Feb

12

Specs. I am trying to write a little something about technical analysis. Here's what I came up with. (by the way the first one to show that random charts and stock market charts look similar was Harry Roberts I think in 1956 or so but Holbrook working may have done it 20 years before). Anyway, how would you improve on what I wrote.

Most traders in the markets use charts and technical analysis to establish and exit their positions. Academicians and skeptics point to the random nature of many technical patterns. Here's a typical chart generated by random numbers. If you don't tell a trader it's randomly generated, they'll come up with all sorts of predictions and patterns that the chart generates. And if you dare to suggest that what they're doing is mumbo jumbo, they take great offense and beat you on the head with examples of great traders who follow charts, and examples of others who consistently make a fortune by using charts.

There's a trader from Harvard who uses charts and has made 20 billion who says "using a chart is like a Dr. taking your temperature before a diagnosis." Another one says that if charts are so useless how come everyone including you looks at it before making a trade. One of the most respected and successful traders, a friend, puts the debate in focus: "There are lots of great tools in technical analysis (some of them in his book like trader's positions, and breakouts, open interest and spreads). They're very useful as part of a bigger trading process. There are good saws and hammers but it takes a good carpenter to make them work."

There's a guy in Japan who calls himself the Japanese Victor Niederhoffer who has turned $ 10,000 into 5 million by using charts. I hope to meet him in Japan when I visit there for a talk arranged by one who believes in charts, an estimable fellow who combines charts with anthropology, life extension and sports, and perhaps I will become the American Matsohita-Masamichi.

Options values are determined by using random numbers with the same standard deviation and distribution of prices as would be generated with the random number generators I just mentioned. Every trader on the floor uses such generators to predict the price that an option should trade at, and they do very well with this model– until something like the 1987 crash occurs and they go broke.

A famous former academic big options trader and head of the exchange said that almost all the scientific options traders he knew found that when you apply the random walk model to options, it turns out that puts are priced much too highly. He said that he's watched every last one of them go broke. The problem here is that extreme events tend to occur much more frequently than the random walk model would predict.

As I write, the Swiss franc recently jumped about 100 standard deviations above its last price in a few minutes, a one in a trillion shot, and billions were lost by option writers who used defective models to place their bets.

Andrew Goodwin comments: 

The error made is in the actual coin flip method versus the computer generated random flips. If you flip a real coin an infinite amount of times, then the side that is heavier because of a greater extruding feature weight will land more often on the bottom excluding unknown aerodynamic effects.

I hereby wish to debunk weighted coin tosses as fair. That includes the wear and tear on the coin that changes the weight. Over time, the side with the extruding images on the same coin wears down and you get closer to random results.

With the computer generated flips you get no advantage betting either way unless you game the random seed.

If you get Monopoly style game dice that are indented 6 times on one side and just one time on the other, then you are better off betting on the heavier 1 dot side landing on the bottom on a given role over large numbers of roles even if the edge is tiny.

I officially quite playing indented dice board games now.

anonymous writes:

One approach I have taken is to identify some price formation of interest that can be defined by quantitative rules (perhaps "inside days" or "upside breakouts") and then analyze that formation in an actual data series. If the occurrence and distribution of the formation in the actual data series is consistent with randomness, then I make the assumption that it is highly unlikely that the formation contains any additional predictive information.

Sushil Kedia writes: 

"A synthetic price series if generated using some function incorporating random numbers looks similar to a real stock chart"

Q1. Is every variable in that function taking random numbers as inputs? Q2. If A1 is no, then is any such function using random numbers akin to the error terms in the assumptions of a good regression model? Q3. If A2 is yes, then how does such a random number generated chart conclude that real markets are random? Q4. If A2 is no, then which parts of the synthetic price generating function are significant enough to conclude that the final outcome is really random?

Please allow a surmise to be placed on this table, before you tear it off:

The outcome of prices is a joint function of the random reaction to new information at that instant as well as a function of sensitivity of all participants to trigger or not to trigger actions on such moment by moment information updates. Sensitivity is again a multi-variable function comprising of but not limited to factors such as existing position (bias), risk perception (capacity to add or reduce risk at that instant), time horizon and so on and so forth.

Please allow just one more surmise on this table, for the moment, where I will unabashedly borrow from the Palindrome's famous idea of reflexivity. Markets have a feedback loop.

