How Traders Achieve Creative Flow, an Interview With Veteran Trader Michael Bigger

Information is abundant and technology is cheap. At the same time, the good ‘ol financial models are changing. Linear, analytical thinking is not enough, and traders who don’t figure out how to access their creativity will fall behind.

Listen in on this free teleseminar as I speak with veteran trader and author Michael Bigger about his latest book, How Traders Achieve Creative Flow. Here are a few of the things you’ll learn in this 30-minute call:

- Why creative flow is so imperative to staying competitive
- The one tool you need to implement to avoid being drowned in information
- How Seth Godin and other unlikely influences have inspired Michael’s winning trading decisions
- How to avoid the mistakes that mediocre traders make

It’s going to be a short, information-packed call. Register right here (you’ll receive dial-in info the day before):

Online Ticketing for [TELESEMINAR] How Traders Achieve Creative Flow powered by Eventbrite

More about Learning Spread Trades

Written by Norm Winer. Follow me on Twitter and StockTwits.

Norm trades spreads for Bigger Capital. Norm comments on Chris Cachat's post about spread trades follow:

We enjoyed your post on spread trading.  It’s nice to hear we inspired you to learn more about spreads, and it’s always helpful to hear how other traders approach things.

Reading your post, I see you are grappling with some of the same issues we did, and still are, and we thought we’d share some of our thoughts and experiences with you (and by we, I mean @biggercapital, @biggercapitalnw, and @fledlingtrader, who collaborates with us on trades).

It looks like you are basing your calculations on a 30 day time period.  We have found that, while that approach works well with some spreads such as GLD-GDX, it often pays to look at longer time periods as well.  We are now experimenting with looking at Cointegration and Z scores (standard deviations from the mean) based on five years, two years, one year and sometimes six months of data.  We have found that something that looks cheap over a 90 day period, or even a two year period, can look a little bit pricey over a five year period.  Just look at where NFX-BRY was trading a week ago and where it’s trading today.

Regarding when to unwind or when to cut, we only recently started giving serious thought to this.  Because we prefer to unwind quickly also, we have probably been cutting winners too early.  We are now paying closer attention to whether a spread still looks cheap or expensive before we unwind, even if we have already made a good return.

Lastly, definitely look more closely at half-life, especially if you’d rather not hold positions for long periods.  Good luck and let us know if you discover anything interesting!

P.S. Micheal's book How Traders Achieve Creative Flow is now available on Amazon.com. If you want to use your creativity to innovate your trading edge, this book is for you.

Learning Spread Trades

This is a guest post about spread trades written by Chris Cachat. Follow me on Twitter and StockTwits.

First off, I barely know what I'm doing here. I had never really thought about spread trades until I began following Michael Bigger (@biggercapital). The guy really seems to have a passion for spreads, and it's kind of contagious. Credit is also due to Aris David (@fledglingtrader) and @biggercapitalnw for posting some spread trades for me to study. Dynamic Hedge is really good with these too, so I thank him for some education too.

The spread I'm looking at is UNH - WLP. Below is a graph of the spread. I'll explain further.

Click image to enlarge.

The top graph is the price of UNH 42.59 / WLP 67.21 = 0.63.
Red line = 30 day linear regression line
Blue dotted line = 2 standard deviations away from the red line
Fuchsia line = 3 standard deviations away from the red line

The bottom graph is simply the price of a dollar neutral (almost) spread: 12*UNH - 7*WLP [Long 12 shares UNH, short 7 shares WLP]. I need this bottom chart so I can analyze the actual prices of my desired spread.

