As long as you cannot predict an event, it is considered random. However, is it true? What makes something be really random? The absence of a specific pattern? The inability to predict what the next event will be?
Humans have an almost uncontrollable desire to find patterns in things. Our evolutionary process has guaranteed our brain as a fantastic tool to classify things: from recognizing the face of your mother from the time you are born to knowing who you can trust or not (!?)
Regardless of what we have learned to classify or not, the big point is that we are too bad at dealing with the lack of patterns. In the post "Predicting Rare Events and Financial Crises" we left open the question "how to calculate the probability of the occurrence of 17 heads in a row if this never happened in your sample?
Do you think throwing a die or shuffling a deck are random events? Maybe not. The act of rolling a die is ruled by specific mathematical laws and if we knew precisely the rolling force, the direction of the wind, the friction with the air, initial position of the die, the throwing angle, the point of friction with the surface and all the other variables involved, it would be absolutely possible to predict what the outcome of the launch would be. The same rational can be applied to a deck or trading. So, possibly, randomness does not exist - and not even the free will - since everything is the result of a combination of previous events, and changing any one of them, lead us to have a totally different answer.
Any change in the initial conditions of the die will influence the final result. Stopping to look at a bird can prevent you from being hit by a car a few minutes later or make you to meet the love of your life - the famous butterfly effect. If things are like this on a daily basis, why would they be different in the financial markets?
When looking at a chart of any asset, the first thing that happens is to fall into the temptation to find a pattern in the prices. As our brain is a beautiful classification machine, we can find several of them already in the first 5 minutes looking at the chart ... we still have the ones who say: if you look at the chart and in less than 1 minute you find nothing, it's because there's nothing to be done! In fact, it is very easy to look at an already drawn chart and find a lot of things that "seem to have happened since others have happened," or better saying, the famous patterns of the technical analysis. What is really difficult is to find these same patterns live, in real time, while the chart is forming. Here is where the "men are separated from the boys".
Everything that happened in the past chart was a consequence of past events and events that no one would even know would happen, others already partially expected and all the consequences of the others - remember the butterfly effect described above. Everything that will happen from this second will still be influenced by the speed of response to the events that are happening now, what other people are seeing on the same chart and the consequences of other possible infinite variables. Any change in price now influences the present so much that forecasting what will happen in the future is practically impossible, assuming that we do not know all the variables involved.
This discussion brings us closer to chaos theory, as defined in one sentence: systems considered to be dynamic are extremely sensitive to their initial conditions. A personal example: one of the reasons for the 2008 financial crisis was the near-zero US interest rate cut by the Fed Chairman Alan Greenspan, to contain a chain effect caused by the dot-com crisis, the internet business bubble. The crisis of 2008 led the job offers and wages in the US to a huge reduction, a fact that made me choose another place to do my internship. This "new" place was close to a mountain region where I went one day to ski for the first time and I broke my knee! In other words, would I have broken my knee because of the dot-com bubble?
Anyway, does randomness exist or does not? Like everything in life, it depends! By the point of view of the classical physics, no...while by the point of view of the quantum physics, yes. The subatomic universe is completely different from the Newtonian physics. With all this talk of randomness, classification and cause-and-effect relationships, we leave an open question for the next post: Is technical analysis a fallacy?
Rare events are by definition events that happen with a very low frequency. Frequent examples of the literature are large tsunamis, earthquakes and the impact of an asteroid. However, the rare event to us is a financial crisis. Rare events exert so much fascination not because they are rare but also because they are difficult to predict, making whoever does it - by luck or not - the next great guru for a few months or even years.
I intentionally used the term "luck" because according to the efficient markets hypothesis, any financial crisis is practically impossible to be predicted, being practically impossible to make money trying to predict what will happen next in the markets. Consequently, when you get it right, it's nothing more than a coincidence of facts.
An interesting point here is that perhaps will never be possible to predict exactly when a crisis will happen, but it is possible to understand that a crisis is imminent with a certain degree of probability - which always brings us a certain degree of uncertainty as well. The problem lies in ignoring the degree of uncertainty and finding that only a high probability is a "guarantee" of occurrence of a particular event. Toss a coin 100 times gives you a high probability of a certain amount of "heads" happening - close to 50% - but nothing prevents you from having 100 "tails" in a row. Okay, it's rare, but nothing says it cannot happen.
Let's do a practical test. Check on the chart below the results from a 1000 coin tosses simulation.
