There are 3 contexts of laws required in trading . The appropriate LAWS OF THINKING for trading, the appropriate LAWS OF FEELINGS for trading , and the appropriate LAWS OF ACTIONS for trading.
The Successful trading is based according to these three laws on
1) POWER OF COLLECTIVE SCIENTIFIC THINKING: A GREAT AND SIMPLE SCIENTIFIC PERCEPTION OF THE FUNCTION OF THE ECONOMY THROUGH SOME GLOBAL STATISTICAL LAW. E.g. The law of Universal attraction in economy: that big money attracts more big money in the capital markets, and this by the balance of demand and supply makes securities indexes of the companies , that are indeed the big money, to have mainly stable ascending trend, whenever one can observe such one. Valid statistical deductions can be obtained with simple statistical hypotheses tests about the existence or not of a trend, with sample size half the period of a dominating cycle). (STABLE GREAT SCIENTIFIC THOUGHT-FORM OR BELIEF FACTOR IN TRADING. )
2) POWER OF COLLECTIVE PSYCHOLOGY: A LINK WITH THE POSITIVE COLLECTIVE PSYCHOLOGY.(E.g. that the growth of security indexes also represent the optimism of the growth and success of real business of the involved companies. And we bet or trade only on the ascension of the index, whenever an ascending trend is observable). (STABLE GREAT POSITIVE COLLECTIVE EMOTIONAL OR PSYCHOLOGICAL FACTOR IN TRADING. )
3) POWER OF INDIVIDUALS SIMPLE , CONSISTENT AND EASY TO CONDUCT PRACTICE. (e.g. a trading system with about 80% success rate that utilizes essentially only one indicator in 3 time frames, simple risk management rules of stop loss, take profit, trailing and escalation, and time spent not more than 20 minutes per day. In this way there are not many opportunities of human errors in the conduction of the trading practice. Failed trades are attributed to the randomness and are not to blame the trader). (STABLE SIMPLE AND EASY PRACTICAL FACTOR IN TRADING)
We may make the metaphor that successful trading is the ability to have successful resonance with the activities of top minority of those who determine the markets.
In trading there are 3 components in the feelings that must be dealt with. 1) The feeling of MONEY itself, 2) The feeling of the UTILITY of the money 3) The feeling of the RISK of the money each time. What is called usually money management in trading is essentially RISK MANAGEMENT.
VALID STATISTICS AND PREDICTABILITY
We must make here some remarks about the robust application of statistical predictions in the capital markets.
1) The theory that the efficient markets and in particular that they follow a pure random walk is easy to refute with better statistical experiments and hypotheses tests. The random walk would fit to a market where the sizes of the economic organizations are uniformly random. But the reality is that they follow a Pareto or power distribution, therefore this is inherited in the distribution of the volumes of transactions and also in the emerging trends or drifts.
2) The statistical models of time series are more robust , when they apply to the entity MARKET as a whole and are better as non-parametric , and not when they apply to single stocks and are linear or parametric. The reasons is that a time series as a stochastic process , requires data of a sample of paths, and for a single stock is available only a single path. While for all the market the path of each stock or security is considered one path from the sample of all paths of all the stocks.
3) The less ambitious the statistical application the more valid the result. E.g. applying a statistical hypothesis test, or analysis of variance to test if there is an up or a down trend (drift) or none, is a more valid statistical deduction , than applying a linear model of a time series and requiring prediction of the next step price.
4) Multivariate statistics, like factor analysis, discriminant analysis , logistic regression, cluster analysis , goal programming e.t.c., are possible to utilize for a more detailed theory of predictability and of portfolio analysis, and sector analysis of the market and not only H. Markowitz theory.
5) In applying of the above applications of statistics, the researcher must have at first a very good "feeling" of the data, and should verify rather with statistics the result rather than discover it.
6) The "Pareto rule of complexity-results" also holds here. In other words with less than 20% of the complexity of the calculations is derived more than 80% of the deduction. The rest of the 20% requires more than 80% more complexity in the calculations.
To make a shortcut to the 12 laws of trading we may state in concise way the 4 groups of principles in trading.
