Happy New Year 2012

Psychological mechanisms of manipulation: freezing and escalation of commitment effects in Forex Part 2

This is the Part 2 of the post about Psychological mechanisms of manipulation: freezing and escalation of commitment effects in Forex.

This article is to explain a patter closely related with the trader's psychology.

Take care with your commitments. The commitment to be a trader is a dagerous one. That commitment may lead you to some very dark places. 

Honestly I can say the commitment to be a professional Individual Forex Trader is the worse thing you can do.

Why?

Because you are not prepared or at leat 95 % of the people who make those commitments are not prepared to do it.

As it is explained in the article the commitment to be a professional Forex Trader kicks in psychological mechanisms of engagement. Those mechanisme of engagement lead to escalation of engagement.

So combine this with the 95 % of probability that you are not prepared and you would have a very big probability of terrible loss.

If a proportion of the engaged are particularly vulnarable, psychologically and financially the drama is nearby.

The story of Igor is a typical example of commitment and escalation of engagement.

Without understanding the process of commitment, freezing and escalation of engagement this would be just a story, that just happened to somebody. Why this story would happen to you? What are the odds of that to happen.

Thanks to the social psychology we know that the odds are big, and they are against you.

OK what happens.

1. Igor makes a commitment to be a professional trader.

2. When you make a commitment you are engaged by your commitment. That is the key. You need to understand that at all costs.

3. Igor makes a mistake. In fact I think that that was not really a mistake whatever he explains for me it was a Black Swan effect a rare event that occurs rarely but when it occurs it blows you. It would be a mistake if he was the only one concerned, but he was not. After the fact it is easy to tell well I did a mistake that would not happen again.

4. What happens here it is important. A freezing occurs, he just can't let it go. He chooses to loose everything (family life) but not to give up trading. A deep personal drama develops a suicide is close. What happens?

The cold facts are that some traders really commit a suicide. And some of the best ever Jesse Lauriston Livermore

When he shots himserlf he writes his last letter:

“My dear Nina: Can’t help it. Things have been bad with me. I am tired of fighting. Can’t carry on any longer. This is the only way out. I am unworthy of your love. I am a failure. I am truly sorry, but this is the only way out for me. Love Laurie”


5. Igor gets a better trader,  again in the game, but another rare event happens, and again he looses everything. You would say that he make a mistake, but on the other hand I will tell you that he would not make a single dollar in the market without taking the risks.

6. He is in a small appartment and starts to write on forum TSD. That is the result of the escalation of commitment and freezing, even if you know that you are wring there is no way back you are engaged in your commitment.

This part of the trading psychology is not wildly discussed. There are a lot of stories about that.

The difference between Elliotware and the Market States Analysis

The market state analysis is different from the Elliotware analysis. In the Elliotware we try to determine a constant market structure otpimize on that structure and hope that the solution we have will work out of sample. I have found such a structure on the 1h time frame on the EURUSD. Before that structure we made out of sample analysis on the uptrend with trading solutions. In those examples I used commercial systems (Trading Solutions and Neuroshell Day Trader) to make the analysis because they offered very good statistical evaluations of the trading systems so I could share the results.

On those examples as they were not rule based we used neural nets it was not possible to use robustness analysis. You know you really do not know what really does the Neural net, what really matters is what data you are going to feed to the net and how you are going to preprocess the data. The strenght of the commercial software is that it has some foolproof safeguards that avoid to the people who do not understand in neural nets to make big mistakes with the neural net parameters (As the Neural nets that are used are different Neuroshell uses some kind of cascade algorythms that adds more neurones as needed, and has a default limitation on the number of neurones limiting the possibilities of overoptimization, Trading solutions is worth because it helps you to follow the good practices for the ration betweensamples to weights ratio for better generalization).



The Market States Analysis

However this time I would make something different as I am using a rule based system of Brain Trend expert (you candownload it here if you haven't downloaded yet).

As it is a rule based system we are particularly interested in the optimization space and to find a global optimum.

The Alternation of Market States

There is something very interesting we can observe on the markets and that is the alternation between the market states. This is not magic of course we can have some theories why this occurs but I do not think I know exactly why it happens. The most probable explanation is as there are phases of accumulation of market orders those orders have to be activated. The transitions between accumulation and activation from a common technical analysis perspective is a break - out. You have a trading range and you have a break - out (the mother of all technical analysis strategies).