A simple simulation of tossing a coin 1000 times, using Microsoft Excel (for the sake of the argument, lets forget questions such as if the RAND function is random and what is randomness), shows us in the following chart an idea of what can happen. In this example, in 1000 "tosses", a sequence of 15 heads (maximum value in a row obtained) occurred 2 times and in 16 times we had a sequence greater than 10.
What do we conclude from this, and what does this have to do with investments or trading?
The first point here is the fact most ignored by the beginners: "this stock has already gone up too much, it has been going up for 10 days ... it will go down, for sure". As we saw above in the coin toss example, if the coin were an stock share and the "head" was a bullish day, we saw that the stock would have gone up "15 days in a row", twice in a period of 1000 days. And we cannot forget that we had 16 times with more than 10 hypothetical bullish days.
This leads us to the second point: is it possible to profit from this? Yes, but never neglect the fact that we can perhaps have one single time 15, 20, or 30 heads in a row. But don't forget that your risk:return ratio, that is, how much your bet is worth is more interesting every time. It is guaranteed? Never will be...especially if the events are independent, like the toss of a coin ... but in markets, where everyone will probably be "seeing" the same event and trying to anticipate what will happen, we have the effect of the self-fulfilling prophecy. This would prove once again the efficiency of the markets and the impossibility of predicting it. One may try to predict something...but taking this guy seriously is another talk.
Finally, the third and final point is that crises are impossible to be predict, since they are examples outside of any sample - outliers. They never happened before, so it would be impossible to try to predict what never happened...it would simply be impossible to calculate the probability. Returning to our example of the 1000 tosses, how to calculate the probability of occurrence of 17 heads in a row if this never happened before?
Lets wait for our next posts!
Scalping in trading is a term used to describe the skill of take several small profits on a regular basis, buying and/or selling several times per day. Scalpers like to try and scalp a few pips from each trade (3 up to 10 pips) and then repeat this process over and over throughout the day. Using high leverage and making trades with just a few pips profit at a time can add up, especially if your trades are profitable and can be repeated many times over the course of the day.
We can also say that scalping is a variation of day trading. A "day trader" opens a position and then close it again during the current trading session; in other words he/she never carries a position overnight. A day trader may look to take a position once or twice, or even a few times a day, but scalpers are much more dynamic and try to take really small profits multiple times in a trading session. In particular, some scalpers like to try and catch the high-velocity moves that occur around the time of the release of economic data and other important news events, such as the release of the employment statistics or GDP releases if that is what is high on the economic agenda. And, for sure, As a scalper you only want to trade the most liquid markets. It is, in my honest opinion, almost impossible to scalp in the stock market. The best market to do it is Forex. We are talking about a key factor that is liquidity, and the Forex Market is by far the most liquidy one in the world. Also, we are usually talking about the major currency pairs, such as EUR/USD or USD/JPY.
The Scalper's way of living
One may think tha scalping is not a good way to trade. Yes, for sure it is for a minority, but still can be profitable. What you must have in mind is that a scalper will be in front of a computer for several ours, and they need to enjoy the intense concentration that it takes to scalp. You cannot take your eye off the screen. You must be the kind of person who can react very quickly because there is no time to think. Being able to "pull the trigger" is a necessary key quality for a scalper. This is especially true in order to cut a position if it should move against you - you have no time for the market take you out some few pips.
Saying it once more, scaping is a very fast paced way of trading. If you like the action and like to really focus, then scalping may be for you. If you have the temperament to react quickly, and have no shame in taking quick losses, then scalping may be for you. But if you like to analyze and think through each decision you make, perhaps you are not suited to scalp. There are lots of other ways to trade. Pick up the one that fits for you and dont worry about any buzz that may bother you when you are trading the markets!
"It has already been said that the true concepts bear the signature of their author; And I believe that are very few of those who carry a signature as sharp as the unconscious of Freud. "
There are few studies and references approaching psychoanalysis and economics. Such approach can be started in the face of the fact that economics is treated as a human science and therefore a social science. This means that it is thought and managed by individuals who are inserted and organized in a form of society. Thus, the fields of study of economics, among them: relations between individuals, way of society organization in relation to production, the exchange and consumption of services and goods in general, exchange of currencies - are the result, and inevitably , pass by individual and social meanings.
Regarding the psychoanalysis, one of its fundamental concepts, the unconscious, which was postulated by Freud and later by Lacan, is a system organized and governed by principles and laws of language: "... it must be assumed that the unconscious is the general basis of psychic life. The unconscious is the wider sphere, which includes within itself the smaller sphere of consciousness. (...) the unconscious is the true psychic reality " (Freud, 1900, p.554).
