Tag: random walk

Random walk: understand supply and demand

If you have not read yet the post about random walk index, please do so because we are going to dig further on this wonderful random walk space.

As highlighted many times, trading is about YOU. You have some objectives, you have some time you can allocate to trading, you have sensitivity whereby you don’t want to have long series of failures even if at some point you get a 200 RR trade which make you hugely profitable, etc, etc…

To apply random walk, you first need to define for how long you commit your money to market, then change the parameters to capture moves within your sensitivity. Some random parameter testing will help you through this first phase.

Random walk is indeed about capturing trends as explained in previous post, but it can also show you some supply and demand zones from which you can kick some very good trades. Note that you would be better off of course with an order book analysis, but institutions orders are well hidden and any supply / demand zones displayed on chart are therefore pure conjecture.

So let’s bring back Random Walk Index on the price chart itself:

The supply zone is displayed in red colour, the demand in green colour. The outside is purely a Donchian channel and the width is a function of volatility. When prices take off from demand zone, they will go to demand zone. It may be also that demand zone comes to prices and stops the movement. A trend emerges if prices manage to go through the supply zone external band. Easy, isn’t it?

When supply and demand zone are close to each other, prices exit from one zone to fall immediately in the opposite zone, it kills the chance of getting a good trade. This is a flat erractic market.

Question: how do I get the buy signal? Come on! Just bring up the random walk index indicator! Crossings of RWI lines or crossing of RWADX with its signal line mark the spot!

For a buy trade, your initial stop should be positioned slighly below the demand zone. Your first target price should be somewhere in the supply zone. If trend picks up, then a trailing stop just above the demand zone. Take partial profit along the path. Example of perfect trade:

That’s it! As a conclusion, random walk theory helps visualizing supply and demand zones, and therefore facilitates congestion zones indentification. We can trade between the bands or trade the trend when bulls or bears manage to go through. No other indicator is so flexible. Best indicator ever? Maybe 🙂

Until next time, trade safely.

Random Walk Index : best ever indicator?

Random Walk Index is an indicator widely available on all chart platforms, but once you display it, you come up with the immediate conclusion about it uselessness.

Indicator is made of 2 lines, RWIH representing bulls in blue color, and RWIL representing bears in red colour.

There are many problems with the display:

  • The calculation of red line is completely wrong if your refer to the formula and try the calculations in Excel for instance. Why can the same bug be seen on every single trading software????
  • The ATR formula used by the software are NOT a simple moving average. They use RMA or others.

Have this interesting indicator powerful features been concealed? On intent? I will let you devise, this post will attempt to restore its original features, and provide enhancement to make it more readable and useful to lay traders

Same chart as above but with original formula

As you can see, it looks completely different.

The RWI has first recentered to zero and an horizontal line has been set at 0.25 level. When the blue line is above this level, it clearly indicates a bullish trend and the opposite for the red line.

When both lines are below 0.25, and even better below zero, it indicates a flat market. If only below 0.25, it indicates a local congestion zone. In any case, we can think of those as accumulation or distribution zones.

By construction, the RWI takes into account prices (calculated upon highs and lows) and a time window (the input parameter). Inside this window, movement is considered random and you can refer to drunkard walk theory in this post to know more.

This looks like much more a useful indicator, isn’t it?

Let’s not stop here and add an other line, similar to Directional Movement Index (and ADX, ..). It will be differnce between the 2 index lines, smoothed by a SMA.

This RWADX line allows the anticipation of crossings and is another key. It can be of further fitted by a signal line to deliver buy and sell signals.

On top of trading rules already mentioned, we can add these ones to use the RWADX:

  • When RWADX crosses it signal, it may indicate a buy or sell signal. One RWI must be above zero and go up, while the other one must go down and value below zero.
  • When there is a divergence with prices, one must understand the cause as we are working with a time window. A previous peak may not be accounted for any more. The way to check that is looking at upper time frame.
  • When the signal occurs in counter trader (buy signal below zero), one should drill down to lower time frame to run a with the trend trade.

Let’s look at two examples:

Moving up to 1h time frame, we see both RWI ines going below zero, indicating flat market.

