Market Weather Basics

In the past few years I have spent quite a bit of effort categorizing distinct market phases as they clearly can affect both discretionary as well as automated system trading. I often also refer to it as ‘market weather’ and my first treatise on the subject was two years ago in a pertinent post. It mostly focuses on the psychological aspects of how market gyrations affect trading behavior and distorts perceptions among market participants. In combination with a trader’s respective cognitive biases various market conditions will affect one’s daily activities. Whereas a swing trader may be perfectly happy and successful playing the swings in a volatile sideways market a trend or system trader may run into draw down periods, thus affecting discipline due to recency bias.

Of course there are various technical approaches of how to categorize market periods and among my favorites are Van Tharp’s SQN based approach or the StretchStat and VolStat indicators developed by Ken Long. Scott recently covered those in his posts, so if you want more meat on your sandwich then I suggest you point your browser here.

In today’s post however I want to go back to the basics as you don’t really need any fancy indicators in order to develop a pretty good ‘feel’ (if I may use that word) for categorizing various market periods on a chart. The human mind is actually pretty damn good at pattern matching – and with a bit of practice it’ll quickly become second nature. So let’s cover a few core markets of recent past, starting with the bonds.

This is actually a wonderful example as the difference in the two prevalent phases couldn’t be more salient. Starting in early January until the end of the month bonds pushed up significantly in what I would call a low to mid volatility trending phase. If you recall Scott’s treatise on the subject – that is a very common period and one I would categorize as easy to slightly challenging for the average trader. Of course your mileage will vary greatly – again for a trend trader this can be fun, for a swing trader this is more challenging as reversals/corrections are shallow.

The inverse speaks true to what followed – a high volatile sideways market which I consider the most difficult for most retail traders. The reasons for that are plenty and have been rather prolific on this subject and prefer to not repeat myself in this post. Suffice to say that anyone with a directional opinion or expecting resolution will be taken the woodshed all the way through Sunday.

Here is another example – the spoos on which I highlighted three distinct phases. The sell off in January was rather directional but with some volatility in the middle. What followed was a low volatility trending phase. Of course any indicators won’t tell you that until you’re halfway in but the human mind can easily pick up the fact that we have very few overlapping candles and most importantly 10 consecutive higher highs in a row.

Since about mid February things however got a bit more dicey and I would categorize the recent month as a volatile sideways period – once more the most difficult to trade for most participants. Psychologically also rather taxing and it has been taking its toll right here in the comment section (which has been rather quiet in the past two weeks). I always try to warn you guys when I see storm clouds on the horizon but often get the impression that very few are listening. Perhaps educational posts like these will serve to instill a bit more sensitivity as to when trading can be easy and when it can feel like helping Sisyphus push a rock up a steep hill.

Another example gold – I think one of the reasons why we have been rather successful in trading the shiny metal is that gold has the habit of switching between volatile sideways and trending phase with a mix of volatility, usually medium to heavy. You probably remember our gold entry in early February at which point I was expecting gold to continue trending higher. What I did not anticipate is that it would make a sudden u-turn but what’s interesting is that the market phase has barely changed – we are still trending and volatility is probably identical to what it was on the way up. So clearly we must differentiate between direction and market phase. For the seasoned trader direction may be insignificant but retail traders often get married to a particular direction, with the expected results.

And then there are charts which are almost impossible to categorize – I usually stay away from those unless I see then knocking on very pronounced inflection points (a subject for a different day). But when you look at a chart just like this – what do you see? What I see is acceleration followed by slower periods. In terms of volatility that creates a strange mix – the tape looks pretty directional but it’s rather volatile. But clearly this is NOT any easy chart to trade, would you agree?

Here is another example that may be even more pronounced – the fabled natgas contract Just look at how different these market phases are and I haven’t even bothered trying to categorize them. An accumulation of slow/sideways tape followed by quick spikes, long wicks, and sudden reversals. I also see a lot of gapping action and for a futures contract that is very rough to trade. Once again, stay away unless you really know what you are doing.