The manifestation of the unconscious on the individual occurs on daily occasions - as in dreams, symptoms, failure acts, as well as in mass behaviors; As well as in the subjectivity of each individual, in desires, choices, paradoxes and anxieties. According to Lacan (1990): "Stumble, faint, a crack. In a pronounced-written phrase, something pops out... There, something that wants to be realized - something that appears intentional, certainly, but also of a strange temporality. What is produced in this hilarity, in the full sense of being fully produced, presents itself as a finding. Thus, from the beginning, that the Freudian exploration finds what goes on in the unconscious " (p. 30).
Correlating the concepts mentioned above, psychoanalysis can contribute in the sphere of economics - since they are two sciences that perpass the social/human relations - going beyond the conceptions of conscience, considering the unconscious character that transpasses the actions of the inserted subjects in a society. Moreover, by providing the individual's autonomy and responsibility in his choices, psychoanalysis disrupts the individual with psychic and social alienation and can help with the apprehension/understanding and transformation of the production relations and monetary exchanges as conceptions of value. That is, the psychoanalytic investigation can become an important element, allowing the reflection and transformation of the subjects' actions against the markets and its transactions.
FREUD, S. The interpretation of dreams (1900). RJ: E.S.B p. 554 (Portuguese Edition)
LACAN, J. The Seminar - Book 11. RJ: Zahar, 1990, p.30.(Portuguese Edition)
About the author: Carina Guerra - Psychologist, expert in psychoanalysis and an Outspoker.
This is a question that many investors (if not all) try to answer every day. In fact, if it were possible, it would be possible to make large returns in a short period of time. However, there is a theory that says no, it is not possible to predict the value of an asset on the stock market, for example. It is known as Efficient Market Theory.
This theory is based on the assumption that all available information is rapidly absorbed by the market by all of its participants and it is impossible to make significantly gains above the market average. This characteristic is the concept of efficient market (FAMA, 1970). Secondly (FAMA, 1991), there are three variants for this hypothesis of efficient markets. The first is the weak hypothesis, which considers that markets absorb only the historical information that is public available. A medium or "semi-strong" hypothesis is based on the principle that asset prices reflect this public information instantaneously. Fama further adds the strong hypothesis, saying that the market instantly reflects even the information considered as insider.
That is, the theory of efficient markets suggests that stock prices follow the Random Walk theory. It states that it is not possible to predict the future on the basis of past data (in line with the theory of efficient markets), that is, it does not mean (for example) that the stock price has increased today, yesterday, or in another period that the price will increase tomorrow as well, because the market works irrationally so the price of a stock will be unpredictable (as well as the movement of a molecule into a fluid).
Let's show in practice how this works by using a decision tree. They are a supervised learning algorithm whose output is If - Then rules that classifies a discrete set of values, given continuous or discrete value inputs. In the figure below we have a classic example of a tree that assists in the decision to play or not given certain conditions like climate and humidity.
In our example we will use a database containing the trading information of the Ibovespa index, from 14.08.2014 to 04.09.2014, every 5 minutes. The available data are Date, Time, Opening, Maximum, Minimum, Last, Volume (contracts), Volume (R$). With this data (1617 records), we created 22 variables to try to predict if, in the next 5 minutes, the index will be up or down.
We run the decision tree in free software Tanagra. After loading the base, we run a χ 2 test to select only the attributes that are really relevant. Here we have our first cut. Of the 22 variables, only 3 remain. The first is if the difference between the maximum and the opening is less than 30 points. The second is whether the volume average of the last two periods is greater than the average of the previous period. Finally, the third measures whether the maximum price of the last period is greater than the maximum of the period prior to it.
Analyzing the result of the decision tree with these three attributes, we see that the chance of knowing if the market will fall or rise in the next 5 minutes is a little bigger than playing a coin. From the confusion matrix, we see that practically the decision tree goes right or wrong at the same frequency.
Notice also the rules that were created. None of them is able to hit more than 62% of the records, with most of them close to 50%.
A curiosity is that in the stock market, a strong consensus among traders is that the traded volume is a strong trend indicator, either for high or low, since it shows that market agents are determined in relation to a specific movement. Of our 3 attributes, 2 are related to the trading volume, showing that the tree was sensitive enough to understand this behavior. Even so, our result is in line with the theory of efficient markets.