The Successful trading is based according to these three laws on
1) POWER OF COLLECTIVE SCIENTIFIC THINKING: A GREAT AND SIMPLE SCIENTIFIC PERCEPTION OF THE FUNCTION OF THE ECONOMY THROUGH SOME GLOBAL STATISTICAL LAW. E.g. The law of Universal attraction in economy: that big money attracts more big money in the capital markets, and this by the balance of demand and supply makes securities indexes of the companies , that are indeed the big money, to have mainly stable ascending trend, whenever one can observe such one. Valid statistical deductions can be obtained with simple statistical hypotheses tests about the existence or not of a trend, with sample size half the period of a dominating cycle). (STABLE GREAT SCIENTIFIC THOUGHT-FORM OR BELIEF FACTOR IN TRADING. )
2) POWER OF COLLECTIVE PSYCHOLOGY: A LINK WITH THE POSITIVE COLLECTIVE PSYCHOLOGY.(E.g. that the growth of security indexes also represent the optimism of the growth and success of real business of the involved companies. And we bet or trade only on the ascension of the index, whenever an ascending trend is observable). (STABLE GREAT POSITIVE COLLECTIVE EMOTIONAL OR PSYCHOLOGICAL FACTOR IN TRADING. )
3) POWER OF INDIVIDUALS SIMPLE , CONSISTENT AND EASY TO CONDUCT PRACTICE. (e.g. a trading system with about 80% success rate that utilizes essentially only one indicator in 3 time frames, simple risk management rules of stop loss, take profit, trailing and escalation, and time spent not more than 20 minutes per day. In this way there are not many opportunities of human errors in the conduction of the trading practice. Failed trades are attributed to the randomness and are not to blame the trader). (STABLE SIMPLE AND EASY PRACTICAL FACTOR IN TRADING)
We may make the metaphor that successful trading is the ability to have successful resonance with the activities of top minority of those who determine the markets.
In trading there are 3 components in the feelings that must be dealt with. 1) The feeling of MONEY itself, 2) The feeling of the UTILITY of the money 3) The feeling of the RISK of the money each time. What is called usually money management in trading is essentially RISK MANAGEMENT.
VALID STATISTICS AND PREDICTABILITY
We must make here some remarks about the robust application of statistical predictions in the capital markets.
1) The theory that the efficient markets and in particular that they follow a pure random walk is easy to refute with better statistical experiments and hypotheses tests. The random walk would fit to a market where the sizes of the economic organizations are uniformly random. But the reality is that they follow a Pareto or power distribution, therefore this is inherited in the distribution of the volumes of transactions and also in the emerging trends or drifts.
2) The statistical models of time series are more robust , when they apply to the entity MARKET as a whole and are better as non-parametric , and not when they apply to single stocks and are linear or parametric. The reasons is that a time series as a stochastic process , requires data of a sample of paths, and for a single stock is available only a single path. While for all the market the path of each stock or security is considered one path from the sample of all paths of all the stocks.
3) The less ambitious the statistical application the more valid the result. E.g. applying a statistical hypothesis test, or analysis of variance to test if there is an up or a down trend (drift) or none, is a more valid statistical deduction , than applying a linear model of a time series and requiring prediction of the next step price.
4) Multivariate statistics, like factor analysis, discriminant analysis , logistic regression, cluster analysis , goal programming e.t.c., are possible to utilize for a more detailed theory of predictability and of portfolio analysis, and sector analysis of the market and not only H. Markowitz theory.
5) In applying of the above applications of statistics, the researcher must have at first a very good "feeling" of the data, and should verify rather with statistics the result rather than discover it.
6) The "Pareto rule of complexity-results" also holds here. In other words with less than 20% of the complexity of the calculations is derived more than 80% of the deduction. The rest of the 20% requires more than 80% more complexity in the calculations.
To make a shortcut to the 12 laws of trading we may state in concise way the 4 groups of principles in trading.
1) The principle of characteristic (exhogenous and endhogenous Rainbow) frequencies that are absolute and eternal. Or the law of rhythms. In other words all financial (and not only) activities are tuned or modulated by them E.g. 11.1 years solar activities cycle of the global climate, annual cycle, quarter cycle of publication of financial statements of organizations, daily cycle of sessions etc. In the same principle is also the property of the fundamental asymmetry of larger time scales to smaller time scales.
2) The principle of maximum likelihood (or volumes of transactions following, similar and of equal importance to trend following). Dr Alan H. Andrews (Andrew's pitchfork, median line) was a good practitioner of part of this principle. Also Bernard Barouk rule "Trade the middle 1/3 only; rarely it is possible to open and close at the exact extremes" is also relevant. According to this law it is preferred to open and close a trade at levels where the probability density of the price re-occurring there is maximum. The main reason is the greater number of trades per time unit that can be opened and closed and better forecasting of the trade. The main application of this principle is in the bulk component of trading, called here adjustment and pyramiding. This principle is a consequence of the law polarity that not only derives the 4 basic price patterns, but also the existence of poles or support-resistance levels. And also of the law of causality and randomness.(see also post 32, and how the flat-waves and stationarities are traded)
2) The principle of maximum likelihood (or volumes of transactions following, similar and of equal importance to trend following). Dr Alan H. Andrews (Andrew's pitchfork, median line) was a good practitioner of part of this principle. Also Bernard Barouk rule "Trade the middle 1/3 only; rarely it is possible to open and close at the exact extremes" is also relevant. According to this law it is preferred to open and close a trade at levels where the probability density of the price re-occurring there is maximum. The main reason is the greater number of trades per time unit that can be opened and closed and better forecasting of the trade. The main application of this principle is in the bulk component of trading, called here adjustment and pyramiding. This principle is a consequence of the law polarity that not only derives the 4 basic price patterns, but also the existence of poles or support-resistance levels. And also of the law of causality and randomness.(see also post 32, and how the flat-waves and stationarities are traded)
3) The principle of momentum conservation and acceleration.(in the financial activities of demand and supply) or trend following. It is a consequence of the law of action. The most useful part of this principle is that part about acceleration and the consequential divergence of appropriate indicators. The largest time frames give the best trends.
