are impacted adversely by your problem? Have others asked you to get help?

E) Do you have a family history of emotional problems and/or substance use problems? Have others, particularly in your immediate family, had treated or untreated emotional problems?

If you answered "yes" to two or more of these items, I would recommend a professional consultation with a trained, licensed professional. I would also recommend consultation with a physician to rule out possible medical causes or contributors to your problem. Trading coaches and self-help books have their places, but neither are likely to provide the kind of help that research finds to be most effective in these circumstances.

The bottom line is this: Do you feel you are in control of your thoughts, feelings, and behaviors or do you feel that those too often control you? The good news is that the vast majority of people can get help in reasserting control. Your well-being will help determine the well-being of your trading account.

Note: For research about the prevalence of emotional disorders and the benefits and limits of therapy, I recommend the following book:

Dealing With Emotional Disruptions When Trading

from Dr. Brett:
Every week I get a handful of emails from blog readers wanting advice on dealing with emotional interference with their trading. Many of these readers feel that they have solid trading methods and plans, but simply cannot follow these with consistency.

In an earlier posting, I explained that there are many reasons for problems of trading discipline. Not all of these reasons are due to primary emotional problems. Many traders suffer emotional disruptions of trading because of how they are trading.

The two main trading reasons for emotional interference are:

1) Improper risk management - Many traders are trying to make a comfortable living from an inadequate capital base. They are undercapitalized relative to their income goals, and this forces them to trade too aggressively. The drawdowns, as a result, are severe and create unnecessary frustrations. As I mentioned recently to one reader's surprise, I have yet to meet a trader who can sustain a good living from an account base of $100,000 or less. Perhaps there are people who can make 50-100% on their money year after year after year, but this is not the norm even among the world's money management elite. Taking large risks in hope of such rewards creates emotional impacts that are difficult to overcome.

2) Trading methods that don't fit a trader's skills or personality - You would not believe how common this is: traders attempt to make money in ways that don't genuinely exploit their strengths. Many times, when traders don't follow their trading plans, it's because those plans don't truly fit who they are. Daytrading might not exploit the analytical skills of a trader; many traders don't have the speed of mental processing to succeed at scalping. Similarly, traders with intuitive skills might be frustrated by trying to trade mechanical rules. Traders not only need methods that possess a reliable edge; they need those methods to fit who they are. A risk-averse person won't follow an aggressive system of scaling into trades; a highly active, distractible individual won't stick with long-term investing.

When emotional disruptions of trading *are* primarily due to emotional factors and not one's trading approach (or lack thereof), there are short-term techniques to change patterns of behavior that are quite effective. A little while ago, I helped write a training guide for helping professionals that summarizes these techniques; my upcoming book for traders has two chapters that are self-help manuals to hands-on change methods. For many people, months and months and years and years of psychotherapy are not necessary to change their patterns of thinking, feeling, and behaving. There are short-term change approaches that have been extensively studied in controlled research and validated for their effectiveness.

Unfortunately, most coaches and mentors of traders have not been trained in these brief methods. They try to help traders by repeating simplistic strategies that can be found in the self-help section of any bookstore. Not surprisingly, these strategies don't dent emotional patterns that seem to have a will of their own.

For 19 years at a medical school in Upstate New York, I not only applied brief therapy methods to medical students, physicians, and other professionals; I also taught these methods to the helpers training to be psychologists and psychiatrists. So it's natural that I try to teach some of these psychological skills to professional traders.

Here are some free resources from my personal site that might help you better understand the common emotional disruptions of trading:

Behavioral Patterns That Sabotage Traders - Part One

Behavioral Patterns That Sabotage Traders - Part Two

Changing How We Cope

Expose Yourself

Finding Solutions: How Traders Can Become Their Own Therapists

Remapping the Mind: Cognitive Therapy for Traders

Turning Your Trading Around - Part One

Turning Your Trading Around - Part Two

Turning Your Trading Around - Part Three

After you read those, feel free to email me with any questions about application. (My email address is included in the "About Me" section to the right). I'll post questions and responses to this blog over the holiday weekend. As I so often say to traders I work with, my goal isn't to become your psychologist. My goal is to enable you to be your own shrink.

