The Structure & Function of Price

[Casper]

So is price predicatable?
In the short-term with a probabilistic mindset, 50/50 maybe.
In the long-term, there are just too many discontinuous events, too much wild randomality, and other variables to even want to predict.

If you mean that on the market opening each day or at any other given time a given stock's share price has a 50-50 chance of going up or down then I disagree.

There are 3 possible outcomes at any given time:

1. Up
2. Down
3. Steady

Even if the probability of each outcome was equal then each outcome would have a 33.333% chance of happening.

But more often than not the probabilities of each outcome will not be equal and will be affected by events in the minutes, hours, days, weeks or whatever leading up to that given time.

Another example to consider: if you take that classic story about the race between the tortoise and the hare then again there are 3 possible outcomes to the race.

1. hare wins
2. tortoise wins
3. dead-heat

Now, barring the hare taking a power nap when it is way infront and letting the tortoise trundle by, then the probability of the hare winning the race is probably about 99.99999999999999999999999% and not 33% or even 50%.

So in summary - yes share prices are predictable but imo the probabilities of each prediction (or possible outcomes if you want to call them that) should also be stated.....and the probabilities of each outcome are not just simply 1/(number of possible outcomes).

 

[ducati916]

Some of the comments on this thread already highlight some of the commonly accepted *truths*........

Theory is that it doesn't matter. Whatever it is, is factored into the price. That's all you need to know. The pattern produces a probability of a future move.

Using the KISS principle, all of the above can be summarised imo by the fact that human fear and greed drive prices up and down in accordance with the concept of supply and demand.

The two above quotes highlight these generally accepted truths, yet, they are without any practical use to the vast majority, as, seemingly they are platitudes that are rolled out ad nauseum to explain price action
Before moving on, it may actually shed a little additional light on the topic if we were to have a look at the inverse, or, function governs structure.

Through examination of function, we can seek insight into the structure. Prior to the examination of the functions of capital markets, we can look at an economic definition. The economic function of the firm, or business is to produce a profit. Price in the economic model, through supply and demand will drive ceteris paribus or equilibrium.

Returning to financial assets, or products, the question becomes, what drives supply and demand of financial assets, and thus the price of those financial assets. Does the market reach a state of ceteris parabis?

So, before returning to the structure of price, here are some of the functions of the market; [in no particular order of importance]

*provide liquidity [depth]
*provide returns [profits]
*to provide valuations [absolute & relative]
*provide capital
*provide regulation & order
*provide transparency
*others

Drawing in Efficient Market Theory, which was actually a defining theory within financial markets, yet decried particularly by technical analysts, primarily through lack of understanding. EMT states that markets are efficient.

Efficiency relates to two definitions; the first definition relates to absolute valuation, the second to relative valuation. Absolute valuations are where the likes of myself hang out, the value investors, and inefficiency is quite common. Relative valuations however are a very different matter, and they are the driving force behind the functions of markets, and therefore a driving force in day to day structure of price, and are highly efficient, maintaining price in a state of ceteris parabis

jog on
d998

 

[ducati916]

There have been some examples of price appearing on other threads that should convey a great deal of information in the price [due to the function and structure of price;

My understanding is that an inverted yield curve generally occurs when inflation is becoming a problem, and as Inflation can lead to recessions if you are holding long positions and dont want to be unemployed, then i guess an inverse yield curve could be bad.

Back in 2000 the yield curve was inverted from Feb through to Nov whilst the market topped and levelled off, and then the market corrected sharply. If it follows that pattern again, Has been flipping back and forth between normal, flat, and inverted this year, can't seem to make up it's mind. (Last two weeks have been inverted). Watching with interest.

I particularly enjoyed the inadvertent pun on the second example.
This price, is of course the Federal discount rate, that forms monetary policy, thus setting the benchmark for interest rates to adjust to.

This is a particularly important price to start with, as it is utilized as the benchmark, or risk-free return from this price, all relative values are calculated.

It will in addition provide the underpinning for absolute valuations, and hence price within this context also.

Structure;
*Federal Monetary Policy
*Adds to, or subtracts from, M3 liquidity.

Function;
*Adds to inflationary pressure, or, adds to deflationary pressure.

This price is set a number of different ways.

jog on
d998

 

[ducati916]

It is the determination of the discount rate, that we can clearly illustrate the interdependance of structure & function within the determination of a single market price.

