Trading Issues: Chaos Theory
In Credit Score of CreditGuru (February 26, 2010 5:54 am)
The introduction to the theory of chaos.
I’d like to devote some time to the curious theory of chaos which is interesting for many traders. Certainly there’s a possibility of studying the history of the market by mathematical and statistical techniques methods to define quite evident standard patterns.
For example I can say that shopping is an evident example of nonlinear dynamic systems. The chaos theory is a mathematical method for analyzing exactly this kind of nonlinear dynamic systems. The direct application of this method shows that market prices are highly random with a small trend component. To explain chaotic systems the concept of fractals are often used. Fractals are special trading indicators which are similar to each other. To cut a long story short I can say that they are such things parts of which are similar to the whole object. By the way there’s a popular example for explaining this phenomenon. It’s simply a tree. While the branches get smaller and smaller, but each branch is similar in structure. I hope it’s clear to you. So there‘s a certain similarly in price fluctuations. When the movement of prices starts for monthly, weekly, daily and intraday charts the structure of the movement is similar on each interval.
By the way there’s another characteristic of chaotic markets which is known as “sensitivity to initial conditions”. This is what makes dynamic market systems so difficult to predict. Since we can not exactly describe the current situation because there are a lot of mistakes and inaccuracies in the description of the situation accumulated over time accompanied by a lot difficulties closely connected with the system, so a precise foreseeing
is likely to be impossible to my great regret. Even if we could accurately predict tomorrow’s price change we would still have a zero accuracy in the prediction even for 20 days in advance.
A considerable number of thoughtful traders and experts is likely to point out that trading using 5 - minute bars is an attempt to trade the random noise and therefore it is a waste of time. Over time, those who trade the noise are doomed to failure because of the cost of trade such as commissions, swaps and so on. At the same time, these same experts argue that long - term price movements are not random. Traders can trade successfully on the basis of daily or weekly charts if they follow trends.
The question naturally arises. OK, it’s clear that both on the same market these short - term price movements are random. Why these random short - term movements have got a predictable character?
In fact, such a paradox can exist. The system may be random in the short term and be predictable in the long term. So you should take it for granted I suppose.
As in any other niche of our life Forex needs some education.
Surely, one can start forex trading and get quite successful about it. But sooner or later the losses will come. This is when one might think “Why didn’t I start with a nice forex book?”
That does not mean that after reading even the greatest forex book you will start closing trading positions with huge income, but this info will save you from lots of troubles.
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