This sort of article is among the most enjoyable for me to put in writing as a result of it is actually only a romp by the creativeness. Since the 1990’s, I’ve made a pastime out of exploring new and different concepts for analyzing the markets, and this can be a nice alternative to mud off a few of my outdated notes, publish a few of these concepts and maybe get some suggestions on them. I’m additionally trying ahead to utilizing a number of the following ideas in my ongoing analysis work on FOREX value conduct. So put in your “what if…” hats and let’s get began!
Market Models – Old & New
Most merchants are acquainted with the 2 fundamental faculties of market evaluation that we name Fundamental Analysis and Technical Analysis. In the 1970’s, members of the educational neighborhood proposed a brand new mannequin of the market often called the “Efficient Market Hypothesis”. This is extra generally often called the “Random Walk Theory” and mainly stated that the primary two faculties of thought have been each losing their time. In response to the Random Walk Model, different lecturers put forth an excellent newer idea of how markets work known as “Behavioral Finance”. These are all examples of complete explanations of what elements drive market costs. Here’s a short abstract of market fashions, a few of that are solely of their infancy:
Fundamental: Market costs are pushed by tangible occasions and circumstances in the actual world, equivalent to earnings, gross sales, administration, pure disasters, climate, financial circumstances, geopolitical tensions and so forth.
Technical: Market costs are pushed by what costs have carried out prior to now. As merchants observe these previous and current value actions, their expectations about future costs result in emotions of greed and concern which in flip create shopping for and promoting pressures.
Random Walk: Current market costs are environment friendly reflections of all recognized basic and technical data, so we will discern nothing about future value actions. The elements that trigger future value motion shall be so different that such actions can solely be random in nature.
Behavioral Finance: Prices are pushed by human psychology which isn’t at all times rational. Traders might base expectations about value actions, danger and reward on faulty reasoning, thus inflicting costs to behave in non-random methods. Bubbles and crashes are basic examples of this.
Chaos Theory: Market costs are a part of a non-linear dynamic system during which outputs are re-introduced again into the system as inputs, inflicting advanced behavioral loops and really delicate dependence on slight variations in circumstances.
Fractal Geometry: Price patterns are recursively nested, which means that a big sample could also be composed of a number of smaller comparable and even equivalent patterns and so forth by all time scales. Elliot Wave Theory is a basic instance of this concept.
Scott’s Emergent Property Model: I’ve mentioned this one in additional element in different articles, however the thought is mainly that identifiable properties of value conduct emerge from the mixture of distinctive particular person buying and selling kinds of the present market individuals. An analogy could be how an individual’s persona emerges from the mixture of particular person neurons of their mind. This value conduct modifications steadily over time in an evolutionary means in the identical means that the conduct of an organism modifications over time attributable to each inner modifications in its make-up and exterior pressures from its atmosphere.
My apologies if I’ve uncared for or grossly mis-represented any of the varied methods of explaining what makes the market tick.
Mechanical Trading Systems
Another topic that always grabs my curiosity is the design of mechanical buying and selling programs based mostly on cash administration guidelines. Some examples of such programs are “buy and hold”, “dollar cost averaging”, Robert Lichello’s “Automatic Investment Management” (AIM) and another programs that attempt to take the emotion out of buying and selling by the appliance of a rule-based system for purchasing and promoting. Systems like this differ from different mechanical programs in that the principles are based mostly solely on cash administration variables equivalent to money available, common value per unit, complete portfolio worth and present place worth.
These sorts of mechanical programs have been usually designed for the securities markets nevertheless, not for the futures or FOREX markets the place the money administration scenario is way completely different. In FOREX, not like the securities markets, we’re not taking some foreign money out of an account that we personal and exchanging that foreign money for some safety (i.e. {dollars} for shares). FOREX entails merely placing down a margin deposit after which utilizing that as the premise for borrowing some bigger quantity of a foreign money and exchanging it for an additional foreign money, making us lengthy one foreign money and quick one other always. This solely completely different construction of the FOREX market presents a brand new problem to the design, use and understanding of the basic money-management based mostly mechanical programs.
Artificial Intelligence & Artificial Life
What if we may design a neural web which may study over time make constant worthwhile purchase and promote selections based mostly on FOREX chart knowledge? Or in the event you desire mobile automata (CA) we may create a kind of in a multi-dimensional format during which symbols “swirl around”, colliding and mixing in new methods creating emergent behaviors. If we rewarded worthwhile behaviors and punished unprofitable behaviors would this CA ultimately study to behave like an excellent FOREX dealer? What’s that you just say? Why not harness the ability of evolution by utilizing Genetic Programming? Ok, let’s create an atmosphere filled with buying and selling packages that must compete with one another to outlive and reproduce offspring packages. After many generations of “nature – red in tooth and claw” we might find yourself with a bunch of very strong FOREX buying and selling packages. They may have earned their place on this digital world the place the prime legislation is “survival of the fittest.”