In summary – market phases are much neglected but integral part of trading and one you should come intimately familiar with. System developers often thrive to write systems that offer a lot of opportunity by being in the market all the time. That’s understandable but it is largely based on an unrealistic assumption that the same entry and campaign rules will work in all market conditions. Instead you will find that some systems promising only a very small or no edge may suddenly work extremely well if used only in the context of certain market conditions. To that end it is important that you sit down and document the characteristics and beliefs of your trading activities and then correlate them with the various market conditions you will encounter. Again, that in itself deserves its own post and I think Scott has definitely pointed the way.

My own work is strongly influenced by market categorization and without padding my own shoulder many here would agree that it has kept us out of various traps in the past. This morning’s spike higher for instance could not have been predicted but it had pretty good odds given what we saw on the Zero as well as in the context of the tape we experienced in recent weeks. Which is why I happily exited my TF trade yesterday according to the rules.

In essence what you always want to ask yourself is this: Does the current market phase impair or support my trading activities? In either case you can either change your current approach or just sit on the sidelines until you see better weather on the horizon. Unlike fund managers or professional traders you are only responsible for yourself and your personal assets, thus you are afforded the luxury of flexibility and the ability to be nimble. Once you are pushing a few hundreds of millions of Dollars around the dynamics of trading become quite different. It’s like the difference between driving a speedboat and an oil tanker. Say what you will – the speedboat is a lot more fun and if you’re lucky you’ll enjoy attractive company in sexy bathing suits.

Well it’s been a rough week and now it’s time to kick up our feet and crack open a cold one. I see you all next Monday morning.

It’s not too late – learn how to consistently bank coin without news, drama, and all the misinformation. If you are interested in becoming a subscriber then don’t waste time and sign up here. The Zero indicator service also offers access to all Gold posts, so you actually get double the bang for your buck.


Building Your Trading System – A practical guide

This is Scott, I’m filling in for Mole this week, and I’d like to help you start the process of building your trading systems. Over the next week or so I’ll be going through the exact process I use, most of which is adapted from the process Van Tharp and his students use which is outlined in great detail in his latest book, which I recommend. Today might seem a little wishy-washy. Don’t worry, very soon we will be down in the detail of how to come up with and generate entry techniques and optimize exits.

I see in the comment section of the previous post that people have posted some of their market beliefs. This might seem a bit silly and I know some of you just want me to break out the entry techniques, but trust me, for a system to work for you it needs to be a very close fit with your psyche. Trading other peoples systems is emotionally fatiguing unless they are a close match.

What we are going to do is clear the mental decks of all the emotional baggage that comes with initial failed attempts at trading, beartardness, guru-itis, etc so that we can see that what is underneath is crystal clear and untouched. Then we are going to think about some trading goals. Then we are going to build a system to meet those goals. Then we are going to practice trading that system until we can do it mistake free. Then we are going to place a proper business plan around this trading system and put structure in place around monitoring ongoing performance. Then finally we are going to trade for small size, increasing position size as we prove we are capable of trading the system perfectly.

What we are trying to accomplish at this stage: We want to examine our beliefs in detail and decide if they are helpful or unhelpful to our goal of becoming a professional trader. We want to commit to our goals, and commit to the process of shedding unwanted emotional baggage. We want to spend significant (as opposed to insignificant) time developing realistic system goals. 


What I’d like you to do is grab a pen and paper (or computer) some quiet contemplative time and ask yourselves the following questions about each belief in order. If you haven’t done the belief list, get cracking.

Question 1) Where did this belief come from?

Question 2) What does this belief get me in to?

Question 3) What does this belief get me out of?

So, for example if one of my own beliefs is that “I prefer simple charts to cluttered charts” the answers are 1) This belief was influenced by my mentor Ivan, who has such skill in tape reading that the visual aids of indicators and averages are unnecessary 2) It has given me a superior tape reading skill, I can read the story that the market is telling me at a very high level 3) It has made me exaggerate the importance of tape reading and chart analysis, which truthfully is not that important to being a world class trader. It has kept me from the use of indicators, which I instinctively distrust, especially price derived indicators. In system building visual aids like indicators and averages can be much more important than for chart reading.