Structure variables;
*Government liabilities
*Government assets

Function Variables;
*National GDP
*International GDP

From the macro-environment, price can be set, but, the micro-environment inputs values that directly influence the macro-environment. It's a bit of a chicken/egg question.

However, this price, the Fed Discount Rate, will as previously mentioned provide the benchmark for all further calculations in the market price of securities in the financial markets. [and hence partly explains the importance of yield curves]

jog on
d998

 

[Kauri]

I particularly enjoyed the inadvertent pun on the second example.




jog on
d998

Never make assumptions...

 

[It's Snake Pliskin]

Casper,

If you mean that on the market opening each day or at any other given time a given stock's share price has a 50-50 chance of going up or down then I disagree.

No I didn't mean this at all.

There are 3 possible outcomes at any given time:

1. Up
2. Down
3. Steady

Even if the probability of each outcome was equal then each outcome would have a 33.333% chance of happening.

"Consolidation" - stock prices only go up or down.

Another example to consider: if you take that classic story about the race between the tortoise and the hare then again there are 3 possible outcomes to the race.

1. hare wins
2. tortoise wins
3. dead-heat

Now, barring the hare taking a power nap when it is way infront and letting the tortoise trundle by, then the probability of the hare winning the race is probably about 99.99999999999999999999999% and not 33% or even 50%.

I think the market is a lot more complicated than the example.

So in summary - yes share prices are predictable

I disagree. That 's holy grail stuff.

but imo the probabilities of each prediction (or possible outcomes if you want to call them that) should also be stated.....and the probabilities of each outcome are not just simply 1/(number of possible outcomes).

So, an accumulation of results would probably lead to a 50/50 outcome. The money made from that accumulation of results is important, not the win factor.

 

[Sean K]

So is price predicatable?

In the short-term with a probabilistic mindset, 50/50 maybe.
In the long-term, there are just too many discontinuous events, too much wild randomality, and other variables to even want to predict.

But those who value invest tend to do well in the long-term, so I would love to hear more from Duc.

I do agree, but what's your definition of 'long term'. Some market factors can turn a company in a few days let alone a few months or years. Some of these factors might be: regulatory decisions, contract losses, unearthed corporate corruption, hurricanes, M&A, yada yada. Perhaps more than one day is long term in this game?

 

[It's Snake Pliskin]

I do agree, but what's your definition of 'long term'. Some market factors can turn a company in a few days let alone a few months or years. Some of these factors might be: regulatory decisions, contract losses, unearthed corporate corruption, hurricanes, M&A, yada yada. Perhaps more than one day is long term in this game?

Hi Kennas,

Long-term I guess is in the eye of the beholder and the terms of their trading style. However, look at clusters of price action and they often tell where they are going - so it is not efficient, clearly this can be exhibited in any chart one looks at. I am talking 3-5 days here(general comment here too). Long-term is a lot more difficult, impossible to predict! Long-term in my view is anything over 6 months.

You mentioned hurricanes. Good. Chaos. How can price action be PREDICTED when the world is CHAOTIC? One discontinuous event blows all fundamentals and charts out of the water. Regardless of the time frame.

I don't believe in prediction, only opportunity.

 

[Sean K]

You mentioned hurricanes. Good. Chaos. How can price action be PREDICTED when the world is CHAOTIC? One discontinuous event blows all fundamentals and charts out of the water. Regardless of the time frame.

I don't believe in prediction, only opportunity.

I'm certainly with you on Kaos.

Even though I do believe the world, and of course our lives, are ruled by random events, there might still be a general trend in place that is governed not by luck but by certain aspects of our environment and our biology. In a sence we are predestined, depending on where we are born, to live a certain life, going down a particular path. This 'life highway' is of course rather wide and curvey, with a few detours, but perhaps the end point is always going to be about the same?

Can I apply that to the market?

Golly, I haven't even had a red yet!

 

[babyboomer]

It's simple basic high school maths.

At a set point in time, there can only be 3 possibilities for the next transaction.

It can either go 1. Up 2. down or 3. sideways (next transaction is at the same price as the previous transaction)

In an ideal world with everything being equal then each of the 3 possibilities would have a 1 in 3 chance of occuring. But the market is not an ideal world and so the probabilities of each possibility will vary from each other but with the sum of the 3 possibilities adding up to 1.0

Charting and TA is a technique you can use to determine what the probabilities of the 3 possibilities are at any time. Everyone will come up with their own values based on their skills in TA and experience. If you can get them right more often than not then you will have a much better chance of surviving in the long run.