4) The principle of optimal adjustments and pyramiding. The best application is the back-office application on the tradable funds compared to the non-tradable cash, during a relatively constant trend of the equity line. Together with adjustment goes also the continuation escalation or (Pareto) pyramiding. The continuation pyramiding or escalation is a consequence of the Pareto or Power law of the duration of the trends which is a consequence of the law of attraction. Both adjustment and pyramiding, can apply to the front office, in the form of a grid trading based on the constant percentage of funds risked. (It relevant to moyenne or martingale-like and anti-martingale-like position size adjustments, but it is different). The highest resolution time frames give the best practice for the adjustments.
We notice the common fallacy here that succesful trading can be based only on the principle 3) that of "trend following". Most of the traders just apply the trend following and ignore the other 3 principles.
From the 12 laws of the financial markets, probably the 5 most important to derive the above 4 principles are the law of rhythms (mainly daily and sessional) , the law of action,(mainly the part about acceleration) the law of polarity (leading to the 4 price patterns) the law of attraction. (as leading to Pareto distribution and size escalation) and the law of causality and randomness (leading to the optimal adjustment).
The principles 1) and 3) are rather in the realm of front office, while the 2),4) rather in the realm of middle and back office. Also the 2), 4) are more significant for automated trading rather than manual trading.
The principle 3) defines the major component of trading (based on the trend) while the principle 4) defines the minor component of trading (based on the neutral random fluctuations ). The major component of the trading is usually conducted manually and it has a characteristic optimal focus frequency (usually of one session or one day). And this manual conduction cannot be substituted by automated trading by a robot. The minor component of trading is usually conducted by a robot , it has a characteristic frequency which is the highest possible that the spreads allow, and is so fast and exact that cannot be substituted by manual trading. The overall is the concept of "manual driving of robot" a concept discussed in post 6.
The optimal adjustment principle accounts for the perpetual micro-retracements of the prices that is a basic source of perpetual profit. While the maximum likelihood principle focus on detecting the lines of maximum density of the price action (including the support-resistance lines but also non-horizontal least squares lines or Dr A. H. Andrew's median lines), that garantee repeated opening and fast closing of the trades (maximum likelihood of closing the trade). These two principles have priority in detection compared to the principle of trend following, and are the holy-grail key to escape from the phsychology of dualism of up or down. So the 1st thing to detect is not if the trend is up or down (dualism) as the markets by default for more than 60% of the time, are ranging and are almost neutral, but the 1st think to detect is the maximum density lines.
The optimal adjustment principle accounts for the perpetual micro-retracements of the prices that is a basic source of perpetual profit. While the maximum likelihood principle focus on detecting the lines of maximum density of the price action (including the support-resistance lines but also non-horizontal least squares lines or Dr A. H. Andrew's median lines), that garantee repeated opening and fast closing of the trades (maximum likelihood of closing the trade). These two principles have priority in detection compared to the principle of trend following, and are the holy-grail key to escape from the phsychology of dualism of up or down. So the 1st thing to detect is not if the trend is up or down (dualism) as the markets by default for more than 60% of the time, are ranging and are almost neutral, but the 1st think to detect is the maximum density lines.
The above 4-principles of trading follow from the basic assumption of the components of the dynamics of prices and volumes in the markets. A classical assumption is that the prices P(t) at each time are the superposition of at least 3 components P(t)=T(t)+S(t)+F(t) , where the T(t) is a non-periodic almost constant long-term trend (especially applicable more for stocks , securities), a seasonal term S(t) with properties of periodicity (in this blog we also assume that S(t)=S1(t)+S2(t)+...Sn(t) the seasonal terms is again the superposition of many other terms at characteristic rainbow frequencies , all of them with properties of periodicities) , and F(t) is the term of stationary neutral random fluctuations (ranging market).
