23 July 2011

Forex and Stock Retracements and Pricing Stability

What exactly is a retracement. A retracement is precisely a valuation, in particular in forex a valuation of one currency referenced to another, which keeps open the possibility of the market itself valuing the currency, as it wishes, but this is not what tends to happen. What does it mean then that directionality makes a wave opposite to the general direction of a pricing trend.

The point of a retracement is that it is unexpected, but by many, not all. Thus until it happened it had near zero expected probability of happening for many, especially if as some argue, retracements are forced valuations by large players, instead of technical phenomena due to market structure.

It did not have certainty of happening for those why may have caused it, for precisely the reason that the market will not necessarily react to a plunge in a valuation on order flow in the same direction. Sometimes it will simply absorb these valuations, other times it will reverse.

That is the problem with probabilistic approaches to forex trading. The probability of a tradable move only exists after the move, not before it.

Is the probability of a retracement zero before it happens for many. No, because there are usually signals for it and large orders take heed of this because they have to, especially if they are causing it. But at the same time, many tend to trade at precisely this moment, in the opposite direction to the retracement.

Thus the probability of a retracement is as an exit signal. That is, it collapses the *probability* of the trend continuing to zero, in effect.

Thus part of the causality of a retracement is the large orders or smart money reversing. Thus when a retracement happens and it is noted that orders cascaded at the top, this is not surprising.

By causality I mean external factors which may or may not be internally causal. That is the market can quite easily take this situation and rise to new heights, assuming the direction was long.

However the relatively low probabilities associated with pattern trading, defined widely, is not unexpected. That is, there may be no probabilities associated with charting formations. There is simply enumeration of events after the fact.

What I mean by this is that the market is a dynamic adaptive and anti-adaptive system, it may not be probabilistic, if it were, one could indeed make money by playing it like a pro gambler, by making high probability trades time and again. What it is adapting to may be incoherence in pricing.

If one trades in forex one may notes that gambling in forex is deeply problematic. The problem is that those probabilistic trades have less or no continuity of probability at all. That is, in equities there is information carried through valuations, especially over the long term. That information is biased towards increases in valuations, that is the structure upon which to base a probabilistic decision.

In forex there does not seem to be such information passage, in fact it seems like the discrete nature of forex events, closes off information passage, making this quite structured market essentially random, but not usefully random either.

This is why I look at process, because it provides a structure by which one can value valuations which are not inherently consistent, it provides a bias by which one can make probabilistic assessments of some kind.

So there are probabilistic trades in equities ? I would suggest not. But what there is, is precisely that which one tries to trade on in forex. It is that persistence to an extent, but this is only a structuring, within this is a dynamic process through which valuations may occur.

That is the process to trade on and it is not probabilistic, it is causal. But the causality is probabilistic before the event, since it is essentially unknown, but it may not be probabilistic over extended periods of time, in certain circumstances, in certain markets.

So if probabilities do not help too much, can we talk instead of stability. That is, we assume that a retracement is an instability in pricing. There is an inherent instability in currency pricing, as one is making a relative valuation.

Retracements can be seen as a way of cohering relative pricings. Then we can perhaps give a kind of probabilistic assessment of it occurring. Is this pricing unstable...

However it has been suggested here that valuations are inherently stable, thus we can see any trending process as unstable. This raises the question of the difference between a trend and a retracement. I think that is not a question to consider that much in forex.

In day trading the sensitivity of pricing to external inputs, make the causality of similar chart patterns different. Why this matters, is something one discovers as one makes a valid trade to find it rapidly retracted because of a news event, or trended against your position. But on the chart it is a pattern which may actually fit in with a technical framework, in fact I might hazard it usually is.

However what I have been suggesting is that the processes in the market itself, especially those from its interconnection with the economy and the equity and other markets may be causal in a stronger way and may perhaps be causal on the technical consistency noted.

Thus anything you want to trade on in forex is unstable, short or long term, but in equities, over the long term, it is stable. However forex pricing itself is stable and equity pricing may not be. Why this is, is the apparent fact equity prices can be pushed up on relatively unsound assets valuations. This is not a state of deception, it is simply that the equity market will value on future expectations.

But over the long term, this is inherently unstable, I mean the act of making such valuations. The speed at which prices collapse to or below present asset valuations when such future expectations are shown to be improbable, seems to show how such valuations are like words in the sand, clear and undeniable, just before the wind blows, gone.

In fact when a company attains that state where its share price will range back and forth, it has reached a price stability akin to forex at all time frames. This said, there may be an asymmetry between very short and very long and the rest of forex time frames.

I say this because I note that some believe that long term frames can be valued. that, is the function of the forex market changes at these long terms. At short time frames (1-5min), for a human traders one is coming close to the functional changes high speed trading, which searches for structural regularities as they come and go.

But as well, one may be coming close to the processes in forex and equities. What I have suggested is that those processes are apparent at long term frames and short term frames. Why this might be, is a function of what actually happens thus at these time frames.

That is the stable, adirectional processes at work, are given directionality, akin to the way phenomenal money flow during the crisis could, but not necessarily would bias the market to a currency move, again and again (not a usual feature of forex). That is the long term processes of the equity market simply disappeared and the forex market proceeded to stabilize valuations.

However this process was equivalent to the collapse of a company valuation to its assets pricing, since this was what was happening in the crisis. It was not a collapse based on fears of future valuations, for example earnings curtailed by a coming recession, or missed.

It was a collapse based on the valuations of extremely highly valued assets being based on apparent mis-pricings. As noted, other high quality assets, did not have anything like such a steep fall, and there was a revaluation based on sets of companies. In fact some classes of companies rose as the market began to fall into the crisis itself.

That is, the retracement of the market itself was arguably a true valuation, or more specifically a numerically accurate valuation with coherence. It might be asked are there retracements in forex which are like this, or are they the kind of valuation function discussed above. One might expect that such valuations might be more detectable than others.

However the pre-crisis valuations were not necessarily inaccurate either, as it could be argued that they were based on future projections, that is that financial stocks for example will attain collective heights again. This takes a long term functional view of the equity market, which is not invalid.

That is precisely the problem with forex, for this is even more the case. The separation of valuation from assets is inherent here, and attempt to value like this tend to come undone, in fact retracements could be seen as this slippage process at work, continuously, which suggests that the asset valuation foundations of the equity market should be kept as sound as possible.

© 2011 Guy Barry - All Rights Reserved.