Reasons for Identifying this Spread

1. Both stocks are in the same industry
2. They are highly correlated 96.45% over the last year. Correlation = A statistical measure of how two securities move in relation to each other.
3. They are highly co-integrated 99.50%. Cointegration = the statistical confidence that a pair will revert to the mean. I think cointegration is the most important. High correlation means that over a given period of time, two stocks will move up or down in synchrony. But high cointegration means the two prices cannot wander too far off in opposite directions for very long before they eventually come back to a mean distance. Unfortunately, my Amibroker cannot calculate cointegration, so I rely of this nifty website Catalyst Corner. I run a trade report (see bottom of post) that confirms some of the things I'm reading on the charts.
4. It is over two standard deviations away from it's 30 day linear regression line. You can see at the beginning of 2011 the spread touched the bottom 3 STD line, then snapped back. It hit the upper range then came down to where it is today. I'm expecting similar action.
5. WLP is short term overbought in my book, RSI(2)>99.

Using Interactive Brokers, you can create the 12*UNH - 7*WLP spread and enter a limit order; they handle the price execution on each stock. That spread closed at 40.63 today, so I might place a limit order below that. I would be buying a price that is statistically very far from it's mean, and likely to revert back.

Exit Strategy

I'm still trying to figure this part out, but I think I'll look to exit when the spread price gets back to it's 30 day regression line, which it $53. I don't know though; I may just use discretion. I'm treating this as a short term trade, so I'd like to get out in a few days.

UNH and WLP are slow movers and I don't really expect fast action, so I think they're good to learn on. When I get more comfort with spreads, I'll look to more volatile stocks. They're not even going to make me big $$, but that's OK. If I got in at $40 and exited at $53, buying/selling $10K of each stock, it would be about $260 profit.

Difficulties I've Encountered

Finding trades on a daily basis! I wish I could just write a code in Amibroker that would scan stocks and give me the spread ideas. I can't though. I think I need to just pick a few spreads that are highly coointegrated and watch them all the time. I'd look for similar scenarios I see with UNH - WLP.

Backtesting - I haven't figured out how to code this in Amibroker. Being a quant (albeit Simple), I feel more comfortable making trades that have some backtested results. I need to work I my coding skills, but in the meantime, I'll really on my human brain and real time trades to figure this out.

Why I'm Trying These

To do something new and expand my trading repertoire. If I can sprinkle a spread strategy with my other strategies, it can benefit my bottom line.

Most importantly, I view a spread trade differently that just a regular 'go Long' or 'go Short trade'. Sure, I want UNH to go up and WLP to go down; that would be ideal. But the way I really look at it: I want UNH to go up faster than WLP or I want WLP to go down faster than UNH. I'm not trying to be green on each stock, just green on the spread. So I'll probably have one winner and one loser, but overall net positive. Also, there's less anxiety about market direction.

So there it is. This spread stuff is a work in progress. I'm just glad I found some cool people in twitterland that introduced me to the idea. I know I'm not considering many factors like half life or Pearson correlation, but in due time. Let me know if I am on the right track.

Cheers!

This is the Catalyst Corner report, click to enlarge

Click image to enlarge.

Freedom to Trade

This is a guest post about flow written by Eric Gong. Follow me on Twitter and StockTwits.

If you’ve never jumped off a cliff, I highly recommend that you try it.

Don't take me seriously, of course. What I mean is cliff diving into the ocean—giving yourself completely to gravity. I want to share this experience with you as it relates to success in trading. I got married in Hawaii in September 2009, which was six months after I began my trading career. So both literally and figuratively, I was jumping off many cliffs, giving myself to whatever was to come.

The experience of jumping off a cliff and into the ocean gave me a sense of freedom that I had never felt in my life before. Only when your pinky toe leaves the rock do you truly realize what you have gotten yourself into. Gravity will take your little body and slam it against the water. The air will slap you across the face every single millisecond of the way down, and there's nothing you can do about it.

That's the beauty of the experience.

As traders, we are always planning and controlling how to manage entries and exits to maximize profits. When positions go against us, we get mad and blame the markets. We blame high frequency programs, the specialists, the government, or the trader next to us who has this annoying habit of tapping the desk when we're in a losing trade. So much about the markets is uncontrollable, and we spend so much time trying to rationalize and control it. What if we gave in to the markets? What if we leapt off the proverbial cliff and let the market take us over? What if we spent more time in that moment when our pinky toe leaves the rock?

