jperl

What stuff are you referring to darth? Next thread will be on counter trend trades at the PVP. We won't get to details about HUP until thread IX or X.

Well Dogpile, I wish I had traded NQ today instead of ER. There were at least four good long entry points including 1 scale-in point. In all trades, the VWAP was above the PVP, so distribution was skewed to the upside as you can see in each of the charts below. Here are my NQ charts #1 Enter long at the VWAP 1933.50, exit at 1st SD 1938.25 profit 4.75 pts #2 Enter long at 1st SD 1939.75 exit at 2nd SD 1945.75 profit 6 pts #3 Enter long at 1st SD 1943.75 Scale-in at VWAP 1937.25 giving Break even at 1940.50 exit at 1st SD 1944.00 or higher profit 7.00 pts #4 Enter at 1st SD 1945.00, exit at 2nd SD 1952.00 profit 7.00 pts. Total profit for the day 24.75 pts Pretty good I'd say using just simple statistics.

Talking about burning out neurons, let me see if I can tackle this one from Dogpile: Sorry Dogpile, but this is just plain wrong. The standard deviation computation IS the true volatility, for the distribution in question, no matter what the shape of it, normal or otherwise. No, 2 std devs doesn't mean anything different. It's just that most people exposed to statistics, have only seen the normal distribution and think the whole world revolves around that (I guess that's why its called "normal"), so they think that 2 SD should always represents 95% of the data for any distribution. The normal distribution,however, is not the center of the statistical universe. There are more different types of distributions than you can count on both your fingers and toes. Academicians have been trying to pigeon hole the type of distribution that markets follow for years. The closest they've come is something called the Pereto-Levy distribution which I don't want to discuss here since it really doesn't have any practical significance for trading. The point is, no matter what the distribution function looks like, the standard deviation is computed in exactly the same way for all of them. How much of the data this represents will of course be different depending on the distributions shape. If you are thinking here that the VWAP is some psuedo mean then that's not correct. The VWAP IS the exact mean for the volume distribution. For any finite distribution of arbitrary shape, you can calculate the mean in exactly the same way. Ok, just don't call it a new mean. I've already given it a name. It's called HUP. We will discuss the meaning of HUP and pivots in a later thread Wrong on both counts. Skewed distributions are funky to you, because you are not used to them, but they have been around a lot longer than any of us have been on this planet. And once again, the mean for a finite skewed distribution is well defined. The VWAP is as mean as they get. lol

Good question and good observation darth. Here's the problem.In a short, if price is already below the 1st SD, (or above the 1st SD in a long) the probability of it returning to the VWAP diminishes with every tick that it moves down. Thus if you expect to take a trade at all, you have to find another entry point, since price may never return to the VWAP. You could of course develop a trading style in which you only take VWAP trades, but you may have to wait a long time for an entry. The 1st SD is then the next best entry target. Yes, if you enter at the VWAP, scaling in becomes dangerous. At the PVP, other things can happen which we are going to cover in the next thread. Scaling-in there or at the next SD becomes a touchy situation, definitely not for newbies. Advance traders might do so, but can easily get caught with there pants down (as I did today, but I didn't lose my pants, only my shirt).

You are quite correct here Dogpile. If a move from the VWAP gives the smallest SD (and thus lowest volatility), then trading at a price just above the VWAP (in the case of positive skew) should have higher volatility and should be a superior location for a trade in the direction of the skew. I thought to myself that this should be correct, but then realized that the probabilites for continuation in the skew direction is declining the further you move from the VWAP, which offsets the higher expected volatility. Exactly where the "balance point is" I don't know. I decided not to pursue this because there other interferences which I call HUP which are virtually impossible to include in a more general computation. HUP will be discussed in a future thread. You are correct here. The SD is a reference point rather than a point fixed in cement where you have to take a trade. When we discuss HUP in more detail in a later thread, you will see that more often then not, the entry for the trade is offset from the SD by the HUP. This can get quite complicated, so I don't want to get ahead of myself in a discussion of it here.

