Essence of Trading: Price Goes Up And Down

iStock_000017014380XSmallBefore you spend time even thinking of the more complex price patterns or technical setups, have you even paying any attention to the most basic foundation of the price charts, like the price bars themselves?

It does not matter you use candlesticks or open-high-low-close bars (OHLC bars). The important thing is whether you know anything about your market and timeframe down to the bar to bar relationship. Many would say no. There is nothing to be ashamed of because we are not told to even look at that. Most of the materials you can find on the Internet just skim over the definition of the bars and then immediately move on to talking about the chart patterns, indicators, etc.

It is important to know the basic statistics about these bars you are using. I am not talking about fancy statistics here. Just simple ones that tells you what is more likely. Price movements, down to transaction level, in its simplest form, has 3 possible outcomes. Trade at a higher price, same price or lower price. Price goes up. Price goes down. It cannot get any simpler than this. The important thing here is to know if there exists bias in the simplest price relationships that you can exploit.

Let’s consider a simple coin-flip betting game. If you know for sure that someone is using a loaded coin that favours head over tail (e.g. 70% of the time you get head) when you flip the coin. In almost all normal circumstances, and that your intention is to win money, you would keep betting on head, right?

So if you know that the market you trade, say, on daily basis, has a 70% chance of printing $5 higher as long as it has not dropped $3 yet, would you not keep buying everyday?

Or if you know every Thursday the market you trade has a 65% chance of closing higher, shouldn’t you pay more attention to the possibility of a late day rally that can print a higher close on Thursday?

Every market and timeframe combination has its own special bar to bar statistical behaviour. It is caused by the traders who participate in that market who focus on that specific timeframe. There is nothing magical about that. Assuming these price movements all behave the same way is one of the major contributors to many chartists’ inability to interpret their charts correctly.

Many smart individuals assume that such basic properties of the price bars would be well discussed or mentioned in books if these statistics have any useful bias at all. Since they cannot find such information readily available, they assume the statistics are either not important or not good enough to be utilized profitably. They could be correct for some markets in certain timeframes, but not all markets behave like that. The several free end-of-day swing trading models I published clearly illustrate that there are useful biases hidden in plain sight all along with no publicity whatsoever.

It is not that useful (and simple) biases do not exist.

It is people not trying hard enough to discover them.


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