Consequences IF/When the U.S. Government Debt Bubble Pops

from Ryan Vanzo on Seeking Alpha:
Ever ask yourself the question “What happens if no one wants our debt anymore?” Some possibilities: currency crisis, war, treasury bond default, massive sell off by Russia, Japan and China of dollar reserves, bank runs, food shortages, civil unrest, snowballing bankruptcies, systemic financial meltdown; skyrocketing interest rates and inflation when foreign central banks stop buying those little pieces of paper that promise them 3% interest paid out of our children’s future earnings. This is exactly the type of environment that makes these things possible. Throw away your arrogance, America isn’t invincible, we are just as prone to these things as any other modern country.

New Home Sales Date Fell 41% in February 2009

from (and this seems to agree with John Mauldin's newsletter this weekend):

WSJ: Sales of new homes rose in February for the first time in seven months, the Commerce Department reported Wednesday, another sign that the housing market is thawing

Bloomberg: Purchases of new homes in the U.S. unexpectedly rose in February from a record low as plummeting prices and cheaper mortgage rates lured some buyers. Sales increased 4.7 percent to an annual pace of 337,000 . . .

Marketwatch: The U.S. housing sector continues to see signs of improvement. The latest government data showed new home sales climbed in February for the first time in seven months, sending shares of home-building companies soaring.


A parade of the mathematically innumerate business writers (and even worse headline writers!) continue to misread data. The latest evidence? New Home Sales.

After incorrectly reporting the Existing Home Sales, the mainstream media misread the Census department report of New Homes.

No, New Home Sales data did not improve. In fact, they were not only not positive, they were actually horrific. The year over year number was a terrible down 41%. Sales from this same period a year ago have nearly been halved.

Why did the media report this as positive? If you only read the headline number, you saw a positive datapoint: February was plus 4.7% over January.

To get the the facts, you need to read below the headline. In the present case, it wasn’t the seasonality factor that was confusing, it was the “90-percent confidence intervals” — or as it is more commonly known, the margin of error.

From the Census Bureau:

Sales of new one-family houses in February 2009 were at a seasonally adjusted annual rate of 337,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 4.7 percent (±18.3%)* above the revised January rate of 322,000, but is 41.1 percent (±7.9%) below the February 2008 estimate of 572,000.

The median sales price of new houses sold in February 2009 was $200,900; the average sales price was $251,000. The seasonally adjusted estimate of new houses for sale at the end of February was 330,000. This represents a supply of 12.2 months at the current sales rate.

Note that the month over month data at 4.7% — plus or minus 18.3% — is statistically insignificant. (i.e., meaningless). The reported data does not inform us if sales improved month-over-month or not. It is a range, from down -13.6% to plus 23%. Since “zero” is part of that range, we can draw no conclusion. As the Census Department itself notes, “the change is not statistically significant; that is, it is uncertain whether there was an increase or decrease.”

The data does however, tell us that the year-over-year sales fell 41.1% plus or minus 7.9% gives us a range of -49% to -33.2%. The entire range is negative, therefore we can conclude sales fell year-over-year.

These are facts. This is data. This is how you interpret it. Most of the MSM reports (WSJ, Marketwatch, Bloomberg) were simply wrong.

Not nuanced, not shaded, but 2+2=5 wrong.

Let me remind that many of these folks incorrectly misinformed you that Housing wasn’t getting worse in 2006, 2007 and 2008 — just as Home sales and prices went into an historic freefall. Now, these same folks are misinforming you that Housing has turned around and is improving. That is simply unsupported by the data.

(And don’t even ask about television — they simply read the wrong news. Here is a life lesson for you: Never believe news people who read teleprompters. They have no idea what they are doing, they are reading what someone else wrote. When it comes to data interpretation, they are quite literally clueless. Rely on news readers to your personal financial detriment).

The bottom line: Learn to interpret data correctly. Avoid using the people who cannot do so as primary news sources.

People's Republic of America

exerpt from Vernon Hill:
"...the latest controversy surrounding AIG—those $165 million in retention bonuses that seemed to have gotten everyone in Washington up in arms last week—actually reveals the absurdity of what happens when government tries to play an active role in managing a for-profit enterprise.

Let’s review what happened. Soon after its bailout, AIG decided, sensibly, to shutter the source of its problems, its Financial Products unit. In order to retain key people who suddenly knew they’d soon be out of a job, AIG offered retention bonuses to traders and others, as an incentive for them to wind down their positions as efficiently as possible. The CDS traders, who were the ones the caused all the company’s problems in the first place, were already long gone and not included in the deal.

So all that sputtering in Washington aside, the deal made perfect economic and commercial sense. Which is one reason, presumably, there was no uproar when the retention plans were first announced last November, and why key members of the government signed off on them.