I experienced that exact feeling once again trading the stock market last week, and it changed my trading forever. I sat at my trading desk with flow that I have not felt in years—a feeling I have only encountered once while jumping off those cliffs in Hawaii. The thing that changed for me was that I finally accepted the market for what it is: a continuous series of uncontrollable interactions between buyers and sellers. During that trading day, as my proverbial pinky toe left that rock, I felt freedom—freedom that only acceptance can bring. As I bought stock, I gave in to the fact that it could go anywhere and that the only thing I could control was my risk. As my profit and loss monitor fluctuated back and forth from red to green, I accepted it as the nature of trading. As I was maxing out my buying power, I accepted the fact that although these trades were the perfect execution of my plan, anything could happen at any given time. I realized that this was the gravity of trading, and I would not spend my days trying to manipulate it; instead, I would accept it.

If my positions went in my direction, I stayed patient until the charts let me know when to release. If my positions were stale, I'd reduce or remove my risk. At the end of that trading day, I felt as if my body hit the water. The experience giving in to the market was the best experience I ever had trading. As I stared at the results from my day trading and swing trading accounts, it became the high watermark of my entire trading career.

Freedom is why I got into the business of trading, and the flow that I am feeling lately is like diving off a cliff in Maui.

My Friend Made $4,000,000 Trading this Pattern

On Thursday, I spent most of the day with a friend/business colleague discussing trading opportunities. I showed him the following chart which displays the SPY-IVV spread. Both ETFs track the S&P 500 index. The spread is highly co-integrated and stable. On average these ETFs don't deviate more than $0.50 from each other. (I want to thank Aris David for his research on this spread).

My friend took the chart, looked at it for a few seconds, and then told me he made $4,000,000 trading similar spreads for his personal account in 2008. I was stunned.

I asked him how he made all this money trading a few spreads. He answered: they wanted liquidity and I provided it to them 24 hours a day during that period.

When securities that more or less track the same thing deviate in price by this much, you are dealing with a liquidity gap. And there is money to be made by traders willing to provide that liquidity.

Click image to enlarge.

Michael Bigger. Follow me on Twitter and StockTwits.

How to Grow a Second Brain on Twitter

That is exactly right. Believe me, it can be done.  If you think I have gone off the deep end, you can stop reading right away.

When you think about Google and Twitter, think about the following picture:

 

The thing that sets Twitter apart from Google is that Twitter is an open API that connects text, brains, algorithms, and whatever else can be connected to it. That is pretty awesome, isn’t it?

It gets even more awesome when you use Twitter to augment yourself as a trader. How do you use Twitter to augment yourself as a trader, or, in other words, how do you use Twitter to grow a second brain? How do you lift yourself from understanding less to understanding more?

•  Follow people who are better than you are.
•  Follow the money.
•  Follow people who make you money.
•  Follow people who save you money.
•  Follow people who move you forward.
•  Follow people who make you think.
•  Follow people who increase your utility.
•  Follow people who watch your back.
•  Follow humans. Humans on Twitter don’t hide behind fake avatars.

Growing a brain on Twitter is a craft. You start with raw material, which in this case is an abundant supply of brain. Then you shape that sculpture (lists) into the mother of all metacognition machines.

Michael Bigger. Follow me on Twitter and StockTwits.

No Pressure

 Feel no pressure…

•  from the market
•  from the market going up
•  from everyone seeming to be making easy money

You are under no pressure to do anything. Sometimes it is better to sit on your rear end and do nothing.

Michael Bigger. Follow me on Twitter and StockTwits.

How I Publish a Book

In a nutshell, here are some of the steps I followed to publish How Traders Achieve Creative Flow.