Now Let’s look at this short signal

It is countertrend trade, so let’s drill down to 3 minutes chart:

Great, here we have a stong trend, we could have anticipated the entry of course, but still a lot of profit to capture 😊

This is not complete trading system, we would need to have SL’s and TP’s. But even the crossings are extremely nice entry and exit signals.

Conclusion: the RWI has been around for a very long time, has surely been scraped intentionally to hide very powerful features. It goes even further, if you replace RSI by this revised  RWI in other indicators such MCDX, you will get sharper and more accurate signals. You will overall a different understanding of the market, so it can also be used as a confirmation. Its capability to detect flat and congestion markets make it an invaluable tool in your trading strategy.

Pitchfork validation: your most important work before trading!!!

Pitchfork trading is not that tough providing that rules are followed. So far we have covered market structures, how to get a signal from pitchfork, which pitchfork to select based on market structure, and what to expect by knowing about possible market structure that are coming after last pivot or swing point has been confirmed by a signal. Please review previous posts, signal is always given by the exit of a valid pitchfork. But wait… what is a valid pitchfork? This is what we are going to answer in this post.

Let’s start with a story though. When traders say that they trade ‘price action’, it is a non sense, they are trading price reactions. Supports for instance are about price hitting same range of price a few times in the … past! Resistance is the same. A moving average tells you the average price in the timeframe between now and a few days or units of time before. It is expected that prices will bump again or react in the future on these same levels of the past. And why would prices do that?

Reason is self fulfilling prophecy as many traders expect these levels and play accordingly. So they can manage, some with good level of success. But it does not work when market is trending or shows more erratic behavior. Also predictions come in terms of prices, not time, which can be an other issue in flat market. The random walk strategy (see other posts) addresses some of these concerns in adequate manner.

Pitchfork trading takes the problem out of the box. We know there was some market action in the past, which can be shown with market structures. Newton has stated that for each action, there must be a reaction similar and equal. Does this apply to market? Market structures or fractals (by Bill Williams) indicate there is fractal nature or some ‘beauty’ like things in nature. Note that we observe the market in some naive way, not an in the box thinking. Markets are free sort of to move the way they want, but if we push them too much in one direction (pivots), they are likely to revert and move in opposite direction relaxing the energy accumulated in first move. The moves are not (always) equal in price movement, because energy released is based on time, so duration of movement.

Having said that, you will read in many books or other websites you should draw a new pitchfork as soon as you get a new swing point or pivot.

How many of you would draw that pitchfork after, of course validating SP1 with a mini pitchfork and say ‘fine, looks like I can put a Target Price on the median’ maybe at the intersection with some Fibonacci levels???

This pitchfork is just NOT validated!!!! Look, price even gets out of the pitchfork a few candles after your entry (Assume for now you are reasonable and have put a SL below SP1). Let’s see what happened next:

Maybe you managed to take some profits but prices never reached the median. And maybe you are going to short, because prices are supposed to go below SP1 in that case because they did not reach median line? Wrong again:

What happened? A pitchfork is validated if it is tested before going forward (so it fails when prices go below) and pitchfork and its warning lines describe accurately the price action (in the past!)

Here we see some ‘impacts’ but major peaks and troughs are not sitting on pitchfork or warning lines.

Can we improve?

See? I now have major peaks or troughs on the pitchfork itself extended to the past. Pitchfork is now re-tested, and no surprise prices go to median and reverse. There might be other possible or even better solutions. But look at the graph again: price oscillate nicely over either the median or MLH’s, it gives a good feeling you are in sync with the market!

What did I do? I moved the anchor (SP3) of my pitchfork to a previous trough, and I am getting a less sloppy pitchfork, with more trading value. I could even have move the anchor to some unknown price area, thereby entering the realm of hybrid pitchforks. For another time!

Until then, trade safely!

Bitcoin: Time for Sales! 25% off! Sales!!

At last!! An expected and welcome correction on Bitcoin.