Except for basic ideas concerning statistical analysis which you can find in wikipedia there are no books or reading material describing what I've posted in these threads as it relates to intraday trading. It's all new stuff that I've developed over the years. I thought it would be a good idea to present it somewhere. There is also a short description of where I'm coming from in post 15717.

Good show on the computation dbntina and your analysis of the outcomes for various trades. As far as risk/reward, think of it as how much does it realy hurt if it only represents 2% of your entire account vs. how much you are hurting if you take multiple stoplosses. To get stopped out in the scenario that is described, the market would have to move 3 SD without a rotation against the skew. You can avoid a chunk of that by not taking trades at the 2nd SD, expecting a move to the 3rd SD, not a high probability trade.

If you have followed the details for scaling in, you should be able to answer the following questions. Take a shot at them and post your answers here 1)Assume your account is 50K and that you have a risk tolerance on any trade sequence of 2% of your account including commissions. A trade sequence is a group of related trades involving scale-ins and scale-outs and/or reversals (which we haven't discussed yet). Let's say you trade the Emini Russell 2000 index futures where 1 tick is worth $10 (0.1 points) and your roundtrip commission/contract is $5.00. You enter a 1 contract trade long at the 2nd SD, but the market moves against you back down to the 1st SD where you scale-in another contract long. The market is relentless and it continues to move down to the VWAP where again you scale-in an additional 2 contracts long. Again the market continues it relentless move down. You finally hit your risk tolerance at the 1st SD below the VWAP, so you exit your entire trade and are flat. Question: What is the value of the SD in ticks? 2)When you scale-in at the VWAP in the above scenario, the market finally rotates and starts moving back up. You exit the entire trade at break even +1 tick. Question: Where is your break even point including commission measured in ticks above the VWAP? How much money did you make on the trade? If you were able to answere these questions without too much difficulty, then you are ready to become a full time trader with all the rights and privileges granted thereto. You are also ready for [thread=2232]part VII[/thread]

