dkrock replies to: Trading Myths and Some Forex Math

The reason the market is not random is because of the way the data points are constructed. If you enter at Price X, then the next trader enters at either Price X +1, or Price X -1. That is incremental, not random. That is why moving averages can show you price direction. They draw IAW the mean, mode, and median of X+1 vs X-1. Whichever variable is larger will move price up more often than down, or move price down more often than up.

Consider the training drill of running the lines. For instance, in basketball practice it is common to have to run from the end of the court, to the free throw line, back to the end, then to half court, back to the end, then to the other free throw line, back to the end, and then to the other end, and back to the end. If you consider that is how price also moves, then you are on your way to understanding how to trade. The entire team is running those lines, but they are not necessarily in unison. Faster guys run faster. Slower guys run slower. However, NONE of them are running in the parking lot, or in the next city. They are all on the same basketball court. So, their running is not necessarily random. It is in a controlled environment and the best prediction is made from averaging all of them. If you are faster than the average, then you are fast. If you are slower than the average, then you are slow. The same is true for the market. Each new price is based on the previous price. They are all in the same market, incrementally following each other up and down. The price you see does not come from another pair. It does not come from another market. While the next value of the increment is unknown, the “market” is not random. Based on the average prices of X+1 and X-1, it is possible to measure the direction of movement.

In order to create a probability, or odds, you need an average. Once you have an average, you can compare each new input of your sample to the overall sample size.

The reason R:R is stupid is because it is not based on anything. First, a person that uses this fake math probably enters from some line that connected previous trades together. So, they are not using an average. They are using a control limit or apex; a top, or bottom, and not an average. And an historical one at that, which means absolutely nothing since you can no longer trade that movement. Second, they create a fantasy profit, 1, 2, or 3 times some fantasy stop loss value. There is no evidence price will go in their direction because they have not compared the movement to the average. There is no evidence prices will stop at their “R” because it has not occurred yet. Until price once again contradicts its average, the trade will continue until it finally does, no matter what “R” a person creates out of thin air.

With an average, you can then use an oscillator to track price to its apex. At the apex of the movement, the oscillator will show price turn back toward the average. A line drawn that connects dead trade’s highs and lows cannot show you the apex of the current price, nor the average price, because it is showing you the apex of the previous trade, not the one you are in. In other words, it is out-of-date for the current trade.

The shape of a candle discussion is just as ridiculous, only for a different reason. It is one part of the average, so to single it out as being significant removes it from the average. If the candle breaks the average significantly, such as a news spike, then obviously it becomes a significant outlier because its value will affect the average value greater than the other candles. Knowing this phenomenon can, and will, occur, a person trading averages should not trade news spikes. The rapid acceleration of X+1 and X-1 within one instance of an average is uncontrollable, and so it should be avoided. The actual, commonly used moving average that is significant is the one that breaks price movement in the opposite direction of the previous candles, once price reaches its apex and breaks the average value of the acceleration, to return to the average value of price. Once it returns to the average value of price, it can bounce back to the previous direction, break through to the opposite apex, or go flat and consolidate along the average. However, consolidation is more likely to occur at the end of the acceleration phase until the average value adjusts to the new X+1 or X-1 values and meets price, rather than price rising or falling to meet it. So, there are two patterns at apexes. Price can return to the average, or it can sit at the apex and wait for the average to come to it.

As for determining how to use averages to trade, remember that the market is broken into time frames. A time frame is just a time frame. They all draw the same patterns. The average candles of the smaller time frame create the candles of the larger time frame. Again, not random, lol. Same market, so same values. The sample size is what is different. Using this pattern means that a range trade on a higher time frame will likely be seen as a trend trade on a lower time frame. So, if you develop your trading system to trade ranges, you can use lower time frames to expand the range into a trend. It is simply magnifying a larger sample size so you can see it better. For instance, if you consider a 3 candle trade from a 30M time frame, it will appear as 6 candles on a 15M chart and 18 candles on a 5M chart. Which chart will your sample size more clearly show an apex? If the range trade of a 30M chart shows buy, and the 15M range trade shows buy, and the 5M trend trade shows buy, then most likely the market will buy. Lines drawn against previous trades are not going to show you that data. When the 5M trend trade begins to change its momentum to return to the average, then the 15M range trade will ALSO show a reverse, and the 30M chart will ALSO show a reverse.

Probability can only be configured from averages. First you need to average the time frame you want to trade, based on your personal time, experience, and comfort level. Next, apply your average to the higher time frames to increase the sample size of your trading time frame, without affecting your trading time frame’s design and signals. Due to the sporadic nature of X+1 and X-1, the higher time frame will likely absorb some of that whipsaw and provide a more stable average. It is difficult to see that value on a lower time frame, so that is why you use the higher time frame. When the higher time frames reverse, the action is already present on the lower time frames, but the probability significantly increases because of the larger sample size.

This is also basic business analysis. In business, you average costs of production, manpower, marketing, transportation, utilities, insurance, etc. You merge all those averages into one to create an average expense cost. Then you create a price for your product to cover those costs and hopefully sell enough of it at that price to break even or make a profit. You align the merged average on some population value, normally a product unit or the equipment to produce it. Based on the amount of profit, you can use that value to fluctuate your expenses as to whether to increase or decrease expenses/production. In the market you average buyers against sellers and simply follow the X+1 or X-1 increments that are higher in average. Anything else, is a myth.