Trading with Market Statistics V. Other Entry Points

[jperl]

	Quote:	thrunner
	Thank you Jerry for the summer lessons I came back from vacation found that you have really done some interesting work. My question for this video is you said "there is no reason why it {target} shouldn't hit the 2nd standard deviation, the volatility of the market says it should". How exactly are you calculating this? It seems to newbie and me that 95% of the prices have occurred within SD2, so going beyond 95% is not a high probability trade. Are you basing this on skewness calculation? (eg, higher the skewness, the greater probability of exceeding SD2). Is there a skewness risk involve in this trade? http://en.wikipedia.org/wiki/Skewness_risk

Very good questions thrunner and good observation as well.
First let me clear up one poorly understood idea about the SD. Most traders think that 68.3% of the data falls within 1 SD and 95% falls within 2 SD. This is only true for the normal or gaussian distribution. For skewed data, that is data that deviates from normal behavior, the best estimate can be obtained using Chebysev's inequality, which states that no less than 50% of the data falls within 1.4 SD, and no less than 75% falls within 2 SD. No less than 89% falls within 3 SD. These numbers are quite a bit different than that for the normal distribution.

These numbers are of course lower limits. The exact values could be computed from the distibution function. But I don't think there is much to be gained knowing that say 55% of the data rather than 50% of the data fall within 1.4 SD.

Another important point which I stated as a theorem in the SD thread, is that for any arbitrary distribution, computing the SD with respect to the VWAP yields the smallest SD possible. What that means in practice is that if you compute the SD with respect to any other price (eg the 1st SD price), you will by the theorem get a larger value for the standard deviation. This implies yet a larger volatility at the 1st SD than it does at the VWAP.

These two pieces of information taken together suggest to me that getting to the second SD (computed with respect to the VWAP) is not all that unreasonable although of course with greater risk than trading at the VWAP. Getting to the 3rd SD however is problematic.

I will discuss in the next thread, about what to do when you take a trade at the 1st SD and the price action does move against you. There is still room for pulling a profit out of the trade.

[darthtrader]

	Quote:	jperl
	Volatile for sure, but you don't want to be trading anything with large spreads . So cooter how about giving us a list that you consider liquid and I will take a look at the volume distribution function.

Hey Jerry, can you look at corn? Corn traded 100k contracts today, beans/wheat were much less.
I don't think gold trades enough to get a good sample.

Do you get that many different vwap setups on the russel vs ym? I'm not familiar with the russel really to know how correlated it is vs ym.
maybe just watching corn/russel/ym would be a good start.

[jperl]

	Quote:	darthtrader
	Hey Jerry, can you look at corn? Corn traded 100k contracts today, beans/wheat were much less. I don't think gold trades enough to get a good sample. Do you get that many different vwap setups on the russel vs ym? I'm not familiar with the russel really to know how correlated it is vs ym. maybe just watching corn/russel/ym would be a good start.

Well if you just trade the VWAP itself, you should follow 4 or 5 different instruments. YM, ES, NQ, ER2, ZC would be good choices. I only follow ER2 these days, since I trade all over the chart.

[darthtrader]

	Quote:	jperl
	Well if you just trade the VWAP itself, you should follow 4 or 5 different instruments. YM, ES, NQ, ER2, ZC would be good choices. I only follow ER2 these days, since I trade all over the chart.

Very interesting on many levels.

I take it you focus on ER2 now because of volatility?
another thing is how would you order these contracts as far as what to look at as a newb for setups? the most interesting thing about your threads is every time its the total opposite of what i would do off the cuff. With that in mind I would think you would order them... ER2, ES, NQ, YM, ZC as far as what to look at first?

[jperl]

	Quote:	darthtrader
	Very interesting on many levels. I take it you focus on ER2 now because of volatility?

Actually ER2 recently has gotten more volatile than even I like. It's getting close to my risk tolerance.