Referring to the 4 basic patterns spikes, trends, waves, and stationarities, obviously spikes and trends belong to the Term T(t), waves to the term S(t) and stationarities to the term F(t). And obviously the major component of the trading refers to the terms T(t) and S(t), while the minor component of the trading to the term F(t).
There is a correlation of spikes and trends.Longer and more stable trends start with spikes.
THE TOP 6 FACTORS OF ATTENTION IN MANUAL TRADING
1) NEVER USE ALL YOUR FUNDS FOR TRADING. DIVIDE THEM TO TRADING AND NON-TRADING FUNDS BY THE RATIO f=R/a^2 RULE (see below for this ratio or in posts 3,13,33). THE DIVISION OF FUNDS AT EACH PERIOD IS ADJUSTED TO CONFORM WITH THIS PERCENTAGE RATIO. NEVER WITHDRAW PER PERIOD FROM THE NON-TRADING FUNDS MORE THAN HALF OF THE AVERAGE PROFITS OF THE TRADING FUNDS PER PERIOD. This division and adjustment of the funds has been applied for many years in buy and hold investments by professor Michael LeBoeuf.
2) THE ONLY CERTAINTY, WHILE TRADING IS ALSO OUR FIRST PRIORITY: WE MAY DETERMINE THAT OUR LOSSES AT EACH POSITION WILL NOT BE LARGER THAN A SPECIFIED PERCENTAGE DEFINED BY THE KELLY CRITERION (see below or posts 3, 13, 33)
3) FOCUS ON MACROSCOPIC INSTRUMENTS LIKE STOCK INDEXES WITH PERMANENT STRONG LONG TERM TREND, even if you want to trade at short time scales. (e.g. of the American Economy which is young and strong and indexes like Dow Jones, SnP500, Nasdaq etc)
4) FOR VERY LOW RISK AT OPENING POSITIONS ON THE PREVIOUS INDEXES WITH PERMANENT STRONG TREND, OPEN AT TERMINAL SPIKES AGAINST THE TREND. This is the Bill Williams technique.
5) THE ASSESSMENT OF THE PATTERNS OF THE MARKET REQUIRES THAT IT IS DONE IN MANY SUCCESSIVE TIME FRAMES CHARTS. This is a basic recommendation by Alexander Elder, which, by now, it is a common knowledge to traders
6) BE FLEXIBLE IN FORECASTING THE MARKET AND DO NOT HESITATE TO FOLLOW PROMPTLY ANY UNEXPECTED CHANGES OF THE TREND OF THE MARKET.
There is a correlation of spikes and trends.Longer and more stable trends start with spikes.
THE TOP 6 FACTORS OF ATTENTION IN MANUAL TRADING
1) NEVER USE ALL YOUR FUNDS FOR TRADING. DIVIDE THEM TO TRADING AND NON-TRADING FUNDS BY THE RATIO f=R/a^2 RULE (see below for this ratio or in posts 3,13,33). THE DIVISION OF FUNDS AT EACH PERIOD IS ADJUSTED TO CONFORM WITH THIS PERCENTAGE RATIO. NEVER WITHDRAW PER PERIOD FROM THE NON-TRADING FUNDS MORE THAN HALF OF THE AVERAGE PROFITS OF THE TRADING FUNDS PER PERIOD. This division and adjustment of the funds has been applied for many years in buy and hold investments by professor Michael LeBoeuf.
2) THE ONLY CERTAINTY, WHILE TRADING IS ALSO OUR FIRST PRIORITY: WE MAY DETERMINE THAT OUR LOSSES AT EACH POSITION WILL NOT BE LARGER THAN A SPECIFIED PERCENTAGE DEFINED BY THE KELLY CRITERION (see below or posts 3, 13, 33)
3) FOCUS ON MACROSCOPIC INSTRUMENTS LIKE STOCK INDEXES WITH PERMANENT STRONG LONG TERM TREND, even if you want to trade at short time scales. (e.g. of the American Economy which is young and strong and indexes like Dow Jones, SnP500, Nasdaq etc)
4) FOR VERY LOW RISK AT OPENING POSITIONS ON THE PREVIOUS INDEXES WITH PERMANENT STRONG TREND, OPEN AT TERMINAL SPIKES AGAINST THE TREND. This is the Bill Williams technique.
5) THE ASSESSMENT OF THE PATTERNS OF THE MARKET REQUIRES THAT IT IS DONE IN MANY SUCCESSIVE TIME FRAMES CHARTS. This is a basic recommendation by Alexander Elder, which, by now, it is a common knowledge to traders
6) BE FLEXIBLE IN FORECASTING THE MARKET AND DO NOT HESITATE TO FOLLOW PROMPTLY ANY UNEXPECTED CHANGES OF THE TREND OF THE MARKET.
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