But once word emerged last week that the bonuses have actually been paid, every politician in Washington suddenly got a convenient case of amnesia, and started hollering. Politicians from the President on down vowed to move heaven and earth to get the money back—money, recall, that was paid according to a contract freely entered into by both sides, and publicly disclosed.

But to the politicians, such legalities don’t matter. They want blood, from individuals who haven’t done a single thing wrong. Congress’s latest tactic is to retrospectively tax the bonuses at 90%.

And so the destruction of free markets accelerates.

This is outrageous. If the government can tax these legal payments at 90%, after the fact, it can arbitrarily tax any of your income, regardless of when you earned it, at whatever rate it chooses.

If it can take back these AIG bonuses, it can do anything it wants, whenever it wants. In the process, our free market system would collapse, and be replaced by a system where the government, in all its arbitrary majesty, would essentially be in control of everything.

And you think the economy is having problems now. . .

Mark to Market Suspended by FASB

from John Mauldin:
The US Financial Accounting Standards Board (FASB) changed the mark-to-market rules last week, which many thought was needed. First, they suspended the mark-to-market rules for assets in distressed markets. Second, they widened the definition of "temporary" impairments of troubled assets, which will "allow banks to write up the value of some troubled assets if these have been hit by falling markets without (yet) suffering any significant credit losses."

Here's the important part. The board decided to make the new changes effective immediately, prior to full board approval on April 2.

As my friend Charles Gave noted, this will allow banks to write up their paper, and it happens before Treasury Secretary Tim Geithner starts putting taxpayer money at risk. Expect to see a pop in valuations. It will be interesting to see if Citi and B of A post profits this quarter.

(I should note that the International Accounting Standards Board sent out a scathing press release. I guess from that we should assume that European banks will not be so fortunate as their US counterparts.)

I disagree with John Mauldin on this for these reasons:

  • One of the primary causes of this entire financial crisis was lack of transparency of these exotic derivative financial instruments. There was not market, no liquidity, and no transparent pricing mechanism for them. The imposition of mark-to-market accounting was to force these instruments to be valued on a more transparent and real-time basis, just like the various exchanges do with their products (stocks, futures, bonds, etc.). By eliminating this accounting standard, we are literally recreating the causes that created the crisis in the first place. We are making them less transparent, not more so. This is no solution. It is delaying the inevitable accounting. It is also injecting -- delaying -- more systemic risk back into the financial system. It is nothing but a delay tactic. It doesn't solve the problem.
  • It assumes that economic circumstances will improve in the medium to long term -- months, not years. What if is doesn't? The whole premise of the assumption could be wrong! If it is wrong, it will only make the final accounting that much worse when the piper must be paid.
  • It allows weak financial institutions to artificially inflate the worth of their stock and the value of damaged and distressed assets. It also deceived investors into believing that these banks are healthy, when in reality, they are insolvent.

Revisions to Government-Issued Data

from John Mauldin:
Typically with these government statistics, you get a preliminary number, which is a guess based on past trends, and then as time goes along that data is revised. In recessions like we are in now the revisions are almost always negative.

There is no conspiracy here. The people who work in the government offices have to create a model to make estimates. Each data series, whether new home sales, employment, or durable goods sales, etc., has its own unique sets of characteristics. The estimates are based on past historical performance. There is really no other way to do it.

So, past performance in a recession suggests higher estimates than what really happens. Then, the numbers in the following months are revised downward as actual numbers are obtained. But the estimates in the current months are still too high. That makes the comparisons generally favorable, at least for one month. And the media and the bulls leap all over the "data," and some silly economist goes on TV or in the press and says something like, "This is a sign that things are stabilizing." It drives me nuts.

Ignore month-to-month estimated data. The key thing to look for is the direction of the revisions. If they are down, as they have been for over a year, then that is a bad sign. Further, one month's estimates are just noise. Look at the year-over-year numbers. When the direction of the revisions is positive and the year-over-year numbers are starting to stabilize, then we will know things are starting to turn around.

Housing Sales Didn't Really Improve

from John Mauldin:

I opened the Wall Street Journal and read that new home sales were up in February. Bloomberg reported that sales were "unexpectedly" up by 4.7%. I was intrigued, so I went to the data. As it turns out, sales were down 41% year over year, but up slightly from January.