So basucally we do not have a two step process

accumulation - distribution

we hace probably a 3 step proces:

accumulation - activation - distribution

And as you can guess there is a very complex dynamics between the market states and the processes of accumulation - activation - distribution.

Well we know that most of the sharp impulses are due to cascade of running stops. There can be said a lot more. But let keep it simple right.

So take a look at this chart.

We had a trending and volatile market state, we had a technical break - out. What you could expect is an impulse. So what to do. It is possible to deploy a robust trading system for impuls environment. (By the way there was a change in the fractal dimension structure but I will avoid to comment this in this example I can say that we have also a fractal break - out a transition from a state of High Fractal dimension towards a state of lower fractal dimension).

And I deply on 3 different time frames the Brain Trend expert. This is not an out of sample analysis, this is the optimization space but as I optimize only 1 parameter it is not multidimensional (lol, simpler the better),

The analysis of those three optimization surfaces showed that the system was robust almost on all possible optimization parameters and that is a robust system. So you can choose a default parameter somewhere at the global optimum.

On this optimization report it is not shown but it is good you have to make the analysis by yourself using the optimizartion tester.

What is interesting is that the drow down is low. So you can set your risk level for example of 5 %. You will know immediately if you are right or not. Of course a visual inspection of the chart is very useful.

The advantage of playing a system in this manner over manually play the break - out is that a robust implulse following and momentum driven system will not let you go against the trend, even if the first break - out is fake, the system will know when and how to reverse.

Traders Anonymous®

Traders Anonymous® Do we need that?

As most of the retail traders are loosing money we can ask yourself do we really need something similar to Alcoholic Anonymous for traders.

That is why I created a group in our social network.

Traders Anonymous® is a fellowship of men and women who share their experience, strength and hope with each other that they may solve their common problem and help others to recover from trading alcoholism. The only requirement for membership is a desire to stop drinking (trading). There are no dues or fees for TA membership; we are self-supporting through our own contributions. TA is not allied with any sect, denomination, politics, organization or institution; does not wish to engage in any controversy, neither endorses nor opposes any causes.

Our primary purpose is to stay sober and help other traders alcoholics to achieve sobriety.

I think you with some sense of humour you will understand that. Those who lack it or are just too proud they can miss that. We just do not care.

Now seriously there is a Trading Alcoholism, it is called over-trading.

"If investing is entertaining, if you are having fun, you are probably not making any money. Good investing isboring." - George Soros

The successful traders I know are not treating trading as something exciting, it is a business, a hard business, the name of the game is money. If you are going to pay your bills you need to put those pips into your bank account. They have rock solid psyche. Really this business is not for everybody. When their system tells them to buy they buy. When their system tells them to sell they sell. That is it. And to have a robust system and to maintain the profitability of your system that is a damn hard everyday work. 

Over-trading is dangerous, emotional over-trading is even more dangerous. It is trading alcoholism. This post about those who are sucked into the retail Forex. Please beware, unless you have several years of experience maybe you are going to loose your account, at least 90 % do. 

So what can you do in order to fight the trading alcoholism or the over-trading?

1. Use mini lots of 0.01 lot. 

2. Start to distribute your trades between the demo account and the real account.

That will stop the bleeding. In another article I will continue the topic.

You are invited to join.

Modern technical analysis or does the Dow Theory still holds?

I have been thinnking lately about the technical analysis in general. I mean thinking about the very foundation of the technical analysis the Dow Theory. For those who are not really familiar with the Dow theory I suggest the Wikipedia link.

I write this because I had some very deep doubts about the Dow theory in general.

I think that the Dow theory is a particular case of market behaviour and not the general way the markets will have to behave in the future.

Here I would like to add two screen shots on the daily chart of the EUR/USD.

Here I will only include two tenets of the theory:

I use exerts from the Wikipedia article with some minor comments.



1. The market has three movements

(1) The "main movement", this is the primary movement or major trend and it may last from less than a year to several years. The main movement can be bullish (we can say we have a bull market) or bearish (bear market).

(2) The "medium swing", is a secondary reaction or intermediate reaction (that means a counter trend movement or opposite of the main trend movement) may last from ten days to three months and generally retraces from 33% to 66% of the primary price change since the previous medium swing or start of the main movement.