Of course, there are more complex methods to try to estimate market movement, but even so, our approach shows that it is a Herculean task that has not yet been completed. The question that remains is: is there any information that is not immediately absorbed by the market, and given this, is possible to use it to predict stocks movement?
The studies continue around the world and if someone finds out, maybe we will never know ;)
As many things in life, trading is not different: if you are consistent about doing something, you will have your reward in the end. Of course, this is not related in doing wrong things all the time (although it will also “rewards” you somehow). Let us say after you have decided to be a trader, you may be luck and have a great first profitable month. Ok, for sure it has a chance of you just being lucky. However, let us assume you were not and were helped by your skills as future trader. As things in life are not linear, in the following month you not had the chance to trade as you did before. What happened? Probably a non-profitable month. Then yours self-steam as trader starts going down and you are done: your emotions will take control of you.
However, in fact, what happened?
Having as premise that you have a profitable trading system, there is one thing you should care about that is the fact that your trading system for sure is not 100% accurate (as none trading system is in this planet). It will be right and wrong according to the market fluctuation. That is why you went in loss for the second month. As we do not know when your trading system will fail, you must do your trades consistently in order to be exposed in the market as much close as possible to all “right” and “wrong” entries. Then you, on average, will be right according to yours trading system average – which means profits. If you trade occasionally, you are setting the odds against you – unless your method tells you to trade occasionally.
Besides this mathematical effect of consistency, we have another point: we humans are very good classification machines. We learn with time from observations. Therefore, if you are trading frequently naturally on every new trade you will become a better trader than before. This is how life works – it is not me saying it, just observe from your experiences. Ok, it is very hard to accept this somethings – but this is what shows that you have emotional intelligence to be finally a trader. You must accept that things does not happened exactly in the time you want them to happen, so be patient (another great skill you develop from being a trader).
Right now, when I am writhing these words, I am in a position that is against me. It is not easy to be comfortable with it but I did my entry based on my trading system. There is nothing to be afraid once I know why I did the entry and when I must leave. As it is an entry based on a high probability trading – and I am doing this for quite a long time – I have the odds in my favor. In case the odds turns against me, a suitable stop loss will take place and tomorrow, I will have another chance.
After so many years, maybe I can say one thing about trading: nothing in your life will be more unpredictable than when you are staring into a chart trying to understand what will happen next. You will start to see things in your life - things you think are the hardest ones to deal - in a very different way. Then, you will fell in love with it. In case you do not, it is not a bad thing. People have different talents and maybe trading is not for you. You can see this when trading stocks. However, there is something else I would like to talk about: it is called Forex Trading.
Ok then, what is Forex?
Forex means foreign exchange rates. A currency is evaluated against another currency based upon several criteria, such as the economic situation of countries, political news, media and so many others factors. The easiest way to understand a currency is think about it is the value of that country in the same way a share represents the value of a company. Trading it means buying or selling foreign currencies. If public companies have shares that you can buy and sell on the market as you wish, then countries have currencies.
In forex, you do trades based on pairs of currencies. An example is buying EUR and selling USD. There are other major pairs made with the USD, like GBP (British pound), JPY (the Yen), CAD (the Canadian Dollar) and so many others. These ones are the pairs with the highest liquidity in the market. In addition, liquidity is another wonderful thing about forex. It is a market of 5 trillion dollars a day. By day, you should understand that Forex is a 24h trade, starting on Monday at 0:00 and ending on Friday at 23:59. During this time, you can be 100% connected to the market. Any open position you may have can be influenced for something happening during overnight.
In the Outspoken Market, we always talk about emotions on trading. That is because we believe this is the key player on trading. Especially if you think about Forex trading, it should be a sniper duty. Cold and accurate. What does it means in real life? It means that emotions should not be used as the sole foundation for your actions. A little bit of control must be exerted continuously on emotions. The two main emotions: fear and greed. In the trading world, greed is one of the two reasons people are losing money. In real world, greed is one of the two reasons people are losing their lives. The second reason is fear. Fear manifests the moment you do not enter that position because you think it will go lower or higher, or when you close a potion too soon, thinking about that the market will turn against you or will never be in your favor. Fear makes you lose money by not letting yourself taking the profits that you worked for.
One common thing about these two feelings is that both will make you staying in a losing trade and hoping for the market to turn into your favor. This is definetely the worst thing a trader can do. It will never happen. You will learn that the small loss is the first one.
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