13 December 2010

Forex Investing Frames

This blog has argued that the equity market to an extent references itself, but it has a scale as well. That scale is its fractal elements, namely the companies which comprise it. This is because the market comprises a future estimation of value by analysis and investors on those companies. But the forex market does not have such a scale. There is no standard of valuation.

There are repeated attempts to force a valuation standard, via a differential. And there are repeated attempt by traders to see these happening in time to hop on. Is this an exploitation of an inefficiency, by which some would argue movement in equities occurs. Not at all, the way agreements reverse sharply in this market shows that they are an anomaly, not an efficient working of this market.

If highly experienced analysts and the markets can so markedly disagree about a correct valuation, then it suggests that the market is not valuing in an efficient way (analytic methods essentially presuppose this). It is valuing in the manner of an optimization, which uses non–linearity to find solutions, but is not non-linear in and of itself. That may be the source of the apparent linearity that attracts many to this market.

This blog has expressed this as the look of a chart historically, how attractive it seems to ride those waves, but the reality is that this expresses a movement that is highly complex, with many possible moves at a given time. More than this it expresses a linear wave of optimization. This blog has argued that the mind can feel this path through that complexity. But as for imposing analytical methods on this, they do not work, even highly sophisticated ones, look at the practical results of GARCH models in forex for example.

Retracements rule here, they express a revaluation, they say the value the trends forced was wrong for the system (the argument here is that this process is much more significant than order flow dynamics). When a valuation does not reverse like this the system accepts it, that seems to be rescaling and it happens with new input. Some might argue that is part of the computational process of chaos in this market. The lack of long memory suggests that a later retracement does not reverse that earlier movement but my feeling is that it does, if it is an imposition by force on this market.

An optimization does not itself have to have a valuation. An optimization which searched for eternity is still an optimization. That is to say, it is not that the forex market searches for a valuation and then finds it and then searches for another one. It is rather that it is a pure optimization process. It reflects something which is part nature and something more, that is possibly the nature of the way the mind computes which is not about end points at all.

It can be argued that forex is a purer expression of this, that is to say that the equity market also attempts to do this. In a properly working equity market, one computes future estimation of value, summations of future income streams discounted in some way. While these are usually not accurate they give you a range which has a tendency to be accurate­, for movements of money flow. Capturing growth is something else. It is not possible to do either in forex. That is another way of expressing why one sets stop losses.

There is an interesting finding that the currency market is closer to a random walk than the equity market. These findings about forex have a tendency not to result in anything useful for making trading decisions, as well as being hard to interpret from a scientific standpoint. But it is to be expected, they are telling you that the market is not searching for a valuation, which you can set a range from a start point, it is an expression of the search for a valuation happening in the equity market.

Its Hurst exponent is not a random walk but it less than those found in other processes (but more than short term equity timescales), because it is still structured by the deterministic mechanics of those markets and more importantly by the bias of that optimization.

If there were a scale to forex, it would probably have been found by now. That is what one searches for with RSI for example, a point of reference. It could be argued that forex is a Hurst process unstructured on any determinism. Structuring by chaos does not imply any determinism. But what does it imply. It implies moments when there is a reference, that is when RSI has some chance of working.

Does this imply that RSI finds that scale in equities. On the long term investing timescale it does seem to. It does seem that longer term that the equity market is firmly a chaos process, short term it probably is not. So what do equity day traders think of RSI, it seems as problematic as forex. I would suggest more problematic because RSI in forex does seem to capture short term processes native to forex.

That is to say that optimization does not worry about time scales, in fact forex may be  more of a deterministic process on shorter time frames. It could be argued the the 30min time frame optimizes the optimization itself and equity chaos. It does seem that long term forex is not really anything except a flux of optimizations which have no reference at all, not even to themselves.

However there may be determinism in optimizations. Edgar Peters notes that Mandelbrot noted that economic cycles mean nothing if they are a Hurst process. This is because they happen because of something outside the system. However the abrupt changes of Hurst processes (which forex seems to be) may have an origin within the system.

This blog believes that this is because of the optimization process. But again at long term time frames unless the currency is directed by interest rate differentials or growth processes contingent on a growing economy, both of which are subject to huge abrupt reversal, producing massive margin calls, this does not seem to produce directionality. It seems to be a purer expression of forced valuations and their consequent reversals.

That means that those who try and invest in forex long term expose themselves to devastating risks (that does seem to be the case). Does that antagonism exist in long term forex trading. That may survive because it is not a process, it is market makers looking for a profit. Thus long term forex trading may put yourself straight up *against* the market with nothing in between. Long term investing (or simply investing) most certainly does not, it puts you with the market, as it grows companies to their potential.

The realities of money flow means that one has to usually hop on and hop off on that ride. However those money flows are sourced through forex, thus it may be possible to use that to help you know when to hop on and hop off, in that sense forex and equities go potentially well together. Like a persistence of structuring into that market.  Essentially optimization is best for short term scales, determinism for longer term scales. Optimization is a fine grained process, determinism a very coarse grained process (with systemic evidence such as persistence).

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