(3) The "short swing" or minor movement it varies with opinion from hours to a month or more. Those three movements may be simultaneous, for instance, a daily minor movement in a bearish secondary reaction in a bullish primary movement.

In the modern talk we can say we have self similarity as nested elements. However at the time of Dow this vocabulary did not exist.

2. Market trends have three phases

Dow Theory asserts that major market trends are composed of three phases: an accumulation phase, a public participation phase, and a distribution phase. The accumulation phase (phase 1) is a period when investors "in the know" are actively buying (selling) stock against the general opinion of the market. During this phase, the stock price does not change much because these investors are in the minority demanding (absorbing) stock that the market at large is supplying (releasing). Eventually, the market catches on to these astute investors and a rapid price change occurs (phase 2). This occurs when trend followers and other technically oriented investors participate. This phase continues until rampant speculation occurs. At this point, the astute investors begin to distribute their holdings to the market (phase 3).

Look at the chart and in whic chart that holds true:

Take a look again at those chart. For the first chart we can say how easy it is. The market behaves according to the Dow Theory.

We see the primary trend, we see the secondary trend. We see the corrections. All that is very nice looking.

You may be a technical trader you are going to make it. If you are going to be a fundamental trader you are going to make it, I do not thing your fundamental analysis would favour taking positions against the trend. If you use a well diversified portfolio in the Stock market you are going to be very well money would keep coming in the bank.

We know that we cannot know the future we can make forecasts based on models, but if the very model is going wrong what is going to happen.

Look at the second chart now. Where is the trend. We have some kind of a different movement. With a minimum of imagination you are going to see trends. But comme on that second picture has nothing to do with the first one. Of course you can fit any market in the Dow model but doing so you may distort the reality and eventually that would affect your bank account in one way or another.

I think that if you want that your trading account and after all your bank account is healthy your models need to cope with reality. However the Dow Theory is a too breautiful model that we just cannot allow ourseles to let it die.

Heiken Ashi SSAep

This is a Heiken Ashi SSA ep. This is a mod of the Smoothed version of Heiken Ashi, however instead of using moving average for the smoothing we use End - pointed Singular Spectrum Analysis (SSA ep).

Basically we do Singular Spectrum Analysis  with the High, Low, Open and Close.

Maybe you would like the result.

you can play with those parameters:

SSA lag: how many bars to use to compute the SSA window

SSA number of computations: This is the number of computations of the SSA

Number of bars ans first bars are used if you want to calculate the Heikin Ashi SSA for more history the default is 300

Trading Strategy


There is not a particular suggestion of a trading strategy, you can use it as an alternative for your own Heiken  strategies, as Heiken Ashi is a very popular tool for technical analysis. You can pick what manual strategy you have in your toolbox and replace the Smoothed Heikin Ashi with this one.

On the shot you can see the indicator plotted on the daily chart on the pair EUR/USD, well even if you do not have any particular strategy it may tell you what currency to hold in your bank account. I mean that even if you are not a trader the currencies fluctuations affect your bank account.  I think for this this may be a very usefull tool, you can use even the weekly bars.

The download link is here. There is a button on the right side of the page, just in case ;).

Tic Volume, Volatility Cycles, Market orders attack and most of all TIMING

Here I will post a picture with the tic volume having in mind the bigger picture. Here we can see that the spikes are related with some important reversals points. What is going on now?

In fact there are some books on VSA (Volume Spread Analysis) analysis, or we can in Forex call that TVSA (Tic Volume Spread Analysis). However there is a difference in my approach and the classic approach. I can say that the VSA analysis was a great tool for analysing crowd behaviour on the markets. Yes it was because the markets has changed. They changed because now first because they are globally interconnected. And there is a second thing still the crowd behaviour is a driving force tmarkets but there is something else. And this is the robot psychology. There is not only human psychology, there is a robot psychology too (welcome Isaac Asimov from the book I robot). As the automatic algorythmic strategies are a big player on the markets it is necessary to consider how they behave. There is a research book that mentions that the algorythmic strategies are much more correlated each other than the human strategies.


The empirical analysis provides several important insights. First, we find evidence that algorithmic trades tend to be correlated, suggesting that the algorithmic strategies used in the market are not as diverse as those used by non-algorithmic traders.