In [thread=2130]Part V[/thread] of this series on trading with market statistics (click here for Parts[thread=1962] I[/thread],[thread=1990]II[/thread],[thread=2008]III[/thread], and [thread=2101]IV[/thread]), I posed the question in the video about what TRADER should do if upon entering a trade at the 1st SD, the market should move against him. I suggested that based on the data given there was only 1 correct answer. That answer we will now discuss in this thread. Before we address the answer, we need to discuss a related topic called risk tolerance. First what risk tolerance is not. It is not a stop loss that you set for each trade based on some support or resistance point you arbitrarily choose on the price chart. More often than not, this kind of stop loss is in the wrong place. These stop losses are not based on market volatility, but rather on some price point that "looks like it ought to hold", usually some local minimum (for long trades) or local maximum (for short entries). That they are wrong probably accounts for the large number of losing trades that new traders have. Unfortunately, most trading books tout these stoploss points as if they are written in stone. Phrases like, "you should only enter a trade such that your reward/risk ratio is 2:1 or greater" forces the trader to choose a stop loss which has nothing to do with the known volatility of the market. So what should you as a day trader do about stop losses? Well for starters, you should set a "system stop". This is an in the market hard stop far from your market entry which protects you in case of system failure (eg, your computer crashes, you cable modem dies, you lose electric power in your neighborhood, etc.). It has nothing to do with the trade itself. Any other stop you wish to use you keep in your brain as a mental stop. And where is this mental stop? Your mental stop should initially be a percentage of your account. Typical values bandied about range anywhere from 1% to 2% of your trading capital. So if you have a 50K account, you should be willing to risk up to 1K on every trade. The mental stop is flexible, it won't increase, but it certainly can decrease depending on the price action. For example if the price action makes the trade profitable, your mental stop can become a hard trailing stop. TRADER is now about to have a second epiphany. He is about to realize that by using risk tolerance instead of some fixed stoploss, he will be able to scale-in to a trade and not feel any angst about it, if the scale-in is within his risk tolerance limit. If it is not within his risk tolerance, then he should not have entered the initial trade to begin with. TRADER should always have a plan to either scale-in or to reverse a trade (to be discussed in a future thread), and the scale-in price should be a point where he could have taken a trade in the first place. Risk tolerance and scaling in may make you feel queasy, because it requires a paradigm shift in your thinking about what trade management is all about. It is not about setting fixed stoplosses and profit targets and then sitting back and watching. It requires your active participation. Like the baby bird who is kicked out of the nest and told by its mother to either fly or die, if you are losing money from stoplosses and your account is slowly bleeding, you need to find a better way. Now that our trader has some idea about risk tolerance, what does TRADER do when after his 1 contract entry at the 1st SD, price action takes the market backup to the VWAP rather than down to the 2nd SD? In the old paradigm of using fixed stoplosses, he probably would have been stopped out. In the new paradigm of replacing stoplosses with risk tolerance, you know what he has to do! He's done it many times before. The market is still skewed to the downside, he normally takes short entries at the VWAP. So why not this time? Indeed why not? TRADER pulls the trigger a second time and enters with a short at the VWAP because he knows that his risk tolerance is still quite large. He is now 2 contracts short. This is called scaling in. His expectation at this point is that the market will move back down to the 1st SD. Is this a reasonable expectation? Yes! Nothing about the volatility has changed. The SD is still where it was before the 2nd entry and that's the measure of volatility. Nothing's changed. TRADER should feel confident in pulling the trigger a second time. He is going to actively manage this trade. He still has a mental stoploss at his risk tolerance level. Where is his profit target? He has three choices now that he is short 2 contracts: 1) He can take 2 contracts off the table when price action hits the breakeven point-1 tick, 2) take 1 contract off the table at the break even point-1 tick and the 2nd contract off at the 1st SD, 3) hold both contracts and exit at the 1st SD. In all cases he ends up with a profit instead of a loss. Watch the video and see how TRADER manages his trade. Scale-in Video What TRADER did in the video is of course controversial (For previous discussions on this topic see the thread "Doc, my passion gives me much stress" beginning at post 13916 where Dogpile expounds upon his firm belief in hard stops and my response. Also the discussion in the thread[thread=1941] "Scaling In and/or Out"[/thread] where I discuss the difference between scaling in and averaging down (or up for short trades) beginning at post 13142. Controversial or not, it is my firm belief that a trader needs to understand what scaling-in is all about. I personally didn't become profitable until I understood this and I use it as one tactic in my trading arsenal. If stoplosses are bleeding you, then consider this new paradigm. NQscale_inJuly25.swf

I have no doubt about that. Even after I tell you everything that I know and do, you will still have a long uphill battle. Trading is like learning how to play an instrument. You need to know all the notes,scales,chords. But even then you still have to practice, practice, practice, and develop your own style. I agree with this too. Newbies shouldn't be trading with real cash until they can demonstrate consistent profits for at least a month in simulation mode. A slow bleed is the worst thing that a new trader can have. It's insidious, because it makes him think that the methods he is using are ok, but they just need some fine tuning. So what does he do? He adds another indicator to his chart, discovers he still is bleeding and so adds another and another. Soon he's wrapped up in so many indicators, patterns,other market internals and externals, he doesn't know whether he's coming or going AND he is still bleeding. Which is why I'm suggesting a paradigm shift in the whole concept of stoploss. Dogpile, On the basis of what NEWBIE knew at the moment, the answer to your question is No. You then present a whole litany of arguments as to why NEWBIE shouldn't have taken the trade. I presented one simple reason why he might have stayed in the trade. Seems to me that simpler is always better. I would agree with you on this. There is a lot more going on, and guess what it is related to? - The PVP, the VWAP and the Std Dev. We will understand a lot more when we discuss HUP in later threads. Guess what HUP is related to? -The PVP, the VWAP and the Std Dev. When you understand risk tolerance which is coming up in the next thread, you will always err on the side of undertrading. Even pros err on the side of undertrading.

