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  • Article A Surprisingly Interesting Index by D.R. Barton, Jr.
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A Surprisingly Interesting Index

“The herd instinct among forecasters makes sheep look like independent thinkers.”—Edgar R. Fiedler

I bet you had friends in high school or college that helped you think outside the box—folks that challenged you, either directly or indirectly, to look at things in a different way.

My friend Donna was just like that. She dated my one of my best friends through most of high school, so we weren’t romantically involved (though we did flirt a lot, but just to mess with my friend).

Donna had a great sense of humor, she was sharp, and she had a different way of looking at the world. As a naïve high school guy, she was the one who would always point out when I was giving someone the benefit of the doubt when they didn’t deserve it. She brought a healthy dose of skepticism to my optimistic world view, especially as it related to how people treat each other.

Donna became an industrial psychologist (her psychology bent showed up in high school and college where she was involved in peer counseling). After consoling countless young ladies who had had their hearts broken, Donna proclaimed to me that all men fit into one of two categories: big jerks or little jerks. (She used a word that was less kind than “jerk.”) She was quick to point out that I was a only a little jerk, which made me feel somewhat better.

Much in the way I appreciated Donna’s unique world view back in the day, I now appreciate trading tools that give me a different take on the market. For instance, I’ve been looking recently at a new (to me, at least) sentiment indicator, which can be very useful at market inflection points, and it seems to provides some useful and thought provoking data.

Surprise! A New-ish Indicator

A top trader that I know showed me this indicator that he’s been watching: the Citigroup US Economic Surprise Index. This is a real indicator, so stay with me and later in the article, I’ll show you how you can find it on a well-known, no-cost website.

In short, the Citigroup US Economic Surprise Index quantitatively shows how actual economic data have trended versus consensus economist expectations. The index measures the magnitude of difference between published expectation and announced data, weighting more recent announcements and market moving announcements more heavily.

If the data are better than consensus expectations, a positive value is registered; if the numbers are worse, the index goes negative. The chart below shows the past three years of data as reported by Bloomberg.com.

chart 1

As you can see, this is not the “normal” sentiment indicator. Most sentiment indicators, like the survey of the American Association of Individual Investors (AAII), are contrarian—when too many people are bullish, the market is due for a pull back.

While the Economic Surprise Index describes contrarian behavior, a high reading on the chart does not mean the market is heading down. Here is how this index works:

• High readings occur when the actual economic data are consistently exceeding expectations. This happens when the economists are pessimistic and keep projecting numbers that are too low. At these times, markets tend to head higher in the following 2 to 8 weeks.
• Low readings occur when the economists are too optimistic. At times when economists consistently project numbers that are too high, the economic data disappoints, giving low readings on the Surprise Index. At these stretch points, the markets are due for a correction.
• Middle of the road readings, like most sentiment indicators, provide us with little directional indication. However, for this particular index, the trend is usually important. When the Economic Surprise Index is trending up, it is showing increasing pessimism. When it trends down, increasing optimism. This knowledge can at least give us some flavor for what is happening in the macro-economic world.

So where does that put us today? Let’s look at the Citigroup Economic Surprise Index for the last six months.

chart 2

As you can see, we’ve reached peaks at the beginning of the last three months, showing pessimism among economists or much stronger than expected economic reports (or a combination of the two). Since the beginning of February, we’ve had a drop in the Index. And the number, though still fairly strong, is at the lowest level since last November. We’ll need more data to confirm the trend for this long-term indicator, but for now economists are becoming more optimistic as the year continues. We have a long way to go before this sentiment indicator tells us to look for a pullback; however, it is entering the zone where pullbacks seem more likely as the economists start to get more optimistic about the economy.

As always, I’d love to hear your thoughts and feedback – just send an email to drbarton “at” vantharp.com. Until next week…

Great Trading,
D. R.

P.S. I almost forgot the link so that you can get up-to-date data on the Citigroup Economic Surprise Index!

You can find it on bloomberg.com in a nifty little interactive chart:
http://www.bloomberg.com/quote/CESIUSD:IND/chart .

About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "vantharp.com".

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Trading Tip

How Competent Are You As a Trader?

How competent are you as a trader? Do you make money every year? Do you make money at all? Can you live off your trading? Maybe you make money, but not enough to cover all your trading expenses. Or perhaps you made a lot of money once, lost it all and then some, and now you are just trying to get it all back.

Based on your response to the previous paragraph, rate your competence as a trader on a scale of one to ten, where 1 is terrible (you lose regularly), 5 is neutral (you break even), and 10 is very good (you make a living trading). You would rate yourself a ten if your earnings are in the top 1% of all Americans. So how would you rate yourself?

<- Poor 1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 - 10 Very Good- >

Rate Yourself Now _____________

Now, rate your future competence on the same scale. This feeling refers to how successful you think you’ll be in the next year, or in the next five years.

