07 August 2010

Forex Behavior

There are many different ways of investing, but it is well known, for example if you want to go with one of the major schools of financial analysis, it is a good idea to read Benjamin Graham (everything) and textbooks on accountancy, financial analysis and the analysis of financial statements, in that order.

I would add read Phil Town's "Rule Number One", first, to give you a method you can use and then adapt as you wish and then later the Frank J. Fabozzi series to give you a knowledge of market dynamics. I would read as well "The Essays of Warren Buffett: Lessons for Corporate America" and "The Investment Zoo" by Stephen Jarislowsky, it brings focus to the interpretation of financial statements.

But what on earth do you do for forex ? There isn't any clear methodology. What you see is endless methods and great disagreement over which one is the best. From an information engineering perspective this looks like a situation where there is no explanatory paradigm, because there is no underlying causal description, in a sense no semantics, just loads of syntax.

Why this is has been discussed in this blog. There is an underlying causal description in big liquid long lasting equity markets (or at least the Dow) there is a semantics, the way the market deals with well run companies which find a niche to sell. That mechanism is itself unclear but it does seem to exist and it can even be seen nesting in high peaks and fat tails of the distribution of returns over the lifetime of the Dow.

But we have noted there does not seem to be anything like this in the forex market. It is my belief though there is something and that something is what some experienced traders use as a semantics. Put it this way, if it's there they will probably connect with it.

For me, these three books convey the primary methods used. There are Raghee Horner's book, "Forex Trading for Maximum Profit", Kathy Lien's book "Day Trading the Currency Market" and Boris Schlossberg's book, "Technical Analysis of the Currency Market".

My very personal interpretation of these books is like this: Kathy Lien's book is about using market structure, with technical tools as a way of doing this. Boris Schlossberg's book is about using technical tools in a sophisticated way to try and get an edge on the market. There is a distinction. One is market driven and one is tool driven, one is about structure the other about function. Would one say Lien's method is better, let the market guide you.

Well, the problem is the lack of a semantics, it is impossible to know what the market is doing, but Lien's methods are those of a bank, with enough power to assert a structure into the market and financial capacity to deal with the other banks and funds ability to do this as well. Explanatory methodologies need structure, function and one more thing.

Horner's book is different, it is like asking how does one make money and not lose too much, it is trading driven, for those who have to deal with the market as it is. It is an optimization on the huge problem most traders face, which is one does not have credit lines behind one, if one loses it's straight from one's bank account. And if one wins it's into one's bank account. This optimization produces a tight and detailed sense of market behavior (the third element of explanation).

It is relatively stripped down in term of technical tools, but it is detailed and intricate because she primarily looks for support and resistance with Fibonacci levels and the related 34 EMA moving average and uses the CCI to confirm breakouts. Behind the Dave wave and they way she looks for support and resistance with Fib levels is something reflective of the complexity of forex computation. It needs detail, precision and flexibility.

It is partly the precise input of computer programs mixed with an infusion of complexity from chaos from the equity markets that makes the forex market like trying to find the end of the rainbow. Order and structure, persistence and precision coming and going like fireflies. But if you were to be inside an advanced computer program you would find similar processes. The problem is nobody has the program...

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