But if you look at the data series, there was nothing unexpected about it. For years on end, February sales are up over January. It seems we like to buy homes in the spring and summer and then sales fall off in the fall and winter. It is a very seasonal thing. If you use the seasonally adjusted numbers, you find sales were down 2.9% instead of up 4.7%. But the media reports the positive number. Interestingly, they report the seasonally adjusted numbers for initial claims, which have been a lot better than the actual numbers. Not that they are looking to just report positive news, you understand.

How to Change Yourself

from Dr. Brett:
People come to psychologists to make changes in their lives. Sometimes, those changes are to build upon strengths. Other times, the changes are to solve problems.

We have a “real” self—the person we think we are—and an “ideal” self: the person we would like to be.

The psychologist’s job is to bring us a bit closer to that ideal self, either by changing our real selves, redefining our ideals, or both.

But how do people change? How do we move closer to our ideals?

A most important psychological principle is that everything we do and everyone we interact with is a kind of mirror. We experience ourselves through our activities and contacts and, over time, those experiences are internalized and become part of our self –concepts.

A work task mirrors for us whether or not we’re capable, creative, and reliable. An interaction with a valued person mirrors for us whether or not we’re liked, loved, and valued.

People do not change in a vacuum. They change because they enter into situations that mirror new experiences of themselves. Being in a loving relationship after having been in bad relationships or being in a fulfilling job after having been mired in low-level work can be profound change experiences.

This is why counseling and therapy works: it provides a significant relationship as a medium for fresh, positive mirroring experiences. A depressed or abused person who feels worthless finds in therapy a validating experience that gradually becomes part of the self.

This is a key principle: We are the sum of our mirroring experiences. If we are in unfulfilling, frustrating situations in work and love, we will experience ourselves negatively. If we are in situations that bring out the best in us, we will develop positive views of ourselves.

The psychologist George Kelly realized the power of mirroring and developed an approach to change that he called “fixed-role therapy”. In a nutshell, he asked his clients to invent a person who represented their ideal self in some fashion. This fictional character was given a name and described (in writing) in great detail.

Once this ideal character was defined, the challenge was to play-act that character in a variety of life situations. In other words, Kelly had people role-play their ideals, making sure they stayed strictly in character.

What Kelly found was that, over time, people received positive feedback about these enactments that made them easier to sustain over time. Eventually, the ideal behaviors didn’t feel like an act at all. They became part of the person’s repertoire.

If you want to make a change, you won’t do it by talking yourself into it or through motivation. Rather, find a social context in which you can be the change you want to make. The resulting feedback will be the mirror by which you’ll experience yourself as your ideal and make that ideal a genuine part of you.

A big part of being happy and successful is finding the right set of life mirrors. And *that* is why finding your trading niche is so important.


The Devon Principle

Using Trading to Find the Heroic Inside Ourselves

From Dr. Brett:
A reader of The Psychology of Trading notes the book's theme of developing one's heroic potentials and asks: "How do I channel these heroic impulses to help me achieve my goal of becoming a consistently successful trader? I fear that the heroic impulses related to trading may be setting the bar a little too high for now."

All of us have moments in which we experience ourselves nobly and heroically, as people capable of accomplishing great things. We lose our petty fears and insecurities and, instead, focus on what is possible and how we can attain it. Tapping into that sense of the possible is what provides reservoirs of energy, fueling unusual productivity and achievement.

Readers of the trading performance book know that a developing trader's goal should *not* be to become "a consistently successful trader." Rather, the goal is to become a consistently good trader. If success is defined as making a living from one's trading, that will be a project that requires substantial initial capital and skill development. While such success may be a long-term vision that sparks your efforts, you will not internalize a sense of heroic stature unless you are doing heroic actions daily.

A heroic action is not simply making a boatload of money on a given trading day. Any fool with a decent sized account can strap on the leverage and make money on a lucky trade. Rather, heroism is defined by the effortful pursuit of valued goals. The trader who overcomes an impulse to overtrade and instead makes just a few good trades in a day has accomplished an important piece of heroism. The trader who develops his or her own unique idea and acts upon it decisively to make money is living out a heroic role.

Over time, living that heroic role--day in and day out--leads to internalizing a sense of heroism. You become the person who, not only wants success, but deep inside lives it, expects it, and deserves it. This is the lesson of what may be my best post ever: create experiences that mirror back to you the person you wish to become. Heroism is about bridging the real and the ideal: enacting what is best within you. Your challenge as a trader is to structure each trading day so that you can experience yourself as a winner, even when you happen to lose money.