So you can see that this core belief has a helpful and an unhelpful aspect. Most of your beliefs will have a helpful and an unhelpful aspect. If you have beliefs which are unhelpful you need to stop before you start building your system and decide to keep them, reframe them or let them go. Examples of unhelpful beliefs

I believe that when XYZ indicator is overbought the market will retrace; I believe that XXX YYY theory predicts prices in the future; I believe the market is manipulated; I believe the little guy can’t make a living in this market; I believe the banksters are ruining this country with QE.

I’ll save a special mention for those who are enamored with methods that claim prediction. These would be things like wave theory, T theory, Gann theory, astrological methods, all of which are magnetically attractive to beginning traders, because like most of the trading related scams they promise to save you from emotional pain by predicting the future.  It is unhelpful and a waste of time to examine these methods and try and convince you they are incorrect (there is a germ of truth in all of them surrounded by a ball of shit). From a system design perspective you are not looking for a prediction but simply a low risk idea. Suppose my belief is that “Wave theory tells me where the market is going next” I might answer 1) This belief came from a period when I was beginning and trading badly losing money, and wave theory promised to stem the flow out of my account 2) It gets me into looking for long opportunities in impulsive movements 3) It makes me hesitant to take trades that are against the wave count which I believe. It means that I go long periods being out of sync with the markets which is very frustrating. Also wave theory is highly subjective and it makes my methods dependent on how well I am trading at this present moment and difficult to mechanize or automate. This is the perfect example of a belief  we can reframe or eliminate. You might reframe the belief into “I believe wave theory can identify low risk opportunities at potential inflection points without predicting prices” (It can). Or you might decide to discard the belief, if you are emotionally unsuitable for discretionary trading wave theory is a weight around your neck that will drown you.

I’ll single out one belief that is the perfect example of an unhelpful belief which needs to be reframed before proper system development can take place. iBergamot was talking in the comment section about his theory that the components of the Dow and other indexes are manipulated inherently by survivorship bias to make in effect a ponzi scheme driving the market up. The truth or otherwise of this belief is TOTALLY IRRELEVANT. The important thing is “Is this belief helpful for trading”? This is the perfect example of a belief which exists just to make you feel smart, better, more in control of what is happening – when for trading well you want to feel humble and comfortable having no control and imperfect information. If you feel strong resistance to letting go of beliefs then that is a key indicator that there is a problem. Unhealthy beliefs, when you ask them to justify themselves, feel internally as though you are a 5 year old refusing to eat his broccoli “NO NO NO I WONT EAT IT! I WILL KEEP SUBSCRIBING TO THAT NEWSLETTER”. Helpful beliefs about the markets do not have the character where you feel like you have to defend them or prove them right.

Let me give you a personal example.

Belief  ”I believe the Krastins patterns are a tradeable edge”. 1) This came from Ivan, who mentored me for a long time. 2) It gives me an effective toolbox with which to build systems 3) It gets me out of looking for entries which are different to these patterns, ie limit entries (since all Ivan’s entries are on a stop or stoplimit). I decided to reframe the belief into “I believe the Krastins patterns work very well in some market phases” which is a more helpful belief for me. Also, seeing how my core beliefs also kept me out of certain strategies is helpful. Ivan’s setups always wait until the market is moving in your favor, but in rangebound markets this leads you to buying the highs of a trading range and selling the lows.

Some of you may have adopted Mole’s market lens or his systems because you assume his is better than what you could come up with. Deep examination of where this came from will reveal that some of you don’t believe at a core level that you can build a high quality trading system. That needs to get cut out of you like a tumor before you proceed. It is highly unlikely you can build a system or trade someone else’s without close examination of this stuff.

So how do we go about fixing these unhelpful beliefs?

For a start it is unhelpful to call a belief wrong, and better to call it unhelpful, since all beliefs have origins in logic for our subconscious. For example if I am operating my trading account out of fear it makes perfect sense to have a guru to tell me what to buy and what to sell and where. Logical, but a deeper examination will reveal that if the belief is borne of fear and not acceptance (it could be either) it is being driven by our subconscious ego, which is never the right emotional place to trade from, and never the right way to build our trading systems.

