Wednesday, April 25, 2012

49. The true rules of volumes and trend


Before reading this post the reader must consult the post 10, of the relation of the power law of volumes (or law of attraction) and the law of action (or trend). Also the post 9, of all the 12 laws of financial markets.


Law of attraction (or power law of the volumes) 


This law explains how the financial populations of demand and supply are shaped. (we mean here not so much population of individuals byt populations of assets, transactions, and money flow.They are shaped much like ecological populations are shaped in biosphere. "Birds of a feather flock together". The shaping of the financial population of the same opinion behavior and decision is also through the mass media news, through web-news, direct gossip, thinking etc. There are three types of financial populations, the money savers, the investors and the traders. These types go from less risk to higher risk in this order. By utilising statistics we may describe the growth and decay of a financial population as a discrete stochastic process. The same law also governs the way that business organisations are shaped. The distribution of the size of populations of demand-supply and of the size of assets of  enterprises follows the Pareto (or a Power) distribution. If we take the logarithm of such a distribution , it will become a straight line. More than 80% of the volume of transactions are made from less than 20% of the organizations (Chebyshev's_inequality , http://en.wikipedia.org/wiki/Chebyshev's_inequality). The freedom of the markets is  more than 80% in favor of the large palyers and less than 20% in favor of the small players. In other words, the FREE MARKETS are the kingdom of the large players, after this law of power of volumes.

Because of the above law, it holds the law of conservation of the momentum , or law of the trend. As it is obvious, when a large player (e.g. a Central bank etc) is giving the order of a buying or selling, the volumes are so large, that this has to be spanned for a very large number of smaller transactions that would take hours, days or even weeks etc.

In spite of what has been written thousand of times in books and texts of technical analysis, the scientific true rules of the volumes and trend are not simple combinations like "increasing prices" and "increasing volumes" but require not only the sign of the trend but the existence of acceleration or deceleration, otherwise we may easily point out counter-examples (not only sample counter-examples but also counter-examples in the average value too).

The volumes measurement do provide better forecasting. The true rules of volumes are
1. A (statistical) momentum acceleration is a true acceleration, if the volumes are increasing too.
2. A (statistical) momentum deceleration is a true deceleration, if the volumes are decreasing too. 
Of course the converse does not hold: An acceleration can be true, even if the volumes are not increasing. But if they are increasing we are sure it is true acceleration. The same with the deceleration.