 

[ducati916]

Interesting to note that the same old, same old thinking still predominates.
From this thread, and a couple others that I keep an eye on;

Sure, any market analysis is necessarily flawed, and as Mark Douglas says “anything can happen”, and “every moment in the market is unique”.

I'm no fan of Mark Douglas, I find him shallow in his thinking, this is simply a brief example. Every moment in the market is far from unique, in point of fact the same trades [in terms of function] are executed 100's of times every day.
Some market analysis is always 100% correct.

Charting and TA is a technique you can use to determine what the probabilities of the 3 possibilities are at any time. Everyone will come up with their own values based on their skills in TA and experience. If you can get them right more often than not then you will have a much better chance of surviving in the long run.

The word probability keeps popping into any discussion on chart based analysis. Chart analysis is not probabilistic, it is deterministic, and people really need to understand the difference.

Let's return to the first example, as after rubbishing MD, I should really present some evidence of my assertion;

The Law of One Price
The Law of One Expected Return

These two basic economic Laws, define moment to moment prices within Financial markets, and are executed possibly 100's of times in any number of securities.

*The Law of One Price;
States that the same investment, must have the same price, no matter how that investment is created.

*The Law of One Expected Return;
States that equivalent investments should have the same expected return.

These two laws, provide the intellectual framework, that constitutes a component of the structure of price, that governs the function of price in the financial markets.

As an example, I shall use the Currency [Fx] markets [hence my previous interest in the tightest spreads] If we look at the US$, Can$ Au$, but, it can be any currencies that catch your fancy

Current exchange rates are;
US$/Au$ = 1.3068
Au$/Can$ = 0.8731
Can$/US$ = 0.8764

These prices are equivalent, and fulfill the two laws.
If however, lets say, the US$/Au$ = 1.4068
There would be a relative valuation differential, and under the two laws a 7.6% spread would develop allowing a risk free profit.

Thus the rise in the value of the US$ would be blunted until, the fundamentals warranted the rise in value [increase in interest rates etc] and or a devaluation across other currencies, to offset [the same rise]

This trade via the two laws, holds true across any type of security & commodity, through multiple timeframes, and is written in stone.
The probability is 100%, with a coefficient of 100%, with a confidence factor of 100%, to a standard deviation of 10 This is a true high probability trade.

It also explains selling pressure that causes breakdowns in deterministic chart patterns, and why a chart pattern will always remain a 50/50 proposition. This assertion is bourne out time and time again, when examining the data of any longer term studies of chart based trading. My own technical trading was almost exactly 50/50 over a 10 month period. tech/a and TT are in the same 50/50 distribution, and currently my Fundamental portfolio is approximately 50/50

jog on
d998

 

[tech/a]

tech/a and TT are in the same 50/50 distribution, and currently my Fundamental portfolio is approximately 50/50

Throw in Reward to Risk and the profit distribution is anything but 50/50.
The vast cavern between my and your use of numbers.

 

[ducati916]

Throw in Reward to Risk and the profit distribution is anything but 50/50.
The vast cavern between my and your use of numbers.

That is true, but completely irrelevant to the topic under discussion.
The topic, was once again this old tired chestnut regarding probability.

Charting and TA is a technique you can use to determine what the probabilities of the 3 possibilities are at any time. Everyone will come up with their own values based on their skills in TA and experience. If you can get them right more often than not then you will have a much better chance of surviving in the long run.

TT, based on current open trades [in profit] and closed trades [losing trades] is currently approximately 50/50, and this is in a bullmarket.

Conceded the open trades render the methodology profitable.
However, that is a function of risk management, not trade selection which is the topic under discussion under the umbrella of probability

jog on
d998

 

[ducati916]

Psychological

Here we have the interesting phenomena of price acting upon itself through the rise or fall of price itself. In addition, outside, emotional factors can influence price.

Price feeds upon itself, and forms a trend, based on volume of orders.
For this to continue for any length of time, or percentage increase in price, a number of factors need to be in place; [assuming a trend higher]

*significant short interest at various levels.
*variability in news flow [mixture of good and bad news]

These first two factors are important in that a sustained rise, needs continued buying pressure at a variety of levels to offset;

*profit-taking
*arbitrage
*short-selling due to news [Fundamental or otherwise]

These three points, will blunt, and in some cases end a trend, unless they are offset by covering of sold positions + new buyers attracted by the trend in price.