My arguments supporting the surmises:

Cause & effect thinking that is the cause celebre and raison d'etre of known forms of sciences has yet not evolved into modelling, evaluating or concluding enough about phenomena that have feedback loops as well as random reactions.

That's where art steps in.

Eventually as the long held and commonly accepted belief (derived from philosphical arguments) of this list has been that there is no possibility of any reward without some risk, since at zero risk the other side of the trade does not exist, all workable methods will have approximations and estimates.

If one method may or may not be better or inferior than the other, having a method is better than no method. If even in the illusion of forecasting better than randomness one can use a chart, any form of art, or any other mechanism to stay actionable in the face of risk and prevent oneself from ruin, then too randomness will allow one to get closer to being rich enough.

Finally I will quote two giants from this list itself:

Ever Changing Cycles as espoused by the Chair himself, refute any scope for any one method to remain superior or inferior to any other.

The Senator having said once to me that every Cigarette packet comes with the statutory warning that smoking kills and yet it is the user of that information who ignores it. So any method is not the bigger factor in performance, it is the user of that method.

Whether Technical Analysis appears archaic, has refused to involve beyond the simplistic and lacks the sex appeal of rigorous numerics, so long as it triggers a trader to be adaptive, manage his risk and makes one pay one's bills, it's ok. There are enough systematic quant funds that have blown up and the biggest blowout did happen when Genius Failed, since it refused to recognize the ever changing cycles. 

anonymous writes: 

A price chart is an attempt to model relevant aspects of price change. Price change is not linear displacement, whether vertical, horizontal or oblique. Nonetheless, price change can be represented as vertical displacement and time elapsed as horizontal displacement. Such a model, however, invariably supports relationships that does not correspond to anything in the original process.The angular inclination of a trend on a price chart is a visually striking feature of this representation. Such angles have no intrinsic meaning for the price series, but this is one of the many factors (along with our facility for pattern recognition and wishful thinking) that contributes to our interpreting more from price charts than rigorous testing reveals is there.

- William Eckhardt


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8 Comments so far

  1. anand on February 10, 2015 8:17 am

    Chairman, I’m not sure the argument that a randomly generated chart LOOKS the same as a stock chart proves or disproves anything in itself. It might show that you get what look like trends, but this may just be a mirage (as they are randomly generated), whereas in a real stock chart you may well be seeing herding take place (which is the premise is behind trend following).

    In your book EoaS in the first chapter (the old trader and the yen) you describe watching USDJPY and your fear of the market moving higher, you talked about the Japanese instinct to follow each other by saying “But they run in herds. The nail that sticks out gets hammered. If the dollar sticks up any higher, the entire Japanese trading community will jump in to buy it. A higher dollar will become an ever rising bubble” [pg5 EoaS]. Was this worry not created by some acceptance that humans have a tendency to follow each other and herd to create trends?

    Your old friend Soros in his book Alchemy of Finance talked about ’self reinforcing trends’, I will quote a relevant section of the book on currency for your interest;

    “Although each self reinforcing circle is unique we can make some universally valid generalizations about freely fluctuating exchange rates. First the relative importance of speculative transactions tends to increase during the lifetime of a self reinforcing trend. Second the prevailing bias is a trend following one and the longer the trend persists the stronger the bias becomes. The third is simply that once a trend is established it tends to persist and to run its fill course; when the turn finally comes, it tends to set into motion, a self reinforcing process in the opposite direction. In other words, currencies tend to move in large waves, with each move lasting several years.” pg 76/77 AoF

    Now you may argue that trends (herding) may occur but this phenomenon is impossible to trade effectively as you never know when the herd will stampede the other way (running you over in the process).

    I think the crux of your argument in this article should be to test if trends do or do not occur (and trend followers make up a large contingent of the flock in the broad church of TA). If you need to use statistical arguments which aren’t as fun to read then its a price worth paying.

  2. Anonymous on February 12, 2015 4:25 am

    Technical Analysis Charting: What We Fail to See

    See picture of apple a la space-time at…

    http://www.physicsoftheuniverse.com/photo.html?images/relativity_light_bending.jpg&General%20relativity%20predicts%20the%20gravitational%20bending%20of%20light%20by%20massive%20bodies

    The common and proprietary knowledge concerning uses of charts with technical analysis (to establish and exit positions) continues to fail without evincing the single truth about electronic exchange markets for one. Essentially, both the understanding of charts and study of technical analysis do not explain the physics of the charting of price action… what we may reduce to understanding as an x/y graphing of buying and selling (or a system of exchange within a market ecology).