However as it is stated in the research paper.


Fifth, we find evidence that supports the recent literature that proposes to depart from the prevalent assumption that liquidity providers in limit order books are passive.

There are some things in the Oanda Open orders group. Here we can see the connection between the open orders and volume. Here We can see clearly that the spike in the volume has been provoqued by the simultanious activation of many orders. As we can see that some accumulation of orders work as attractors of the market action.

Fifth, we find evidence that supports the recent literature that proposes to depart from the prevalent assumption that liquidity providers in limit order books are passive :). This chart can be interpreted that a major level of orders was hit and that provoqued a spike in the tic volume. The next major level shows where the reversal can go if it is about to continue.

What is important is that when we see that the tic volume has clear oscillatory patterns we can see WHEN the next attack would be.

Brain Trend family of Systems

1. The logic of the Brain Trend systems

The logic of the brain trend is based on 3 key aspects:

A signal is generated whe we have a momentum + volatility break - out of a digitally filtered price over a momentum treshold.

The first aspect is the momentum

The Brain Trend needs a momentum computation in order to generate a signal for the trade. The momentum is computed using the Stochastic indicator. As the momentum often preceeds the price action this is a sound technical principle.

In fact it is possible to change the tresholds for the momentum manually.

In the privded expet we did not touch to this parameter. The default setting is a 9 period Stochastic for momentum computation.

As far as I understand we need a strong momentum in the direction of the price action in order to generate a signal. If we go up we need the momentum to go in the overbought area. If we seel we need the momentum to go in the oversold area.

The second aspect is the breaking of a volatility range

The momentum by itself is not sufficient in order to generate a signal A break - out over a determined range is needed.

The signal would be active only the price goes beyond a predetermined range. This part of the formula has never been touched. However as we know the volatility is changing all the time in the forex market and there are repeatable patterns of volatility I think that should be adapted.

There are many possible ways to determine the break - out. The core idea of the digital mods is to use not the price but a smoothed price in order to check if there is a break - over the predetermined range or not. The more smothed is the price the break above range level would be identified later. In fact this is the thing that is used to regulate the sensitivity of the filter and this was the main innovation of the digital brain trend mods. For example in the jurik JJMA versions we are not used the actual price but we are using the values of the filter. And we are looking for smoothing without delay and that is what the digital filters do in the digital Brain Trend. It was not very far the idea to use jurik everywhere in complex systems so that gave birth to a whole new generation of systems. However we can use everything that smoothes the prices without lag.

The third aspect is a volatility stop

This is a classic in the trend following systems. The idea is to slide the stop loss level point by point based on the current volatility in the trend.

2. The history of the advanced systems

A mystical guy appears on the cyrillic Russian alpari forum that uploades the first digital mod.

I tried to contact him in vain, the files have been edited by Larionov, and the JJMA library is of Kositsin, from the copyright information). There is has been for some years. Then I wanted to share with others as the Alprai forum was only in Russian and practically unaccessible to non cyrillic readers. I shared it both on Forex Factory and TSD. After that I started to to share private messages with some traders. This was Mr. Tools from TSD. And we discussed the possibility of putting different things instead of JJMA. I was thinking mainly about Fractally modified Jurik, the idea was to use more smoothing than general but to obtain a fast response when the market breaks out sharpy prvoquing a change in the fractally adaptive jurik smoothing filter.

He thaugt about using double smoothed jurik. And there are two versions that practically are different filters: mladen's version and the original kositsin version. That is how the new generation of brain trend was made.

After that logically I wanted an expert adviser in order to know the truth about the profitability of this system. In fact I use a simple rule, stop and reverse rule. Using that rules even if there were entries that were profitable before going negative at the reverse signal the expert prooved to be a good one.

I do not use the expert for trading I use for for knowing and optimizing the parameters. From this part it is
excellent, because the system appears very robust either it is profitable on all parameters either it is not profitable at all. The 30 minute frame on EUR/USD prooved to be the most profitable on the back test with almost every setting. The daily frame is profitable on almost every setting.

Lately I decide to disclose what I have here. This is a state of the art trend following strategy if used in its conventionnal way. Howver this should be mentionned we need a very carefull selection of the istrument we are going to trade. We need something that is making clear impulses, not necessary trending.

