Smorgasbord

 The statistical reality of trading, stocks retest and retreat according to script, GPBUSD topping

In the past two weeks my following has doubled. This means that it is probably time to stop following me, and start fading me. That is the way it works, folks. A hot hand one day turns cold the next.

You may think that speculation is about the unique characteristics of different markets, companies and industry categories, fundamentals, macro economics, QE-whatever, the Fed, deflation, inflation, the value of the US$, the incompetence of the three mouseketeers (Obama/Geithner/Bernanke), etc., etc. You would be wrong.

Trading is about statistical probability theory and risk control. Period! Traders trade price and price alone. Nothing else matters. Trading outcomes are ruled by the random distribution of trade-by-trade results against the backdrop of win/loss sequencing and values.

Do you know, for example, that:

  • A swing trader with a 50/50 win/loss ratio will be wrong five or more straight times in 16 different sequences of trading events during a three-year period?
  • A trader with a 50/50 win/loss record and a risk/reward profile engineered to achieve an average annual rate of return of 60 percent will experience a 70 drawdown in the next 36 months?

So you think risk control is just about using stop-loss orders? If you believe that, let me tell you that jet propulsion is all about blowing hot air out of a tube. By the way, understand probabilities is a reason why good poker players are often good traders. So I have heard anyway — I don’t play poker.

Which brings me back to my original point – it is getting to be time to fade me. What I think about a market and all the reasons why I think prices should go down or up mean nothing. Statistics trump narrative. Probabilities trump opinions. Over an extended period of time my trading will revert to a random distribution governed by certain statistical profiles.

There is no reason why I cannot retain a hot hand. But, sooner or later statistical probability will catch me from behind. That will happen just about the time I start to believe I know what I am doing. Head and shoulders or no head and shoulders, three-fan principles or no three-fan principles, retests or no retests. Statistics rule all trading operations. They rule Goldman Sachs HFT and they rule the hedges put on by a corn farmer from Iowa.

The reality is that nobody is smart enough to outsmart the markets. The best we can hope for is an edge. Edges are everything. And edges are slim. A trader with a 50/50 win/loss ratio would nearly double his or her performance by increasing the value of the average win to loss relationship from a $1.20 to $1.00 ratio to a $1.30 to $1.00 ratio. That is only an 8 percent increase in the size of the win against the size of the loss. Do you still define risk management as using stops loss orders? Do you still believe that the Gold/Silver ratio must return to 18 to 1 because some Spanish king in the 1600s declared it to be so? How naïve!

Stock market

The retest rally in the stock market during the past 32 hours has been right according to the script I guessed at (and it was a guess) yesterday morning. Do I think the market will continue to follow the script? Not very likely. The chart below shows the marks I made on the S&P chart yesterday. I was asked via email and blog reply today questions about the market undergoing an A-B-C correction. Folks, I don’t even know what that is. I am a classical chartist, not an Elliott Wave expert. The basis for my zig-zags was the history that panic moves have in correcting in the form of a rising wedge.

I am hoping that the market corrects in the S&Ps to 1200 to 1210. I want to extend my leverage. We will see if that happens. The retest in the Nasdaq of the broadening top is seen below.

 GBPUSD

Sometimes it takes several attempts to establish a position that works. Sometimes I can keep trying a trade over and over and over again without success. On Tuesday I shorted the GBPUSD in anticipation of a right shoulder high of a massive H&S top. I was run in within hours for a 25 basis point loss. On Wednesday I tried the trade again. I am risking the short to above Wednesday’s high, this time about 50 BPs. I believe the $GBPUSD is forming a top of major significance.

Markets: $SPY, $ES_F, $QQQ, $NQU, $GBPUSD, $G6B_F

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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