In a recent video shared by SMB Capital, I discuss why creativity is necessary for trading success. Quite simply, in order to achieve unique returns, we have to be able to perceive and act upon unique opportunity. What we see in markets is a function of where we look. If we’re drilling for oil and look in the same places as everyone else, we’ll come up with a lot of dry holes. Half the battle is knowing where to look for the opportunities that others are missing.
An important topic in the Trading Psychology 2.0 book is how to develop our creativity by asking questions that others don’t ask and studying information that others don’t gather. Here’s a nice example of creative processing from my trading many years ago. My point in that article was that “creativity is the new discipline”. It’s not enough to find an edge and stick to it in a disciplined manner. Now the discipline has to extend to finding fresh edges.
Here’s an example of a creative edge emerging from unique data sets. For a number of years, I have tracked, each day, the number of stocks across all indexes that make fresh one-month new highs and fresh one-month new lows. Normally, we look at the data reported by the NYSE regarding 52-week new highs and lows. I have found value in the shorter-term measures. Over the past three years, all of the market’s gains (SPY) over a next 10-day basis can be attributed to low levels in the monthly new highs. In other words, it’s the relative absence of new highs that predicts positive returns over the next 20 days. Similarly, a relative absence of new monthly lows is significantly associated with positive returns over the next ten trading days. What is meaningful, interestingly, is the absence of new highs and new lows. I would have never anticipated this had I not collected and investigated the data set.
(A good exercise is to develop an explanation for why this edge exists and how you might use the underlying logic to create edges at other time frames or in other markets. That’s how the creative process works).
Here’s another unique finding over that same period. Essentially all the market’s (SPY) upside on a next 3-5 day basis has occurred when few stocks close above their upper Bollinger Bands. Similarly, we see superior returns over a next five-day basis when few stocks close below their lower Bollinger Bands.
In short, there is information in the absence of strength and weakness.
When you look at new and different data, you open the door to seeing new and different patterns in markets. And that means your drilling is more likely to strike oil.
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Image and article originally from traderfeed.blogspot.com. Read the original article here.