These are all examples of how the concepts popularly often called AI and A-Life is likely to be utilized to FOREX buying and selling. Using programming languages equivalent to LISP, I believe it could be fascinating to make use of neural nets, mobile automata, genetic programming environments and different strategies to create rudimentary buying and selling packages. These packages could be uncovered to many units of market knowledge (in all probability intraday charts) and over time would “learn” or “evolve” into knowledgeable buying and selling programs. This is not science fiction, but it surely’s on the frontiers of cognitive science.
Computer Modeling of Dynamic Systems
What if the markets are deterministic in some methods? In different phrases, I’m questioning if there’s a form of “physics” behind value actions that’s finally topic to advanced trigger and impact relationships. After all, we all know that trigger and impact relationships actually exist. I determine to purchase some FOREX foreign money pair, which causes me to position an order, which causes a number of provides to be hit so as to fill my order, which causes the bid and ask of the FOREX pair to rise, which causes some cease orders to be triggered, which causes extra shopping for, which causes one other value rise, which causes a number of information companies to take discover, which causes a number of different individuals to purchase, which causes the value to grow to be so excessive that folks begin to take income, which causes me to promote. Whew!
Keeping observe of all these relationships the place every occasion could also be brought on by and in flip causes a number of different occasions is a job for pc modeling. In reality, pc modeling or simulation is what we use to attempt to perceive the conduct of any advanced system that we will describe by a number of easy guidelines.
We can use this system to attempt to perceive the dynamics of what goes on within the FOREX markets as described above. We may also use it to explain what is going on on within the financial system. We do not essentially have to make use of trigger and impact relationships both. We can mannequin things like the availability and demand ranges of cash, items and labor within the financial system in addition to the value ranges of this stuff. In a market, we may attempt to uncover what elements result in the buildup of shopping for or promoting “pressures” and what elements may act as a catalyst in releasing these pressures, inflicting catastrophic crashes or sudden bubbles out there.
I do loads of modeling on paper by merely drawing diagrams of how I believe sure programs may work. This is completely different from pc modeling in that I’m not attempting to simulate the conduct of the system. Instead, I’m usually attempting to scale back the complexities of a system all the way down to some quite simple ideas so as to perceive what the principle driving forces are.
Here’s an instance of this. One of my favourite methods to scale back the complexities of any financial system is to have a look at it as a easy set of components and behaviors equivalent to: People apply labor to pure assets, thus producing items which they’ll both eat or save, permitting them to boost their high quality of life and proceed the method. Believe it or not, it truly took loads of diagramming earlier than I found out that an financial system actually may be boiled all the way down to:
1. People who wish to reside effectively, and 2. Natural assets which permit them to take action.
Every different financial idea like labor, cash, wages and costs, and so forth. are simply extensions of this fundamental mannequin.
Another means that I wish to attempt to mannequin the market is when it comes to the several types of individuals and their behaviors. For instance I’ll divide the market up into “contrarians” who promote when the value goes up and purchase when it goes down and “trend followers” who purchase when the value rises and promote when it falls. How will completely different mixes of pattern followers and contrarians have an effect on the conduct of the general market? Conversely, is there a means simply by observing market conduct that we will inform if the market is dominated by pattern followers or contrarians?
Of course none of those fashions may very well describe actuality precisely. We must keep in mind that fashions are actually instruments to assist us recommend numerous hypotheses about the best way issues work. We can then check these hypotheses scientifically.
Inventing New Indicators
One of probably the most fascinating coincidences (to me anyway) between the market and the bodily sciences is the usage of the variables “P”, “V” and “T”. In chemistry and thermodynamics these normally stand for the Pressure, Volume and Temperature of a fuel, and they’re associated to one another in a means described by Boyle’s legislation. On a value chart they stand for Price, Volume and Time. Are all of them associated? What if we had an indicator that stored observe of how a lot time it takes on common for the value to maneuver by a certain quantity. Is it taking longer to maneuver up than to maneuver down? Is there extra quantity related to down strikes than up strikes? What about an indicator for that? Or an indicator that mixes all three variables?
I used to be studying one other dealer’s weblog a number of weeks in the past and so they talked about that they want to arrange a shifting median indicator of the value as an alternative of the usual shifting common which makes use of the imply of the costs. The dialogue went on to take a position about how an everyday shifting common and a shifting median plotted collectively would work together. Would a crossover of the median by the imply be important? I believed it was a fairly fascinating thought.
Coming up with new indicators is a typical pastime for a lot of merchants, and I simply needed to offer you an instance of the thought course of that I’d undergo when inventing a brand new one. Of course there are extra indicators on the market than anyone individual may ever use, however who is aware of…perhaps the following one will give us new perception into the motion of costs that we have by no means had earlier than. So let’s preserve inventing!
Conclusion
Well that is it for our flights of fancy and romps by the creativeness. Or is it solely the start….?
Scott Percival
October 2006
Comments