I have to admit I found the reaction to my last post very interesting. I struggled to write that one because I thought I was writing something that was kind of cerebral (big word for “geeky”) and wouldn’t really be interesting to the community, but I was happy with (and surprised by) the response it got. Many of these posts you see here are coming out of my work on the new Advance Technical Analysis program. I think a good understanding of probability, expectancy, and the nature of randomness are critical for a trader’s long term success in this business. I will write a bit more on this topic in the near future, but I want to share another way to look at the issue today.
In my last post, we saw that many of the patterns we see in markets also appear in random data. This is true, but we should not necessarily draw the conclusion that market data is also random. (That’s backwards reasoning. If all firetrucks were red, we cannot say that all red trucks are firetrucks.) There is actually a raging debate in some circles about how random market data actually is, but for today I want to leave you an interesting and instructive game. (I emailed this to about a dozen traders a few weeks ago, and only one replied. Most people have already had enough of my silly games. 🙂 )
There are 10 charts below, all including a single trading day of 5 minute S&P futures bars, with a 20 period exponential moving average. 5 of the charts are actual trading days, but 5 are impostors… very good impostors. They were created by taking all of the 5 minute bars for the past two years, shuffling them, randomly drawing them out of the bag (sampling with replacement), and then linking them together to create a fake trading day. (As someone alluded to in the comments to the last post, one of the issues with generating random data is the distribution of returns. This solves that problem by sample actual trading data.)
So… the question is… which are fake? In my opinion, there are two fakes here that are absolute layups, and then two that turned out to be more difficult. I am guessing most traders should be able to identify 4 of the 5 fakes pretty easily, but most importantly, jot down your reasons for why you think they are fake. We’ll revisit with answers in a few days.
(Why is this important? Because it drives right to the issue of what is not random about markets…)