Rate Yourself Now ______________

Guess what? You’ve just given yourself a predictor of your success. Competence at trading starts with feeling competent and being competent. If the average of your above scores is less than 6, you’ve got work to do.

This all gets into some key psychological issues about trading. Most people think that trading success comes from finding some magic secret and once you have that, you just apply it. And once you’ve applied it, you BECOME a successful trader.

But that’s not how it works. Success comes from inside. You must BE a successful trader. That means you must have the persona that successful traders have. What is their nature? What is their beingness?

When you step into the BEINGNESS of a trader, you will start to do what successful traders do, only then will you start to have what successful traders have: success and profits.

The Floor Trader Who Could

In the Peak Performance Course for Traders and Investors, I wrote about a floor trader who made millions in the market. However, one day, because of poor position sizing™ strategies, and perhaps a little too much cockiness, he lost all but the $30,000 he put away just in case something like this happened. So he still had a $30,000 cash reserve to sustain him as a trader. (And this was 15+ years ago when $30,000 went farther than it does today.)

Regardless, having only $30,000 really got to him. He felt like he couldn’t spend any money and that he had to be particularly careful in everything he did. In fact, he said he used to go into bars at happy hour, buy one drink and eat all the free food—and that was dinner.

During this time, he didn’t trade well. Within a few months, his $30,000 was down to about $10,000. He didn’t have the beingness of a successful trader! He was very concerned about losing. And he was living at a lifestyle that was way below the lifestyle he had when he was successful.

At this point, he made the realization that he was no longer that person who had made millions in the market. He said to himself, “What the heck, I only have $10,000 left, so I'M just going to go back to the type of person I used to be.” And he did just that—he resumed his old lifestyle, which meant that he probably had enough money to last him about two weeks.

At the same time he made the decision to resume his old lifestyle, everything else inside of him shifted. He could trade well again, and he was making a lot more money than he was spending. He was now BEING a good trader, and within a few years, he was a millionaire trader again.


So What Does This Mean for You?

Does this mean that you should just assume that you are a competent trader, spend money like you were going to make millions in the market this year, and just charge forward? No, not at all.

Here’s what it means: you need to study the psychology of competent traders. One way for you to do this would be to find good traders and try to get inside their heads. I’ve already done this; you can find this information in the Peak Performance Course. Study what good traders are like and then become one.

In addition to studying successful traders, you need to develop a business plan and some systems that work. Almost every good trader I know of works hard to create these things. Remember, the reason you are doing all of this is so you’ll have the confidence to trade well. When you have a great business plan and some great systems in place that you’ve proven will work through your testing and simulation, it is easy to assume the BEINGNESS of a good trader.

The Market Wizard Exercise

I’d like to talk about one of the exercises we’ve done in the Peak Performance 101 Workshop. I call it the Market Wizard exercise. (The term Market Wizard is derived from Jack Schwager's famous book in which he interviews the world’s top traders).

The first part of the exercise is to imagine yourself in a situation in which you are not doing well at all in trading. Now, get up and walk away. Look at what you look like when you are trading poorly. Notice your body. You’ll probably notice that you are slumped over, tense, and not breathing properly.

The second part of the exercise is to imagine a Market Wizard sitting in that same situation in which you were having so much trouble. What is that person doing? How are they handling things? The amazing thing about this exercise is that everyone can do it—even beginning traders who have never seen a great trader in action. Even novice traders know exactly how that Market Wizard is BEING. And typically he is relaxed, upright, and breathing well. Basically, he is behaving totally differently from the way you were.

The third part of the exercise is to go over to your chair and become that Market Wizard. This is a perfect illustration of how you must BE a great trader to DO what great traders do, and HAVE their results.

So what do you need to do? Understand the psychology of top traders and investors and then adopt it. Study, work hard, and develop a plan that you believe in. Develop confidence in your future success and, when you are ready, just BE a great trader. The results will follow.


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As you progress, the game changes the systems you trade so you can experience what it’s like to trade different probabilities and expectancies. Beginning with Level 5, you have the option of going long or short on a trade, which means that you can go with the probability or with the expectancy. Hopefully, you'll learn how dangerous it is to bet against the expectancy, even though you get to win (or be right) more often.

In Levels 6 through 10, you have to earn your big R-multiples by letting your profits run on a winning position. Losing trades happen quickly, but winning trades take time to develop fully. When a winning trade starts, it is probably just a 1R win but chances are that it will continue to be a winner as the trade progresses. Once a winning trade starts, you have to decide how much to risk—time period by time period. Do you want to risk a portion of your profits for a further gain or all of your profits for a shot at the moon? In the process, you learn not only about position sizing strategies but your emotional experiences along the way, which helps you exercise and develop your discipline.

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February 29, 2012 - Issue 566

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Tharp Concepts Explained...

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