    Why?

    Watch an apple fall from one’s hand to the ground. Why does it do so?

    It is not due to the environment (or charting) so encompassing the event, nor is it the process and positioning of the apple relative to the hand and ground (or the technical aspects). Its core truth, the principle of it is as Newton observed… gravity. Yet one cannot see it… gravity per se.

    Victor’s cites… academicians and skeptics as to the random nature of technical patterns; a trader from Harvard who uses charts and has made 20 billion; a guy in Japan who calls himself the Japanese Victor Niederhoffer; traders with generators to predict price…; a famous former academic big options trader and head of the exchange. He then notes the Swiss franc’s recent 100 standard deviations…

    All evidentiary in understanding our devolution, first being the discipline of fundamental analysis from the 1950’s to the study of technical analysis to the most recent decade(s) being a concentrated codification known as (algorithmic) quantitative analysis. All three periods fail to yield an explanation of that single principle which “appears” unseen when looking at price action on any given chart — as with the falling of an apple.

    So we are left with the excerpt of Eckhardt by Anonymous, notably… ” Nonetheless, price change can be represented as vertical displacement and time elapsed as horizontal displacement. Such a model, however, invariably supports relationships that does not correspond to anything in the original process.”

    Note Eckhardt’s statement… “Look at the Detailed Structural Information in Price Data and Not Just Summary Results.”

    See… https://whatheheckaboom.wordpress.com/2013/06/29/quotable-quotes-from-william-eckhardt-mechanical-trend-following-systems-trading/

    Choice of the word “devolution” here is a relative criticism of both academic and professional alike… Instead of scientific inquiry (or best guess for enlightenment contra best hedge for profit), for instance, into the geodesics of price action, our last 60 years of operating with market ecologies evince a decent into lower states of trickery and gamesmanship… hence the crashes, blowups, and bailouts of epic proportions.

    Lords of our markets have contrived statistical pillory amongst it few to eject the masses. Yet when a given cycle (e.g., dotcom, derivative, quantitative easing [?]) is leveraged beyond viability, corrupt political configurations tax those same masses to refund the very market royalty whom extolled ruin upon their “fund-to-fund” fiefdoms.

    Such is the truth of technical analysis charting?

    No sir. No madam. It is not. What may be true, however, as some chide, that all three periods of modern market theory amount to little more than overbought or undersold religious-like products that continue to fail to resonate within sanctioned halls but are still hailed from pews of the self-promoted selectees… For the nature and properties of electronic exchange market ecology concerns a phenomena that we as students of it, simply put… fail to see.

    A favorite game of mine when meeting such, those self (or website) extolled, is asking like a first-year entry, the freshman… “How and when do you favor ticks or minutes?”

    Invariably… well, so far batting 1000… bananas not apples appear as the solicited fruit.

    dr

  3. drdimick on February 12, 2015 4:26 am

    Technical Analysis Charting: What We Fail to See

    See picture of apple a la space-time at…

    http://www.physicsoftheuniverse.com/photo.html?images/relativity_light_bending.jpg&General%20relativity%20predicts%20the%20gravitational%20bending%20of%20light%20by%20massive%20bodies

    The common and proprietary knowledge concerning uses of charts with technical analysis (to establish and exit positions) continues to fail without evincing the single truth about electronic exchange markets for one. Essentially, both the understanding of charts and study of technical analysis do not explain the physics of the charting of price action… what we may reduce to understanding as an x/y graphing of buying and selling (or a system of exchange within a market ecology).

    Why?

    Watch an apple fall from one’s hand to the ground. Why does it do so?

    It is not due to the environment (or charting) so encompassing the event, nor is it the process and positioning of the apple relative to the hand and ground (or the technical aspects). Its core truth, the principle of it is as Newton observed… gravity. Yet one cannot see it… gravity per se.