MACD is still positive so it is not a bearish trend change. Volumes are increasing on this last move, so it is very possible for Bitcoin to reach my random walk objective of 41800$

Once we get there, higher than the November low, we will obviously have an hidden divergence on MACD, Bitcoin should go back up from there. Careful, however, wherever Bitcoin goes afterwards back up, the market will be in unstable configuration, which might bring it down to 20k$, which be of course a huge buying opportunity. We are not there yet!

Until next time, trade safely!

The boring market report Feb 15th 2021

For bull traders, life is easy as I will show again in the next few graphs. Our random walk tells us tells us when to step in, then get out. Two options to get out:

  1. Partially on first price objective and then wait for the stop
  2. In case of time out (the observation period), try to exit on multiples of risks (the dotted lines)

Case in point with SOX. Price objective is recalculated each day, but the flat sections above major troughs are the ones we target. SOX is above the green belt, even making new highs. Just hold for now.

Tesla: you should start raising an eyebrow or two! See that divergence with MACD? Worth securing some profits…

Bitcoin is back up again after the January consolidation. Getting above the green belt was a good buy signal. It has already passed through the first objective (not shown) and it adheres to the second dotted line. Your stop should be bottom of the green belt for longer term, and top of belt for short term trading. Next objectives are 53700$ and 58200$. 50k$ might be a short term psychological blocking point but random walk says not to care!

Etherum is wonderful. No need to do anything.

That’s it. Until next time, trade safely!

The boring market report, Feb 3rd 2021

We talked about the short squeezes, which if coordinated, can lead to strong bull markets. This is usually the case when prices reach an area around the one year high, which is seen as resistance, and so many are shorting to benefit from a price reversal. This works from time to time, but the back testing does not validate it on markets, all stocks, … so be careful!

Coming back to our random market model, it is easier to pick up a trend when it starts, and drive it until it wears out. That is what I am doing with Bitcoin and Etherum. Bitcoin has walked back from its recent top to the random walk path (RWP) and is ready to pick up again. MACD is still largely positive, no reason to exit for now. A partial profit was of course welcome in January.

Etherum is even stronger. The RWP has not even pointed south one day! I don’t know if it will go to 100k$, but 1800$ is surely next target in the short term!

Tezos might be a candidate for near future. MACD is in positive area after a divergence, so just monitor!

There are two crypto-like stocks (in terms of performance). One is of course Tesla and the other one is …. surprise…. Ford!

In spite of never ending pandemic, a looming economic crisis, everything is bull, except maybe dollar and gold. Strange, isn’t it?

That’s it! Until next time, trade safely!

Relative Strength Index: weaknesses exposed

Today we will take a quick look at most popular, most used indicator, but I have never understood why traders give it such value! Let me give you some tips to make it interesting. We are going to use Facebook for our study!

On the graph, you can see RSI indicator at the bottom, just below our customized MACD. It looks very noisy especially with default parameter 14, but since it is an oscillator (as opposed to trend indicator that MACD is), you may spot better synchronization with market tops and bottoms. If you can’t see, move your seat away from your screen, a bit more, even more… can see now? Good… The blue lines indicate the overbought and oversold levels, which, as you can see, are not reached very often!

So what’s wrong? The problem lies in RSI formula:

RSI = U / (U + D) where U is average of up moves in last n days, and D average of down moves over same period.

As I have previously demonstrated, market is a random and existence of trends is the proof of its randomness. So where is the link between this formula and random nature of market? The calculation could give similar results whether all the up days are consecutive or not, so with totally different market configurations. So, yes, it may work if you are very short term trader (a few days at most) and work out the divergences, market tops and bottoms, and decide what to do about it.

Could we modify it for more interesting usage? Of course! We can even use it for trend trading. Just replace delta between today’s and yesterday’s close by the delta measurement on your favorite moving average!

Now look at this new indicator. Buy signal is generated when improved RSI (iRSI) crosses above 50. You will notice it goes straight to 100 and stays then there until exit time. Easy, isn’t it?

As usual, use a stop to secure your gains. You may also define overbought and oversold areas at +30 and +70 if you want to stay with the trend as long as possible. False signal do exist of course, and there are 2 on the graph; the moving averages tell you not to go!

That’s it. Until next time, trade safely!

