Here’s why there is a bullish bias for the coming week…
We generally think of traders as either discretionary (trading patterns that
they read from visual inspection and prior experience) or mechanical (trading rules
and signals derived from historical study). Discretionary traders are
often leery of historical research, as it may bias them with an opinion that
could blind them to real-time market developments. Similarly, mechanical
traders generally avoid discretionary inputs, fearing that subjective bias could
erode their backtested edge.
This article is authored by a discretionary trader (Brett) and a system
developer/trader (Henry), who have been carrying on a continuing dialogue
regarding the possibility of integrating these seemingly opposite sources of
edge. Our idea is that discretionary traders, relying on their usual
setups, can benefit from knowing the historical price tendencies of
markets. Henry’s idea was to convey this information to traders in a very
simple way: by issuing green and red lights, indicating that there is a
statistically significant upward or downward bias to the market. Many
days, the lights are yellow, indicating no discernable edge (which, in itself,
is a useful piece of data).
Brett first became interested in this integration of trading styles while
working with discretionary traders at a Chicago proprietary trading firm.
During morning “chalk talks” to the new traders, Brett mentioned
statistical market forecasts from his website.
Eventually, many experienced traders voiced an interest in these studies.
They realized that, even if they did not trade the patterns mechanically,
knowing the market’s tendencies could help them get aboard good trades and avoid
bad ones.
We strongly suspect that sophisticated retail traders could similarly benefit
from the signals of well-tested trading systems. One of Brett’s favorite
services for traders, Jason Goepfert’s
Sentimentrader, investigates historical patterns of market behavior based
upon a number of sentiment measures, providing useful trading ideas.
(Disclosure: Neither Brett nor Henry has a proprietary interest in Sentimentrader; nor do we receive any compensation or consideration for
mentioning the site). Henry has taken this notion one step further by developing
entire trading systems that provide decision support for discretionary traders.
It’s an interesting idea with many potential applications. For
instance, one could use the mechanical signals to confirm usual trade setups,
increasing the confidence (and perhaps the bet size) one places in that
trade. In the reverse scenario, one might think twice about a long setup
in a red light market, making it easier to stop and reverse the trade if
conditions dictate. After Tuesday’s down market, Henry now has a green light for the S&P 500
that extends from Tuesday’s close through the second profitable
close or Wednesday afternoon, whichever comes first. Basically that means that
we have a bullish bias for the coming week. This signal has an
enviable track record: since 1997 it has been profitable 52 times and
unprofitable 25 times for an average win of 20 S&P points. Now Brett
will be on the lookout for setups on the long side to capitalize on the signal.
Let’s follow this in real time and see how it goes.
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of The
Psychology of Trading (Wiley, 2003). As
Director of Trader Development for Kingstree Trading, LLC in Chicago, he has
mentored numerous professional traders and coordinated a training program for
traders. An active trader of the stock indexes, Brett utilizes
statistically-based pattern recognition for intraday trading. Brett does not
offer commercial services to traders, but maintains an archive of articles and a
trading blog at www.brettsteenbarger.com.
Henry Carstens is a proprietary trader in
Portland, Oregon who uses a portfolio of statistically-based automated and
discretionary trading
systems in the markets. His thoughts about system design and automation can be
found at https://www.verticalsolutions.com.