Sunday, June 5, 2011

Markets: Is any pattern absolute?

Markets have one property - their inherent unpredictable nature. Nothing in the market is absolute.

Technical traders are familiar with the an indicator called - Bollinger Bands. These bands are drawn two standard deviations from moving averages. The concept of two standard deviation is: 95% of prices should be inside the 2SD bands. Therefore, when price moves out of the band, it is just a 5% occurence, suggesting that price will come back inside the band.

However, in real life, prices remain outside the bands much more than 5% of the time. Therefore, what should be 'normal' is not the reality in trading.

Now, a 20 standard deviation move should occur about 1 in 500 times. This means, that it is almost impossible for such a move to occur. But, the markets have seen not one but multiple occurences of 20 standard deviation moves in the past fifty years. Statistics tell us that such a move should not occur. Markets tell us that it comes about many times.

Therefore, there is no such thing an an 'absolute' pattern in the market. But, traders still have to work with some kind of patterns. Therefore, we base our trading on the stock market cycle of Accumulation - Realization - Distribution. We also know that sometimes this pattern will be disturbed or broken in unknown, unpredictable ways.

1 comment:

raman said...

I think, the best indicators to bet THE TREND:

1) M.Avg. price channel tech.
say when 5sma cross the 20lsma & 20hsma as per trend +/-....

2) Elliott waves along with WAVE propagation CHANNELS, fibno. retracements etc - my favourite

3) SAR, RSI, MACD, Narrow breakout Range 4/7 for reference...

I m also bullish @ INDIAN BENCHMARK INDEX as i m expecting a FLAT formation @ Y wave. (w(zigzag) - x(zigzag) - y (flat)).

But the most important thing is LUCK, FINANCIAL STARS. May be i m wrong but this is my believe/faith.