Is price movement really random and unpredictable?
- Thread starter schizo
- Start date
especially if the past movement has a good reason like increasing profit margins or earning increase
just because noise is defined does not mean that it can be managed and management is the main thing.
The Importance of Price Noise
Market noise is an important but elusive component of price movement. It is the up-and-down, erratic price movement that goes nowhere and often causes you to be stopped out of a trade only to see prices reverse back in your direction. Traders have no trouble recognizing noise. Most price shocks are an extreme case of noise, when the large move is followed by an equally sharp reversal the next day. A price shock is not noise if prices continue in the direction of the shock. That is most likely a structural change. The elusive part is:
- How do you tell the difference between a structural change and a price shock?
- When does a price move indicate a trend change, and when is it just noise?
- How do you take advantage of price noise?
NOISE EXPLAINEDThe way we think about price noise is a day with very high volatility but a close nearly unchanged, or a day when prices closed sharply lower, then reversed nearly the entire move the next day. We also associate noise with the way prices react to our trading method. We get stopped out of a long position when prices break a key level, but that turns out to be the low of the move, and we're out at the worst price of the day.
In general, noise is a disorderly move. It doesn't need to be volatile, just erratic and unpredictable. Econometricians say that when you remove the trend, the seasonal pattern, and the cycle, the three main components of price movement, what you have left is noise. That's interesting but not very useful. We don't want to remove those three elements because the combination of everything causes price moves that can generate profits. Instead, we'll think of noise in the same way we approach the walk of a drunken sailor (no offense to sailors—it could be anyone).
If a sailor were to walk from point A to point B in a straight line, we can say that his route has no noise. If he meanders slightly off that straight path, we can see that as a small amount of noise; however, if he staggers first to the right, then sharply to the left, then backward and forward by different amounts, but ultimately heading slightly toward his goal, we would say there was a large amount of noise.
FIGURE 2.1 Noise is calculated as the net move (from A to B) divided by the sum of the individual moves (1 through 7). All values are taken as positive numbers.
Once you understand the picture, seen in Figure 2.1, the concept should become clear: the straighter the path, the less noise; the more erratic the path, the more noise. This pattern can be expressed as a value we call the efficiency ratio. First, we measure the net distance gained from point A to point B, always taken as a positive number. Then we measure the actual path taken by the sailor in his journey from point A to point B. Those values are also always positive, regardless of whether he is stumbling forward or staggering backward. The efficiency of his walk is given by the ratio
Referring now to the efficiency ratio (ER), if the sailor walked in a straight line, the ratio would be 1 because the numerator and denominator would be the same. As the sailor wobbles more, the denominator gets larger. If he wandered back and forth for a really, really long time, the denominator would get very big, and the ratio would move toward zero. Therefore, a walk with no noise will have the ratio of 1.0, and a completely directionless walk would be zero. This can be shown mathematically as
where t represents today, P is the price, and n is the total number of days used in the calculation. As with many financial calculations, this is done over a fixed, relatively short period. By calculating the ratio each day based on rolling time periods, we get a history of the price noise. When we average those individual ratios over a long period of time, we get a profile of the amount of noise in a specific stock, index, or commodities market.
Note that the value ERt can be zero (or near zero) if the denominator is extremely large or if the numerator is zero, which can happen if the starting and ending prices are the same. The ratio has no sign, so that we don't know if the prices have gone up or down over the calculation period.
Because the calculation is greatly dependent on the starting and ending values, some mathematicians consider it unstable. However, averaging the values over some period of price history minimizes that problem.
The theory is true in the long term. In the short term, there are pockets of predictability due to luck or some skill. Short-term can be 20 or 30 years. All traders and investor lose their wealth at some point due to the randomness. Getting out of the market when hitting target wealth is the key objective. The stock market is a little different due to constant financing by the central bank but there are several examples worldwide of total losses. Markets are meat grinders. No one escapes in the long term. In the short term, some become rich.
But seriously? Why would a sane person like you literally dump 1000 ES contracts on a whim, without any regard to where the price is trading? I don't think you're such a fool (or maybe you are...I need to think about it)
The point was that at any point in time someone could dump an order at the market for reasons that have nothing to do with what's going on in a <= 5-minute chart. I believe that's what happened leading up to the Flash Crash.
So, in essence, trying to make a meaning out of every single tick or spike in one of the most liquid markets in the world is a futile exercise and I would say that anyone who thinks otherwise is a fool.
Well, you can't short because I'm dumping at market randomly without looking at your 5-minute chart.
And by the time of the spike down, you won't know if it's a PB or the initiation of a new move lower. So, you're at a loss for which decision to make. Besides, by the time you made up your mind, price likely moved already.
Buddy. If every tick and spike was predictable and tradeable, you wouldn't be averaging down on entry on micro contracts.
I know an investor which got started around the same time QE started and literally became rich throughout the last decade.
I later saw a webinar with a guy utilizing the exact same strategy which got hammered starting out a few years prior.
Same strategy, different market environment, different outcome. The QE guy thinks he's an investing genius. The webinar guy became a trader.
Just by chance, there's always someone who's killing it in the markets. And of course, everyone who's making money in the markets are highly skilled while those who lose are simply out of luck. LOL.
Malcolm Gladwell the author of Outliers and Blink, said the month you were born has more to do with success in sports than talent; the year you were born has more to do with wealth and successes in life than IQ, hard work....I know an investor which got started around the same time QE started and literally became rich throughout the last decade.
I later saw a webinar with a guy utilizing the exact same strategy which got hammered starting out a few years prior.
Same strategy, different market environment, different outcome. The QE guy thinks he's an investing genius. The webinar guy became a trader.
Just by chance, there's always someone who's killing it in the markets. And of course, everyone who's making money in the markets are highly skilled while those who lose are simply out of luck. LOL.
I said where you were born who you were born to have more to do with wealth than smart or hard work, and we don't get to choose either.
At the end of the day, it really doesn't matter whether it is luck, skills or the market as long as we get there.
ES / MES right now. This is what I mean by random flow. It's just random back and forth.
But if anyone can predict the next tick or bar - let's hear it...
And no - after the fact doesn't count...
Because after the fact it will be an obvious consolidation before continuation lower.
Or it will be an obvious consolidation / higher low before moving higher...
My prediction is that ES will recover to at least 4820 today and close green going into the long weekend.
But I have no illusions about predicting the next random tick.
But I have no illusions about predicting the next random tick.