Emotions as Numbers

• Posted by Derek
• on March 29th, 2011

While commenting on this post from Asymmetricity, I thought “who the heck am I to spew advice on his trade?”.  Then I thought, “this is something I’ve worked through 100 times, why not share a solution that has worked for me?”  He’s putting himself out there in public, I’m not a good friend if I hold back information that may resonate.  I had no one to consult but dead authors along my trading path, and certainly no blogosphere to interact with others sharing my passion…the ability to discuss and debate is a gamechanger for those of us embracing its benefits.

Continuing with the present/past/future theme, I thought I’d share a simple method I use(when I remember) to keep perspective on where we stand in the recent swing.  Since most are familiar with Brian Shannon’s work on Stage Analysis, I’ve included his Stages in hopes of making it easier to follow…notice the conflict(“versus”) in Stages 1 and 3 vs. the dual tailwinds(“using”) in Stages 2 and 4.  I’ve discussed ways in which I use “% of Stocks Above Their 10 Day MA” before; what follows is a depiction of how I view the prevailing emotions during those times:

There are things in this graphic I consider fact.  When the % of stocks sitting above their 10 Day MA is above 65-70%, the prevailing emotion is “fear of underexposure”.  When it’s below 30-35%, it becomes “fear of overexposure”.  Perhaps I need more context…I believe this applies to those of us 1) seeking absolute returns but 2) aware that our clients(be they subscribers or managed accounts) will grade us on absolute returns in a down market and relative returns in an up market.  I think the competitor in most of us grades ourselves by the same standard.

Long-only managers and daytraders who go to cash each night may not feel these emotions.  Those trading their own account may feel it on occasion but it should be muted since there’s no one on other other side to magnify the feelings.  But there’s enough money being managed actively that these feelings run far and wide, and to acknowledge them and to use them is the best way I know to improve my swing entries and exits.

Unlike the unlimited price potential in present and future frames as I defined them in this post, the swing frame is one of oscillations and boundaries that need recognition to capture the trends in the day and other frames.  This month alone has seen a swing from 24% above to 70% to 11% to 90%…no matter the timeframe, it pays to acknowledge and measure where we stand.

This is not meant to be a buy/sell/short/cover approach on the scale of Brian’s work.  It’s simply a tool that helps me keep perspective on how many stones have already been overturned, to convert the sense of under or overexposure that I may feel into an objective sense of what the rest of the street may be feeling.  By doing so, I can not only understand where the crowd is but confidently act on where the crowd is bound to move.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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