If the price rise is ended, then, the same principal works in reverse with the last to buy, selling on stops, and working back through the various levels.
A price decline is halted by the value investors gradually taking positions, and ignoring further declines, thus stabilizing the volume of selling.

These examples are of price influencing price
Emotional triggers [externalities] are generally unexpected bad news events.
These tend to cause very large, and very fast declines.
The ultimate effect is very dependant upon valuation.
If the valuation is very high, this can trigger a trend reversal.
If the valuation is very low, it tends to shake out traders, and the trend will remain intact.

In the middle of the range valuation wise, random, based on too many factors to accurately analyze, and generally results in choppy consolidation with increased volatility.

jog on
d998

 

[tech/a]

Conceded the open trades render the methodology profitable.
However, that is a function of risk management, not trade selection which is the topic under discussion under the umbrella of probability

I'm seeing the need to analyse,disect,and explain.

When in fact its not necessary.
If you just accept that price will rise and fall for who cares what reason (End of emotional trading),simply get on rising stock and stay there as long as it rises,get off falling stock as quick as you can.

I know its annoying and it shouldnt be so---- but trading profitably is so so so simple.
Most of its participants by their actions make it so incredably hard.

Analysis paralysis is one very real affliction both of entry ,exit and SELF

 

[ducati916]

I'm seeing the need to analyse,disect,and explain.

When in fact its not necessary.
If you just accept that price will rise and fall for who cares what reason (End of emotional trading),simply get on rising stock and stay there as long as it rises,get off falling stock as quick as you can.

I know its annoying and it shouldnt be so---- but trading profitably is so so so simple.
Most of its participants by their actions make it so incredably hard.

Analysis paralysis is one very real affliction both of entry ,exit and SELF

Yes, I have that need to understand.
Why, you may ask?

For the simple reason that your methodology is not new or original, it is in essence the old Turtle system. The Turtle system also worked well for a period of time, and then blew up.

I am interested therefore in understanding how to consistently & safely make money within the financial markets irrespective of market beta.

jog on
d998

 

[tech/a]

it is in essence the old Turtle system

Duc

The only similarity it has to the Turtle system is that it is a longterm trend following system.So is Stevo's you may wish to check his blog.

Ive shown some short term stuff in this section.More profitable % wise again---more time consuming as well.

Mate I'm convinced your looking for NO RISK.
You have only found it in Arb.

What youve got to do in all honesty is get comfortable with RISK and simply manage it.
Aint that hard.

 

[ducati916]

Duc

The only similarity it has to the Turtle system is that it is a longterm trend following system.So is Stevo's you may wish to check his blog.

Ive shown some short term stuff in this section.More profitable % wise again---more time consuming as well.

Mate I'm convinced your looking for NO RISK.
You have only found it in Arb.

What youve got to do in all honesty is get comfortable with RISK and simply manage it.
Aint that hard.

I am mostly interested in low, or zero risk, quite correct.
Which is why at heart I am an arb.
Surprisingly, there are many strategies that fulfill this requirement [or come passably close] and present numerous opportunities on a daily basis, so that there will never really be a requirement for speculation, even on a mechanical basis.

jog on
d998

 

[barnie]

The word probability keeps popping into any discussion on chart based analysis. Chart analysis is not probabilistic, it is deterministic, and people really need to understand the difference.

It is possible to determine the probability, based on accepted TA techniques and/or personal or others' experiences, of each of the 3 possible price movements just like it is possible to determine that the probability of a tail coming up on a given coin toss is 60% if you found that a tail came up 6000 out of 10000 times in previous trials, even though there are only 2 possible outcomes.

Of course, after 1M trials you might find that a tail came up 650,000 times and so the probability of a tail would then be 65%. So, the more trials (or in the case of share trading the more back testing data ) you have the more accurate your probability determinations will be.

So, identifying high probability possible outcomes from scanning and interpreting charts will result in a much higher probability of you being profitable in the long term.

 

[Porper]

Of course, after 1M trials you might find that a tail came up 650,000 times and so the probability of a tail would then be 65%. .

Sorry, I don't see this.No matter how many times a tail comes up in a row there is a 50/50 probability of a tail coming up next time.

So, identifying high probability possible outcomes from scanning and interpreting charts will result in a much higher probability of you being profitable in the long term.

This is totally different from tossing a coin.A coin toss has no other influences, it is a totally random act.Price action is not totally random so we have a chance of making decisions based on something other than a random event occuring.

I am happy to be proved wrong.