Stock movement, standard deviation and psychology

[phoenix_rising]

Quote from ig0r:

btw, what's your point about the bands being created around a simple moving average?

Rodden said that the bands don't track price. I was only pointing out that they do indeed follow price. I wasn't suggesting any value or non-value of a simple moving average for use in calculations.

Quote from ig0r:
Think back to high school statistics, in any mathematical model, a value's standard deviation is calculated from it's distance from the MEAN. The job of the bands is to encompass price, if price goes up the bands are supposed to go up.

I think that is what I said, no? The bands track price. Rodden said they didn't.

 

[ig0r]

oh, sorry phoenix, I misunderstood what you were saying

 

[phoenix_rising]

No problem.

 

[rodden]

Quote from harrytrader:

I like your formula "formulaic" is it really english

According to COLLINS. "Formulary" is also valid.

 

[dbphoenix]

Quote from rodden:



According to COLLINS. "Formulary" is also valid.

Unless you've read Harry's posts, you may not know that he doesn't own a dictionary.

 

[rodden]

Quote from dbphoenix:



Not unless you're claiming that the Bands can expand to infinity, so that price never leaves them. In that case, what's the point of the Bands?

Apologies for the delayed response; I had to attend to family business here.

The bands don't have to be expandable to infinity to be valid as approximate limits to price; they track the probability of a trade occurring within them with 95% confidence. As the trader reviews the BB's he/she can see how the instrument's volatility has been fluctuating to that point. For volatility to fluctuate, obviously trades are occurring at their respective prices and YES, db, the bands will follow the price trend, but only as an envelope, with increasing crudeness as volatility increases.

Check the BB's of an active issue, especially one with a strong trend. You'll find the price tending to hug one line or the other, with occasional shifts toward the opposite line. In this instance, the nearer line functions somewhat as a price tracker - but what about the other line? The only time BB's function as price trackers per se is when volatility is very low, but generally, as price trackers, BB's are very crude - indicating, as they do, only a general region of price. This is because BB's track the volatility of price, not price per se. Mathematically, BB's are a function of a function of price: g(f(x)) where x is price, f(x) is volatility of price, and g is the recording of the volatility of price - the actual bands themselves.

I concede that BB's do track price, but only very crudely as that is not their raison d'etre.

 

[dbphoenix]

The Bands themselves, however, are not limits to price. The only limit to price is price itself.

 

[rodden]

Quote from dbphoenix:



Unless you've read Harry's posts, you may not know that he doesn't own a dictionary.

I've read Harry's posts. Mad genius excuses a lot of shortcomings - including the occasional grammatical slip.

No offence intended Harry.

 

[rodden]

Quote from dbphoenix:

The Bands themselves, however, are not limits to price. The only limit to price is price itself.

True, but 95% probability is pretty good when you're playing a risky game.

 

[rodden]

Quote from jbtrader23:

I don't believe stock movement is as "random" as the EMH and random walk theorists would have you believe. Stocks, and any market for that matter still behave according to the laws of supply and demand and more subtly to the "laws" of standard deviation.

If you pull up a chart of any stock you like and add Bollinger Bands, you'll find that stocks stay inside the bands about 95% of the time (set at 2 standard deviations away from the mean). Very rarely will stocks go more than 3 standard deviations from the mean. Once in a blue moon (like the crash of '87), stocks fall much further than 3 standard deviations. But on average, I think its remarkable that stocks (or any traded security) stay so confined to a seemingly random number such as 2 standard deviations.

My question is, what are the psychological principles behind the standard deviation numbers? There must be some. There are statistical principles behind it (Central limit theorem). But pyschologically speaking, why would stock prices "stop" at 2-3 standard deviations when a stock is going up. Why not 8 or 10? Perhaps human emotions are tied to the same standard deviation numbers. Greed and hysteria reach a certain point and then stop. Fear on the other hand can be much greater than greed. Thus, stocks can go down much faster than they go up. The market can fall 20% in one day, but it's never gone up even close to 20% in a day.

I was in such a hurry to respond to the first part of jbtrader's post that I didn't get the interesting notion presented in the last paragraph ( where the actual question is posed ) . " What are the psychological principles behind the standard deviation numbers?" . Why does greed generate 2-3 SD's of volatility while fear can generate much more? As manifested in stock activity it appears to be a terrific question, but - on the other hand - there are other arenas of human endeavor where greed appears to be the dominant emotion. People will risk their lives to protect their property or to take the property of others. Again, competitors may risk everything to win a valuable reward.
War, where fear is omnipresent, is often fought over materialistic issues that have their roots in what we might call greed.

Yet, it is true - in the market, fear-motivated moves tend to be more volatile than those motivated by greed. Maybe the answer is that greed per se isn't really what motivates people to invest; maybe buying is inherently less emotional than selling.

Maybe. Interesting question though.