    Victor’s cites… academicians and skeptics as to the random nature of technical patterns; a trader from Harvard who uses charts and has made 20 billion; a guy in Japan who calls himself the Japanese Victor Niederhoffer; traders with generators to predict price…; a famous former academic big options trader and head of the exchange. He then notes the Swiss franc’s recent 100 standard deviations…

    All evidentiary in understanding our devolution, first being the discipline of fundamental analysis from the 1950’s to the study of technical analysis to the most recent decade(s) being a concentrated codification known as (algorithmic) quantitative analysis. All three periods fail to yield an explanation of that single principle which “appears” unseen when looking at price action on any given chart — as with the falling of an apple.

    So we are left with the excerpt of Eckhardt by Anonymous, notably… ” Nonetheless, price change can be represented as vertical displacement and time elapsed as horizontal displacement. Such a model, however, invariably supports relationships that does not correspond to anything in the original process.”

    Note Eckhardt’s statement… “Look at the Detailed Structural Information in Price Data and Not Just Summary Results.”

    See… https://whatheheckaboom.wordpress.com/2013/06/29/quotable-quotes-from-william-eckhardt-mechanical-trend-following-systems-trading/

    Choice of the word “devolution” here is a relative criticism of both academic and professional alike… Instead of scientific inquiry (or best guess for enlightenment contra best hedge for profit), for instance, into the geodesics of price action, our last 60 years of operating with market ecologies evince a decent into lower states of trickery and gamesmanship… hence the crashes, blowups, and bailouts of epic proportions.

    Lords of our markets have contrived statistical pillory amongst it few to eject the masses. Yet when a given cycle (e.g., dotcom, derivative, quantitative easing [?]) is leveraged beyond viability, corrupt political configurations tax those same masses to refund the very market royalty whom extolled ruin upon their “fund-to-fund” fiefdoms.

    Such is the truth of technical analysis charting?

    No sir. No madam. It is not. What may be true, however, as some chide, that all three periods of modern market theory amount to little more than overbought or undersold religious-like products that continue to fail to resonate within sanctioned halls but are still hailed from pews of the self-promoted selectees… For the nature and properties of electronic exchange market ecology concerns a phenomena that we as students of it, simply put… fail to see.

    A favorite game of mine when meeting such, those self (or website) extolled, is asking like a first-year entry, the freshman… “How and when do you favor ticks or minutes?”

    Invariably… well, so far batting 1000… bananas not apples appear as the solicited fruit.

    dr

  4. daniel watkins on February 12, 2015 10:47 am

    I find charts very useful, indeed vital, in Time and Price projections for my eclectic Time and Price Confluence System. Real world example: Below see links to my last two timely and publicly posted predictions at a well read site using my methods. Although in my comments, for brevity, I reference the Lindsay approach, that approach was just part of the Confluence and (this is important) my crucial proprietary work was not mentioned or presented because I have nothing to sell.

    One produced the October plunge of intraday SPX 10% from the exact high on 9/19/14; the other nailed the 12/29/14 high exactly.

    http://www.safehaven.com/article/35203/and-now-plunge-the-spx-lindsay-package-for-91814-91914

    http://www.safehaven.com/article/36170/122914-the-lindsay-package-for-a-tradable-short-term-high

    These were my ONLY two posts for Time using this method.

  5. daniel watkins on February 12, 2015 12:29 pm

    One of my favorite stories concerns a Buddhist scholar and a Zen Master. The scholar had an extensive background in Buddhist Studies and was an expert on the Nirvana Sutra. He came to study with the master and after making the customary bows, asked her to teach him Zen. Then, he began to talk about his extensive doctrinal background and rambled on and on about the many sutras he had studied.

    The master listened patiently and then began to make tea. When it was ready, she poured the tea into the scholar’s cup until it began to overflow and run all over the floor. The scholar saw what was happening and shouted, “Stop, stop! The cup is full; you can’t get anymore in.”

    The master stopped pouring and said: “You are like this cup; you are full of ideas about Buddha’s Way. You come and ask for teaching, but your cup is full; I can’t put anything in. Before I can teach you, you’ll have to empty your cup.”

    The folks who find charts useless, come to them with their cups already full.

