When you want to know where price is going to go, there are many ways to guess. Among others:
1. Return to average. If price go too far away from average, then they are likely to go back to average
2. Fibonacci retracements and extensions
3. Check analysts price objective
The weakness is the same for all: when? in one swing or after many up and down swings?
With volatility trading, we can answer thoroughly two different ways
1. The drunkard’s walk
The concept of ‘drunkard’s walk’ was introduced by William Feller by the following math problem:
If a drunk guy leaves the lamp post he is leaning against, how far would he have gone, on average, after n steps?”
The answer is he would have gone the square root of n multiplied by the average length of his stride:
√n * Average length of stride
Here is how to translate for price objective setting: start from a major price bottom, the first objective that should be reached within n days is the average price change (or Average True Range)
Example: if we look at an ATR over 25 periods (days, weeks), the first objective that can be reached in 25 days is lowest low (the lamp position) plus 5 x ATR25.
Easy, right? If objectif is not reached, then just give up.
When we say first objective, it is because we are considering a random walk, but if a trend is given birth (or the street has a slope for our drunkard), then prices may go much further away and you need to re-estimate the new objectives with each swing low.
The usual way to use action-reaction is enclose price action into channels, so as to get high probability entry points. Also the distance between lines gives the potential objectives in straight lines.
I am removing previous lines for clarity but I am now drawing an other set of lines. Distance between the lines also indicates potential
By having two sets of AR lines on the chart, crossing of lines indicate precisely where prices are going to go. There may be several possible objectives, but many can be discarded (too sloppy change required, or objective in the past)
See here yellow highlighted target reached almost on time (depending on accuracy of lines drawing)
That’s it! Because we are analyzing price and time together (aka volatility), we are reaching high quality trading