	Quote:	darthtrader
	another thing is how would you order these contracts as far as what to look at as a newb for setups? the most interesting thing about your threads is every time its the total opposite of what i would do off the cuff. With that in mind I would think you would order them... ER2, ES, NQ, YM, ZC as far as what to look at first?

For setups, it doesn't matter what contracts you look at. More important is what the volatility is compared to your risk tolerance. Once you establish a risk tolerance for yourself, and you know what the volatility is of the contract you are trading from the SD, you will know what to trade.

[Dogpile]

<<I have two questions regarding this thread. First, is there a TradeStation eld for plotting the PVP?>>

you can use Tradestations 'Matrix' window to see the PVP (longest volume bar)...

[houghton]

Thanks, Dogpile. That, of course, requires manual insertion of the PVP line onto the price chart. I'm wondering how Jerry plots his PVP which updates automatically as PVP changes during the day.

Karl

[nelo]

Jerry,

In (almost) all books is suggested to strive to achieve 3:1 RRR (reward to risk ratio). I do not doubt your method works (with enough practice) since I am watching it and there is nothing unreasonable. But the RRR seems more like 1:3 (taking trade on 1SD), so with one loser you have to have 3 winners to break even at least. This leads to huge and fast drawdowns - if it is not compensated with a great winning probability.

Every method has some psychological draw-backs, or requirements, for someone is more suitable scalping and for someone trend following. What psychology set-up or "traders mind" would you recommend and what expectation a trader should have to successfully follow your method?

Maybe you could also share some of your path, how did you discover your style. I believe most of us will appreciate it.

Thanks for great videos and sharing your experience.

[jperl]

	Quote:	nelo
	Jerry, In (almost) all books is suggested to strive to achieve 3:1 RRR (reward to risk ratio). I do not doubt your method works (with enough practice) since I am watching it and there is nothing unreasonable. But the RRR seems more like 1:3 (taking trade on 1SD), so with one loser you have to have 3 winners to break even at least. This leads to huge and fast drawdowns - if it is not compensated with a great winning probability.

Good observation nelo. I was wondering when someone would see this. The point I will make here, is the old paradigm about choosing trades with a 2:1 or 3:1 reward/risk ratio with fixed stop losses for most traders results in a slow bleeding of their account. We are going to cover this topic in more detail in the next thread, coming soon.

	Quote:	nelo
	Every method has some psychological draw-backs, or requirements, for someone is more suitable scalping and for someone trend following. What psychology set-up or "traders mind" would you recommend and what expectation a trader should have to successfully follow your method?

Probably the most important mind set that I had to overcome, was giving up the idea of fixed stoploss on every trade and substituting the idea of risk tolerance instead. It wasn't until I did that, that I became a profitable trader.

	Quote:	nelo
	Maybe you could also share some of your path, how did you discover your style. I believe most of us will appreciate it. Thanks for great videos and sharing your experience.

My style is something that developed over many years. I was initially a strong proponent of classical technical analysis and traded futures and stocks for quite a number of years using classical methods. I oscillated back and forth between swing trading and daytrading, but was never satisfied with the results. Some years were profitable, other years were not. There was no consistency. I slowly came to the realization that classical technical analysis was not going to yield a consistent picture of market behavior. It was too heuristic. I wanted day to day consistency. I looked very carefully at market profile analysis. Realized that there was something there but it was woefully incomplete and in some cases just plain wrong. I wanted to be able to write my own software, but there were no good charting packages for doing that until ensign software came along. Being a student of molecular simulation theory, I knew enough about statistics to realize that the logic of the market could be found in a proper statistical analysis of the data. That coupled with understanding risk tolerance and trade management is where I am today. My trading is now quite consistent and I am happy to say has become quite enjoyable. I am both a teacher and student. I've been both my whole life and I am happy to share with you what I've learned about market behavior. There is still much about market behavior that I don't know and learning about the markets will be a lifetime experience.