A Simple Approach to Market Statistics

I have noticed a lot of people in here fighting trends... A lot of people don't have the slightest grasp of the statistics of market movement. I decided to share with you this simple way of analyzing probability. I don't actually use this when trading so it won't hurt me to share it. However, I do use it to review the overall situation.

First, let me give you cheat-sheets for compounding probabilities. A "OR" compound allows you to compound the estimated probability of an event like Mean Return. A "AND" compound allows you to estimate the compound the probability of two separate events like price testing a half ATR under mean and a half ATR above mean in the same candle.

Here are the Cheatsheets, next post is the first lesson.

Probability || Compounds
90% Probability 2xOR Compound = 99%
80% Probability 2xOR Compound = 96%
70% Probability 2xOR Compound = 91%
60% Probability 2xOR Compound = 84%
50% Probability 2xOR Compound = 75%
40% Probability 2xOR Compound = 64%
30% Probability 2xOR Compound = 51%
20% Probability 2xOR Compound = 36%
10% Probability 2xOR Compound = 19%

90% Probability 3xOR Compound = 99.9%
80% Probability 3xOR Compound = 99.2%
70% Probability 3xOR Compound = 97.3%
60% Probability 3xOR Compound = 93.6%
50% Probability 3xOR Compound = 87.5%
40% Probability 3xOR Compound = 78.4%
30% Probability 3xOR Compound = 65.7%
20% Probability 3xOR Compound = 44.8%
10% Probability 3xOR Compound = 27.1%

90% Probability 4xOR Compound = 99.99%
80% Probability 4xOR Compound = 99.84%
70% Probability 4xOR Compound = 99.19%
60% Probability 4xOR Compound = 97.44%
50% Probability 4xOR Compound = 93.75%
40% Probability 4xOR Compound = 87.04%
30% Probability 4xOR Compound = 75.99%
20% Probability 4xOR Compound = 59.04%
10% Probability 4xOR Compound = 34.39%

90% Probability 5xOR Compound = 99.999%
80% Probability 5xOR Compound = 99.968%
70% Probability 5xOR Compound = 99.757%
60% Probability 5xOR Compound = 98.976%
50% Probability 5xOR Compound = 96.875%
40% Probability 5xOR Compound = 92.224%
30% Probability 5xOR Compound = 83.193%
20% Probability 5xOR Compound = 67.232%
10% Probability 5xOR Compound = 40.951%

Probability && Compounds
90% Probability 2xAND Compound = 81%
90% Probability 3xAND Compound = 72.9%
90% Probability 4xAND Compound = 65.61%
90% Probability 5xAND Compound = 59.049%

80% Probability 2xAND Compound = 64%
80% Probability 3xAND Compound = 51.2%
80% Probability 4xAND Compound = 40.96%
80% Probability 5xAND Compound = 32.768%

70% Probability 2xAND Compound = 49%
70% Probability 3xAND Compound = 34.3%
70% Probability 4xAND Compound = 24.01%
70% Probability 5xAND Compound = 16.807%

60% Probability 2xAND Compound = 36%
60% Probability 3xAND Compound = 21.6%
60% Probability 4xAND Compound = 12.96%
60% Probability 5xAND Compound = 7.776%

50% Probability 2xAND Compound = 25%
50% Probability 3xAND Compound = 12.5%
50% Probability 4xAND Compound = 6.25%
50% Probability 5xAND Compound = 3.125%

First, lets look at the ten period running statistics for the 5SMA on the EUR/USD weekly. Ever since the start of the trend it has maintained a 100% probability of prices touching under the 5SMA every week. There has not been one week where prices held above the 5SMA. This is quite normal for a moderate/strong trend.

Now, let me show you how to use the statistics cheat-sheet to come up with some very interesting numbers...

See the S 0.5- probability line. That has been the running probability of price testing a half ATR under the 5SMA each week. Lets assume the probability is still 80% even though it's probably trended down to around 70% at this point.

Any particular week there is a 80% probability of prices testing half a range under the 5SMA.

Compound it over two weeks...
80% Probability 2xOR Compound = 96%

Over two weeks the probability is 96% that one of those weeks price will touch a half range under the 5SMA...

80% Probability 4xOR Compound = 99.84%
Over four weeks the probability is 99.84% of price touching a half range under the 5SMA during one of those weeks.

Now, here is the kicker... The 5SMA has been consistently trending downward. Not only do you have a very high probability of price testing under mean, you also have a mean that is falling... This slants the odds even further to the bears!



Recently, there was a period on the daily where probabilities balanced out during the period of consolidation... But, before that the market was locked touching half a range under mean every day... And that mean falling by a third of a range or more per day...

The bottom line... Do NOT fight a strong trend unless you are a pro... The odds are stacked that you will get cut by the falling knife.

Forex markets behave like "Trending Random Noise"... They are much different than equities.

You must also realize a lot of different markets are "fixed"... It's not a fair horse race for the Bears and Bulls.

For example, the S&P 500 has maintained a uptrend of 20 points/month over the last couple years... Recently it's dropping down to merely fifteen points a month. Divergence and potential trend failure is approaching by next year.

However, if you review the statistics of the bull market from start till now... There was only one single month where prices failed to touch over the 5SMA... The debt ceiling panic of 2011. The entire rest of the market has maintained around a 40%+ probability of prices touching 1ATR above 5SMA, and that 5SMA trending up steadily most of the time... Especially since the market support programs went into play in 2012-2013 where the fed embarked on a new policy of modifying monetary policy in favor of supporting the economy.

40% probability of 1+ ATR over mean doesn't sound like much, until you compound it...

40% Probability 5xOR Compound = 92.224%
Over five months that is a 92.224% probability of touching 1+ ATR... And with a stable rising mean... You do the math.

Don't fight the fed!

Note, in the top left of these charts there are two numbers next to ATR, that is the 5SMA trend rate and the longer period SMA trend rate.



May the odds be ever in your favor!

My naming might have been confusing, so I changed it. The indicator lists the recorded statistics of market behavior, however... Current probability generally is trending slightly.

For example... There is around a 10% probability of 0.5+ ATR from short term mean each week by my estimate. (EUR 1.1459) Next week that will likely drop to about 1.1420.

Markets don't just shift on a dime... It will take a long time for the euro to balance out where the odds for the bulls or bears are even.

One thing very important to know... Markets have a tendency to run, and run very aggressively...

The more days down, and the stronger they are down... The higher the probability the next day is down, and so on! Things run onward until every single speculator is optimistic or pessimistic and piled in short or long. Most trends do not end without 90%+ polarization of the sentiment of the active traders/speculators in the market.