For more information and to download the files go there

I always wanted to have a system able to profit from the Eur/Usd mega trends. Yes there are some really mega trends.

I have been back testing the COT report from a year now. I would like to share two things.

1. The COT report can be used as a valuable tool, indicator for a trend trending system profitting from the Eur/Usd megatrends. From one hand every day trader need to diversify through time frames on the other hand it is possible to have a nice system and to be in the game without the hard day to day analysis.

And as a trading system does not have to be difficult here there is a very simple system. Unfortunately there is one problem, there are quite a few opportunities per year.

First I would like to make a shot of the technical signals and the COT report. You know during that year there have been some very clear technical signals. And those signals have been confirmed by the COT report. Mainly we are tracking the big money.

Whe look what is the net position of the big Monney, large speculators. And we go with them. The signal is

-when there is a transition through the zero point.

-that happens to a place where there is a very clear technical analysis signal.

-we have aconfirmation with a trained system that gives us a signal.

On the other hand the other visual pattern is when the large speculators buy too much and the overbought level is reached. Then we could expect a reversal. Those moments are much more unpredictable.

For the rest of the article ...

Tic Volume, Fractal dimension and Volatility Cycles

Here I would like to add some observations. In the main article I described the Curtis Faith market states cycles. Here I would like to add some more insights.

Let start with the data. Here we can see a tic volume chart. On the tic volume chart we can see that there is a ciclicity in the in the tic volume.
The ATR cycles

The lower indicator is the ATR (Average True Range). This is a volatility indicator. We can see that the volatility is positively correlated with the Tic Volume. What is interesting is that we can see periodic cycles in the volatility as well.
The iVAR readings
Basic explanation once again (I repeat my self I know).
The lowest indicator is the iVAR. This is a fractal dimension indicator. Most of the readers here are really advanced but I will briefly explain what it means.


-iVAR below 0.5


The readings of this indicators of they are below 0.5 that means that the movement is persistent (there is a bigger probability that the next movement will be in the same direction as the previous). In our technical analysis context means that the next bar would go in the same direction as the previous. And that is really very important for every technical trader.
Why?
1. It is important if we play a break - out through a certain level.
2. It is important if we follow a lagging indicator. Even if the indicator is lagging it still will work because the next bar movement is in the same direction as the previous and the lag works for filtering the noise.
3. Basically brain trend excels in this kind of environment


-iVAR above 0.5


Basically this means that the movement is anti-persistent. The next movement will be in the opposite direction as the previous. From a technical analysis perspective that means that the next bar would be in the opposite direction than the previous.
However please do not confuse this with the technical analysis definitions of trend and range. This is something completely different. This is how the price series fulfill the space. Here I should explain that the iVAR is sgowing the same thing as the FDGI (fractal dimension graph index). However for FGDI it moves from 2 to 1, and iVAR moves from 1 to 0. The center line for FGDI is 1.5 for iVAR is 0.5.
More the iVAR is the inverse of the Hurst exponent (H) and FGDI (measuring the fractal dimension) = 2- H.
If the Hurst exponent os 0.51 the iVAR would be 0.49 and the FGDI would theoretically be 2-0.51= 1.49.
Anyway those exponents are not calculated they are estimated and different algorithms exist for that. And the probabilities they calculate are in practice very small, for example if iVAR has reading of 0.47. That means that there is 53 % of chance that the next movement would be in the same direction than the previous.


-iVAR at 0.5 level.


This means that the movement is totally stochastic the probability of going up or down is the same.


The iVAR cycles


It is important to mention that the iVAR has also cycles but it cycles are not going together with the volatility cycles. The fractal dimension cycles look like they lack any clear cyclic osclilatory pattern. However they have one very important feature. If they are antipersistent that will continue for some time than they will move lower and they will become persistent.


So We could combine this analysis with the volatility analysis and see when there is an increase of volatility. I mean when we expect the cyclic increase then we should pay attention in what fractal dimension cycle we are.
If we are clearly antipersistent. Please do not expect any impulse following algorythm to work well, as brain trend for example. But if we have a break out (readings of iVAR above the 0.5 are crossing the 0.5 line and going lower) we can be confident in ours impulse following systePublish Postms.