The bottom line is that reasons borne of fear or greed or other base level emotions are childish reasons for doing anything. “I don’t like Janet Yellen because the Fed is evil” is really a childish thing to say or think. “They are bad” is a roundabout way of saying “I’m good” which reflects deep seated low self esteem and emotional insecurity. Virtually all traders who identify as “bears” have this crippled self esteem and in many cases sabotage their accounts as though their lives depended on it, because deep down their sense of worth is only “born to lose”.

There are various ways to modify or eliminate a belief depending on how deep or embedded it is. Sometimes all that is necessary is to articulate it on a written down piece of paper, and explicitly deciding to change that belief. An “out loud” or “written” commitment to change this may or may not help. This will probably be more effective if you take a few minutes to calm yourself, and notice the physical sensations going through your body. This is how I do it, which is a Vipassana Meditation which is highly effective, and I believe more effective for insight meditation than breath watching methods.

Get comfortable. You can recline on a couch, sit in a favorite chair, or if you are particularly excitable lie down with a pillow. The only requirement is don’t get sleepy.

1) Say, out loud (its easier to do out loud than mentally) which of the senses you are using right now. If the first thing that comes to mind is “seeing something out the window” that would be “seeing”. If you are hearing a car go past “hearing” “Feeling” is for sensations of the body like itching, rubbing, pressure, etc. If you have physical sensations with emotional content (like anxiety chest pains) just label them “feeling” and move one. If you are thinking just say the word “thinking” and don’t try and change it. Note every 1-3 seconds (3 seconds is a good place to start) and if you experience a strong desire to stop or a strong feeling that this is stupid then note “aversion” and stick with it.

2) After you are fluent with this process (may be 1-2 minutes may be longer) just add another layer of granularity. So instead of “feeling” you might say “itching”. Instead of “thinking” you might say “looping thought” or “scenario spinning thought” or “remembering thought” or “imaging thought”

By intensely focusing on the bare sensations that make up our experience, instead of the movie-loops and endless chatter of the mind, we begin to see things as they are and not as we would like them to be. I find this extremely useful for trading. You spend many hours in front of the screen, and spending those hours training the mind is a great use of that time instead of reloading evilspeculator! You might be about to place an order for a trade and feel anxious and worried if it is the right time to buy. Instead of letting your mind try and come up with reasons why it is right or wrong, just come back to the bare sensations making up your experience. You might note “tightness”, “chest pain”, “fear”, “aversion”, “anxiety” but the longer you keep doing this the more those unpleasant sensations will naturally pass without you mindfucking them away. You might see that the confusion you felt about the trade was just a manifestation of the fear your animal body is feeling about uncertainty or fear of loss. You wouldn’t bedgrudge your dog being scared of a thunderstorm, and it is perfectly natural for your equally animal body to be scared. Also, the endless chatter of the mind is just one more sense door for the non-existent I to experience. What I mean is that things you think are no more or less important than the things you see, hear or smell or taste. I like to conceptualize a thought as passing a billboard on a highway, interesting for a moment but gone in the blink of an eye.

What you think is NOT WHO YOU ARE! You are NOT your thoughts! Repeat as often as necessary until you get this fundamental truth about the nature of your existence

3) When, after a few minutes you can objectify your thoughts you will see that while you are labeling your thoughts it is very difficult to become “stuck” in them. If I have a looping thought that “this is stupid I need to do web research and find a better indicator”, then after labeling this “looping thought” several times you will see it becomes a little silly to continue identifying with it. It feels like someone else’s thought, which it is. At this point you can calmly conceptualize the belief you wish to examine. Go through the 3 steps of the belief examination paradigm clearly, without the useless chatter of the mind, and with the diamond clarity of your own market insight, which is perfect and always was. If you make a clear, adult decision to modify or eliminate beliefs in this state there is a much better chance of it sticking.

If you are interested in meditation I can highly recommend the excellent online resources at:

If you are looking for a teacher Kenneth Folk teaches live on and he is superbly knowledgeable and totally legit.

Also these two books are extremely useful.

I don’t want to meditate – I want to trade. I’m not a hippie goddammit let’s break out the trading stuff!