  6. d r dimick on February 13, 2015 4:38 am

    Hi V… Posted it then disappeared. Hope all is well. dr

    Technical Analysis Charting: What We Fail to See

    See picture of apple a la space-time at…

    http://www.physicsoftheuniverse.com/photo.html?images/relativity_light_bending.jpg&General%20relativity%20predicts%20the%20gravitational%20bending%20of%20light%20by%20massive%20bodies

    The common and proprietary knowledge concerning uses of charts with technical analysis (to establish and exit positions) continues to fail without evincing the single truth about electronic exchange markets for one. Essentially, both the understanding of charts and study of technical analysis do not explain the physics of the charting of price action… what we may reduce to understanding as an x/y graphing of buying and selling (or a system of exchange within a market ecology).

    Why? Watch an apple fall from one’s hand to the ground.

    Why does it do so? It is not due to the environment (or charting) so encompassing the event, nor is it the process and positioning of the apple relative to the hand and ground (or the technical aspects). Its core truth, the principle of it is as Newton observed… gravity. Yet one cannot see it… gravity per se.

    Victor’s cites… academicians and skeptics as to the random nature of technical patterns; a trader from Harvard who uses charts and has made 20 billion; a guy in Japan who calls himself the Japanese Victor Niederhoffer; traders with generators to predict price…; a famous former academic big options trader and head of the exchange. He then notes the Swiss franc’s recent 100 standard deviations…

    All evidentiary in understanding our devolution, first being the discipline of fundamental analysis from the 1950’s to the study of technical analysis to the most recent decade(s) being a concentrated codification known as (algorithmic) quantitative analysis. All three periods fail to yield an explanation of that single principle which “appears” unseen when looking at price action on any given chart — as with the falling of an apple.

    So we are left with the excerpt of Eckhardt by Anonymous, notably… ”Nonetheless, price change can be represented as vertical displacement and time elapsed as horizontal displacement. Such a model, however, invariably supports relationships that does not correspond to anything in the original process.”

    Note Eckhardt’s statement…

    “Look at the Detailed Structural Information in Price Data and Not Just Summary Results.”

    See…https://whatheheckaboom.wordpress.com/2013/06/29/quotable-quotes-from-william-eckhardt-mechanical-trend-following-systems-trading/
    Choice of the word “devolution” here is a relative criticism of both academic and professional alike… Instead of scientific inquiry (or best guess for enlightenment contra best hedge for profit), for instance, into the geodesics of price action, our last 60 years of operating with market ecologies evince a decent into lower states of trickery and gamesmanship… hence the crashes, blowups, and bailouts of epic proportions.

    Lords of our markets have contrived statistical pillory amongst it few to eject the masses. Yet when a given cycle (e.g., dotcom, derivative, quantitative easing [?]) is leveraged beyond viability, corrupt political configurations tax those same masses to refund the very market royalty whom extolled ruin upon their “fund-to-fund” fiefdoms.

    Such is the truth of technical analysis charting?

    No sir. No madam. It is not. What may be true, however, as some chide, that all three periods of modern market theory amount to little more than overbought or undersold religious-like products that continue to fail to resonate within sanctioned halls but are still hailed from pews of the self-promoted selectees… For the nature and properties of electronic exchange market ecology concerns a phenomena that we as students of it, simply put… fail to see.

    A favorite game of mine when meeting such, those self (or website) extolled, is asking like a first-year entry, the freshman… “How and when do you favor ticks or minutes?”

    Invariably… well, so far batting 1000… bananas not apples appear as the solicited fruit.

    dr

  7. anon on February 13, 2015 4:50 am

    Charts of Indexes certainly do not look random. Tops are always rounded, bottoms are sharp. Much more of an edge trading them via charts.

  8. drdimick on February 18, 2015 8:46 pm

    It’s Your Party

    Happy Birthday to…

    “Alessandro Giuseppe Antonio Anastasio Volta (18 February 1745 – 5 March 1827) was an Italian physicist[2][3] credited with the invention of the first electrical battery, the Voltaic pile, which he invented in 1799 and the results of which he reported in 1800 in a two part letter to the President of the Royal Society.[4][5] With this invention Volta proved that electricity could be generated chemically and debased the prevalent theory that electricity was generated solely by living beings. Volta’s invention sparked a great amount of scientific excitement and led others to conduct similar experiments which eventually led to the development of the field of electrochemistry.[5]”

    http://en.wikipedia.org/wiki/Alessandro_Volta

    dr

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