To trend or not to trend, that is the question

Today we are going to study how trends transition to more or less flat markets and how to position ourselves for the best!

I am sure most of you are already familiar with indicators which supposedly indicate when a market is trending, and when you would be better off sleeping and out of the market.

Moving averages are close to be one of best indicator for that purpose. See that graph of Microsoft with Alligator indicator. Note ADX indicator at the bottom does not indicate too much!

The truth is investors are either having the same opinion at the same time and there will be a trend or investors disagree and market ends up being choppy and overall very flat. So any time that you see what could be the end of a trend, switch to drunkard mode and start counting the steps! If you need background information, please refer to this blog post.

Sure enough you could wait for prices to cross Alligator lines and then that colors are in the right order, … then you may have lost 50% or more the big next move! You need think differently. Don’t worry, I will skip the action-reaction lines for today!

First step if course to detect the end of an existing trend (at least 2-3 weeks long), you can use MACD crossing over its signal for this purpose. See this example with AMD:

What the heck am I supposed to do here? We are obviously leaving a short down trend and we don’t know where market is going to go. Nobody does unless you can dig into the brains of all investors at the same time!

Again we assume the most recent bottom is a lamp post, from where our drunk guy is going to walk northwards, maybe in trending manner or in random hesitating steps. But we know about the objective he can reach within the next period of observation. This is the first dotted line above the candles. In this example, it is 8 steps away and we are going to draw lines every 2 steps.

Now we are ready, the 3-months objective is roughly 55$, you need to use a convenient stop to protect and dimension your trade. See this post for instance. Let’s accelerate the time now!

2 weeks later, objective is reached (8 steps), the drunkard makes it even to the 10th step. From there, market reverses, a new long trend does not really pick, so you can do the exercise in opposite direction:

This time the drunkard does not go beyond 4-steps and after 3 months, you need to give up your short play. Then MACD goes again above signal

We reach first objective within 3 weeks, but this time the trend continues reaching 20 steps. You have successfully mixed together trending and random action!

That’s it. It does not need to be complicated. Don’t forget to choose stocks or indexes that have the capability to trend. Until next time, trade safely!

The boring market report – September 18th 2020

Volatility is still quite high out there, so the chances of big downfall are somewhat limited, … but non zero!

The graph of Nasdaq will show it all:

There is a nice divergence with WAD2.0 indicator and my personal indicator indicates a correction is already taking place, which is true. But before taking a position, you need to ponder about the volatility and objectives.

Volatility is still high, but a down move results in increasing volatility. So the best shorts start from small volatility. As said before, volatility and price objectives are closely linked together. 8940 is probably worst case objective but reaction lines (not shown) tell me it is an improbable scenario (at least not in straight line). I therefore favor more horizontal wandering for some time, … until we get exciting news like end of pandemic, or US election, or ????

Short Tesla and Buy Ferrari?

Tesla may have gone up pushed by a whale and bulls have bought hysterically the stock. But it was stopped… by a reaction line! Just kidding of course, but it is worth noting that the action-reaction theory works whatever market conditions to predict somehow where market hiccups or changes direction!

Market fundamentalists estimate the real value of Tesla to be around 240$, meaning it was somehow well priced beginning of July before acceleration. Shorting Tesla is an interesting bet but be careful, trend is for now up and very strong, volatility needs to decrease first so it can go up for a downtrend!

No need to say I am very bullish on Tesla in the long term but they need to produce and sell more! Back to basics!

Ferrari on the opposite did not benefit too much from recent rally, a small 50% gain! Because of small volumes and many gaps, I am working on the 3-days graph! Stocks still bumps on random walk lines and Ferrari was also stopped by a reaction line. Ferrari is a totally different business: you order one now for 100k$+ and you will be delivered in 2022! The correction is likely an opportunity to get extra stocks if you can not afford the car itself (even second hand units can be more expensive than the brand new ones!)

I will follow this idea in coming weeks: short Tesla and get more Ferrari stocks with the gains! Careful! Market needs to be re-assessed with each new data and I may totally change my mind. Market is not ready for now.

That’s it. Until next time, trade safely!

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