1. I constantly explore trading (investing) ideas and methods that have strong profit potential. I usually write about some of them in blog posts. My latest book titled How Traders Achieve Creative Flow (to be released next week) is about Flow, Creativity and increasing your value to infinity.
2. In July 2010, I wrote the blog post titled How Traders Achieve Creative Flow. This post generated a ton of traffic. It resonated with traders. I decided to investigate the topic further and push the idea way beyond the scope of the original post.
3. Then I had to determine what would be in it for the readers. Do I have the skills required to write material that will move readers forward?
4. Then I had to determine what would be in it for me. As Jim Altucher said in this post “I’ve lost money on every book I’ve written.” I am not the type to lose money. I must be compensated in one way or another; gaining augmented knowledge, boosting my reputation, etc. Whatever it is.
5. I committed to do the work. Once I commit, I don’t look back.
6. I filled in the ShipIt booklet developed by Seth Godin.
7. I started writing the material in September 2010.
8. While writing the subject I identified two of my Twitter Relationships that could add value to the book. Sean McLaughlin wrote a chapter about minimalism. Renita Kalhorn created the bonus material titled Into the Flow Zone.
9. I spent the month of January proofreading the material.
10. Kristin Walinski, the editor, finalized the book on 2/4/2011.
11. On 2/6/2011, I sent the material to be transferred from a Word document to a Kindle file to be published globally on the Amazon.com publishing platform.
12. Next week I will send the free copy to financial bloggers for review.
13. Then, I will push the content to Amazion.com, two weeks before my Ship it deadline. ;-)

Our next published work will be about spreads. Stay tuned. 

Michael Bigger. Follow me on Twitter and StockTwits.

Moving Your Value Forward Towards Infinity

Last night, I was checking out some blogs on my Galaxy Tab, and one of the first thoughts that came to my mind was….I am drowning in a sea of information.

Do you feel the same way when trying to empty your Google Reader queue?

Having all this information at your fingertips does not necessarily increase your wealth. In December, I wrote a blog post that explained why that is. My goal was to make you realize that because market participants have not demonstrated a greater ability to gain meaning from more information, the value for traders of the ability and expertise to interpret information goes to infinity. Traders should focus on honing their ability to interpret vast amounts of information instead of trying to get more of it.

The act of writing a blog post helps traders hone their ability to interpret information better. For that reason, the value derived from this exercise is skewed toward the writer of the post much more so than readers. The readers drowned before they could reach the end of their queue. Often, great posts never reach their full potential.

It becomes imperative for traders to adopt methods to harness the abundant information flow and to use flow to move their value forward toward infinity. 

I just completed my second book titled How Traders Achieve Creative Flow with that purpose in mind. The book will be available in about two weeks.

I wrote the book to show you how to use your creative self to exploit abundant information and cheap, ubiquitous technology to innovate your trading game—a game you will crush because you have created it to work to your own advantage.

You are about to take an exciting journey into the fascinating world of creative flow. Stay tuned. 

Michael Bigger. Follow me on Twitter and StockTwits.

Greed, Fear, and Volatility

I enjoyed reading Fred Wilson’s short post about fear and greed. The post can be summarized by the piece hanging behind Fred’s office desk:

Last summer I wrote a post about why the stock market is a great optical illusion. When prices march much higher, realized volatility decreases but embedded instability (potential energy) in the system increases. The opposite is true after a big fall. Realized volatility is high but the embedded stability of the market increases. The post can be summarized by the picture below.

These statements lead us to state the following dualities:

• Perceived instability is potential stability.
• Perceived stability is potential instability.

What works for the investor/trader at the greed/buy part of the cycle are:

• Long stocks.
• Short volatility.
• Short correlation.

What works for the investor/trader at the fear/sell part of the cycle are:

• Short stocks.
• Long volatility.
• Long correlation.

If he allocates capital following what works, he will repeat until broke.

Michael Bigger. Follow me on Twitter and StockTwits.