There are many ways to get a grip on who you are and why you think the way you do, and change the things you want to change. Trading is a mental game and working on your emotional “stuff” and training your mind is exactly the same as an athlete goes to the gym to get stronger.

You could do some psychotherapy, and I have had great insights doing “inner child” therapy in particular. Ed Seykota is an advocate of holotropic breathwork, which he does with traders through his “trading tribe” program. Breathwork is a weird lsd like trance which I have found to be useful in working through emotional trading issues. Van Tharp recommends a bunch of self-help style stuff like the sedona method, a course in miracles, etc. I’ve tried the Sedona method for letting go of unwanted ideas and it seems ok.


Let’s answer a few questions before we think about the goals of the system. Do you want to trade stocks/etfs/FX/Futures? Do you want to sit at the screen all day, a few times a day at “rollover times” like Ivan does, at the start of the trading day, or at the end? How many trades do you expect to take each day/week/month?

In the context of those answers we need to spend some time generating system goals. The systems goals are NOT something to gloss over, they are something to spend a lot of time on, most likely several days. The system goals for Heisenberg were:

System to make 4R per week with no more than 3 losing trades in a row, taking on average 10 trades a week at .4R expectancy, with a 6R max drawdown at SQN greater than 3.2.

Your system goals might look something like “I want to make 30% per year compounding without more than a 6% drawdown trading only large cap ETF’s”

The Crazy Ivan (unfiltered) goals were: Make 40R per year at .2 expectancy with a max 15R drawdown.

I had the opportunity to review an excellent system with the following goals, which are articulated clearly.

There is something very strange about this process. I’ve personally experienced that the end result looks a LOT like the system goals, nearly every time. I’m fucked if I know why, since when I start designing a system I have no idea what sort of entry or exit techniques I will use.

So let’s all come up with realistic system goals. What are realistic system goals? For short term traders .2 expectancy is a viable system, and only the very best systems average above .5 expectancy in the long term. Automated systems rarely get above .25 expectancy (though I think Heisenberg will blow that away) I’d like you all to actually imagine the worst case drawdown and imagine how it would feel. Imagine taking it right at the start of trading a new system compared to taking it on the market’s money at the end of a great year. The last thing you want to do is tell yourself that a 30% drawdown is going to be acceptable when a 10% drawdown has you changing your pants.

This process is non-trivial, and it is unlikely anyone could finish it before the next post tomorrow (it takes me about a week). Flag this for later examination, tomorrow we move onto finding an edge and building an entry technique to exploit it.

Scott Phillips

Friday Morning Briefing

Welcome to our morning briefing. Here we are reviewing short term setups ahead of the NYSE opening bell. If you are a scalper or swing trader then these setups may be of interest to you. As usual keep in mind that these are short term setups although they could be used as early entries for more longer term positions.

Pretty thin out there on the short term setup front. I think the best play are the spoos right now – we’ve got a date with the 25-hour scheduled sometime near the open. That should happen around 1840 and if you add a tick then you’ll match a brand spanking new Net-Line Buy Level currently on the daily. So this is pretty easy peasy – long above 1840.25 – if triggered I will put my stop below 1834 (i.e. the 100-hour SMA). Yes, quite a stop which should result in a very small position size.

So let’s do the math – if our trigger is at 1840.25 and my stop is at let’s say 1833.75 – that comes out to 6.5 handles or 26 ticks. We type that in our handy futures risk calculator and we swiftly arrive at 3 contracts given a principal of $100,000.-. If you use a smaller stop then you simply measure the distance from your entry to your stop and use that instead of the example above.

FWIW – if you’re bearish you can also be short here with a stop above the NLBL. In this case you probably get away with a much smaller stop – somewhere around 4 – 6 ticks ought to do it. Obviously this affords you a much larger position size – 13 handles for a $100k account.

That’s all for this morning – see you guys later this afternoon.

It’s not too late – learn how to consistently bank coin without news, drama, and all the misinformation. If you are interested in becoming a subscriber then don’t waste time and sign up here. The Zero indicator service also offers access to all Gold posts, so you actually get double the bang for your buck.


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