Your ears must be ringing, dbntina, that's exactly where we are headed. But not quite yet as we still have some basic stuff and intermediate stuff to cover in the coming threads. That's correct.

Ok, for your reference unleashed, I took a look at YM at 12.28 EST. My values for VWAP and PVP are as follows: VWAP= 13445 PVP = 13433 for a difference of 12 ticks. And yes you could have taken the trade at 13445 and exited at the 1st SD which was 13472 at 13:54 EST for a profit of 27 ticks or held on until the 2nd SD at 13500 14:02 EST for a profit of 55 ticks. HOWEVER---if you set a stoploss at the PVP you would have been stopped out earlier with a loss on the trade. This is a good example of why hard stoplosses will slowly bleed you to death. In the next thread we will discuss an alternate paradigm called risk tolerance to replace hard stop losses

Unleashed, perhaps you can post a chart of what you see and I can take a look

There is actually no good way to back test something like this Dogpile, because the distribution function, the volatility and HUP distribution (Hold Up Price, which we haven't discussed yet) is constantly changing from day to day. What you will discover in the next thread, is a new paradigm about stop loss placement and trade management. Very good question, glad you asked. I'll phrase it differently. How large does the skew have to be to consider taking a trade at the VWAP or SD in the direction of the skew. The answer is: I was concerned about this for a long time. It turns out, that there is no correlation between the size of the skew (as measured by the Karl Pearson definition of skew which is (VWAP-PVP)/SD ) and the momentum of the trade in the skew direction. What only seems relevant is that a skew exist. Other HUPs will come into play between the entry point and the profit target which will play an important role in the momentum of the trade. We will discuss these in a later thread.

David, Here is the end of day VWAP +- SD for today August 2, 2007 ES 1474.11 +- 3.64 NQ 1968.52 +-5.77 No, it is not correct. To compute the variance correctly, use the equation I posted in the SD thread post 14545 You have to multiply each term in the variance by the probability distribution for the volume because the VWAP is volume weighted. That takes care of the normalization factor. The example I gave, had no weighting factor, so the variance was simply divided by the number of terms in the summation.

Glad you are finding that market statistics speaks to you dbntina. It speaks to me too. I realize for many traders, statistics is a difficult subject, so that is why I am trying to approach this in a slow methodical way, in the hope that those who are not generally familiar with statistical analysis will be able to follow along. Starting with the next thread on scale-in, stoploss and trade management we will be getting into virgin territory for most new traders.

volume histogram: available peak volume : available VWAP : available SD : not available but can be programmed by user as a DYO Also if you ask Howard Arrington (owner of Ensign) he would probably make it available if there was enough demand. My own software is presently not available for general use.

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. 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. 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.

Sorry to have to disagree with you on this Dogpile, but there is more to it than just a break away from the VWAP, tight coil or otherwise. You would be correct if the skew was in the same direction as the breakout, that is < 0 for a short or > 0 for a long. Under any other conditions (skew =0 or breakout in the opposite direction to the skew) you could be in deep doo doo. I've have yet to discuss either of these two other situations, but they will be discussed in future threads of "Trading with Market Statistics"

Data: I use interactive brokers. Data $10/month if I don't trade, otherwise just commissions which run $4.80 round trip. There may be other fees for other exchanges other than Globex or ECBOT. Platform: charting software: Ensignsoftware which links to IB for data. $40.00/month Front end for IB: zerolinetrader $70/year (yes that's for one year). Provides simple and effective DOM for one click trading including scale ins, scale outs and reversals. Other than the computer itself, nothing else.

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

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 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.

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.

You are catching on fast darth. In the next thread I will be discussing scaling-in