Two thoughts that have always stuck with me:
- If you long or short randomly, there is almost always some time x or price p that exiting will give you a profit.
- Probabilities concerning how price can move in the future, without context (past) are probably not useful since TA relies on trading the future based on the past.
To me, these are both true and important to be aware of, but the first comes to odds with the second in the sense that the raw probabilities have to be consolidated and meld with the model itself. The smaller your MFE/MAE ratio becomes, or the smaller the MFE becomes in terms of a raw pip number, the more “wrong” you are and the more likely you are to be in the wrong “direction”. Yet one can’t deny that no matter how bearish a movement is, there is always some room to go long. Understanding and using this is how it seems a lot of scalpers cut their losses. To me (although I have no concrete proof as I would need to know the complete strategy to know this) it seems like cutting losses is not about seeing a position go south and dropping it, but rather more about finding a way to the a movement that is down, and manage to get a few pips in profit in the slight up movement provided. I see now how range bars can attempt to solve this issue of how price can move in up/down direction at any one given point. However, a problem I’ve always had with any model or minimum movement statistic is that in practical trading terms, it’s very hard to put to use. Similar to transient zones from years ago, it’s easy to get a very high probability with a small profit, but that small percentage of time that fails very easily leads to a margin call.
I wanted to explore a bit more about how price moves from point A to point B, and what price at any (random) point looks like.
Raw MFE: Using H1/48 hour- Calculation of difference between max price of next 48 bars – current bar close creates the category “up”, and current bar close – min price of next 48 bars creates the “down” category. In picture form:
This helps answer the question of what’s the minimum movement in either direction at any one point? Something to be aware of is that sometimes price can gap down and stay down for the next 48 bars – in other words, the max upward movement can still be negative.
The 2% quantile is about 1/48. I kept 5% in even though 2/48 is about 4% and 3/48 is 6.25%. For what it’s worth, 4% is about 4 pips and 6% is about 6 pips. This means that roughly 1 bar in every 2×24 hour cycle has just a 2 pip movement in the non-favorable direction. Of course, bars aren’t random. It’s possible that you have some consolidation and a short blip before a reversal, in which case you could have 3,4 or more bars that only have that 2 pip “grace” area. So it’s worth also taking a look at blocks of 48 hours together.
These are looking at collections of 48 bars that themselves look at a 48 hour period, so the max period of time covered is 96 bars (bar 1 will look into the future 48 bars, bar 2 will as well, and since they are next to each other, bar 2 only creates 1 extra bar of “new” information). So although a bar will have that 2 pip buffer with frequency 1/48, 58% of assorted real data 48 blocks contain a minimum buffer of more than 2 pips. Hence why context is so important.