Trading with Market Statistics. IV Standard Deviation

[Dogpile 10]

<<If you are going to use unweighted prices to compute SD, then use an unweighted average to compare it too. Be consistent. Don't compare apples to Oranges.>>

 

I already do that with Keltner Channels and Bollinger Bands.

 

I am looking for 'variation of price' around the point of 'value' (VWAP).... I am not looking for 'variation of volume-weighted price' around the point of value...

[nelo 10]

Jerry's point is that a 1 point swing from VWAP with 100 contracts is different from 1 point swing from VWAP with 10,000 contracts, during the same time period. So the formula in his first message is correct.

 

I suspect that treating VWAP as moving average and calculating SD as the difference between VWAP and price as in bollinger bands is incorrect. Though, I do not know how much it differs.

 

Jerry, one thing just wonders me, why you did not take VWAP in your formula, so Variance = SUMi[Pi(pi - VWAPi)2] ? This would make more sense to me.

[jperl 11]

Jerry, one thing just wonders me, why you did not take VWAP in your formula, so Variance = SUMi[Pi(pi - VWAPi)2] ? This would make more sense to me.

 

Ok let's give an example of computing variance:

 

Consider the 5 numbers, 1 2 3 4 5 all of equal weight for simplicity

what is their average: (1+2 + 3 +4 +5)/5 = 3.0

what's the variance: [(1-3.0)^2 + (2-3.0)^2 + (3-3.0)^2 + (4-3.0) ^2 + (5-3.0)^2]/5 = [4.0 +1.0 + 0 + 1.0 + 4.0]/5 = 2.0

 

Do you notice what value I use for the average in each of the squared terms? It's 3.0.

 

If I added another number to the series, say 6, then the new average would be (1 + 2 + 3 +4 +5 +6)/6 =3.5

I would then compute the next variance using this average in the squares.

 

Hope this clears up the computation method

[Dogpile 10]

ah yes, good point.. too bad that is a computation/coding nightmare...

[Dogpile 10]

Check this out...

 

(first note that yes, my code is a bit flawed but I don't think by much since there is little movement here in the VWAP number so the numbers are not far off...)

 

Look how my std dev bands compress and expand. This shows classic market behavior in that it is oscillating between 'balance' and being 'out of balance' -- a core market profile concept.... (this chart is using rolling 90-minute period for its std dev (45-period chart on a 2-min chart)-- its acting like a bollinger band does -- using rolling data -- but based on VWAP rather than a moving average).

 

More interesting is look how price breaks lower out of the triangle/balancing and forms a classic 'bear flag' prior to breaking lower. I used to hate coils -- but the VWAP std dev bands show a market that is doing its thing -- coming out of balance then going back into balance -- then coming out again... knowing which environment you are in is crucial.

 

you can see how the market shot out of the balance with a jolt down (it actually gapped). this was followed by a mini bear-flag which set up excellent location for a short... Yes, I traded this pattern today.

 

http://bp0.blogger.com/_5h-SWVGx6Ms/RqfSmOvXa6I/AAAAAAAAAV8/W9MY6-aw6wk/s1600-h/July+25+ES+Coil+Break.bmp

[walterw 10]

Check this out...

 

(first note that yes, my code is a bit flawed but I don't think by much since there is little movement here in the VWAP number so the numbers are not far off...)

 

Look how my std dev bands compress and expand. This shows classic market behavior in that it is oscillating between 'balance' and being 'out of balance' -- a core market profile concept.... (this chart is using rolling 90-minute period for its std dev (45-period chart on a 2-min chart)-- its acting like a bollinger band does -- using rolling data -- but based on VWAP rather than a moving average).

 

More interesting is look how price breaks lower out of the triangle/balancing and forms a classic 'bear flag' prior to breaking lower. I used to hate coils -- but the VWAP std dev bands show a market that is doing its thing -- coming out of balance then going back into balance -- then coming out again... knowing which environment you are in is crucial.

 

you can see how the market shot out of the balance with a jolt down (it actually gapped). this was followed by a mini bear-flag which set up excellent location for a short... Yes, I traded this pattern today.

 

http://bp0.blogger.com/_5h-SWVGx6Ms/RqfSmOvXa6I/AAAAAAAAAV8/W9MY6-aw6wk/s1600-h/July+25+ES+Coil+Break.bmp

 

 

interesting contraction expansion pattern there with vwap and bands..

[jperl 11]

this chart is using rolling 90-minute period for its std dev (45-period chart on a 2-min chart)-- its acting like a bollinger band does -- using rolling data -- but based on VWAP rather than a moving average).

 

Dogpile--glad to see you are using VWAP in your own way and that you find it useful. I hope it works for you.

 

I have a problem using rolling 90-minute periods or for that matter any N-period method for computing the SD or N-period technical analysis in general. (This is includes all moving averages, CCI's, stochastics, MACD's, RSI's and any other method that requires a period length, and yes, sad to say Market Profile Analysis which uses 30 minute periods and an arbitrarily defined value area). The period length is arbitrary and would have to be readjusted when market properties change as they do daily. This is why I am presenting this general statistical method of viewing the markets. It's independent of period length of your chart and only depends on your starting time.

As we delve deeper into this you will see the utility of using this generalized statistic.

[jperl 11]

NEWBIE now has an arsenal of tools to trade with, all generated from the volume distribution function. He knows how the distribution is skewed by comparing the VWAP to the PVP, and he knows how volatile the market is by including SD bands above and below the VWAP. The SD now determines is exit strategy. If he enters at the VWAP, his exit will be 1 standard deviation above the VWAP (for long trades ) or 1 standard deviation below the VWAP (for short trades).

 

Here is an example from today's ER2 price action of a trade that NEWBIE takes with a VERY LARGE SD. Watch it to see how NEWBIE trades it. In this video NEWBIE has the opportunity to make 4 or 5 points because of the large SD. But he doesn't. He properly exits early. Watch it and understand why he exits where he does.

 

ER2shortJuyly25

ER2shortJuly25.swf

[Dogpile 10]

<<The period length is arbitrary and would have to be readjusted when market properties change as they do daily.>>

 

yes I agree with you but I think the point of indicators is simply to aid you in identifying the current 'structure' of the market. my 90-minute indicator is not signalling a trade -- it is simply helping to clarify the current structure. I could have identfied this by simply drawing a triangle. But seeing the bands come together around the VWAP jumps out at me visually and 'speaks to me.' as Jim Dalton says ~"the human brain is particulary adept at identifying visual patterns" -- indicators are good but clearly only good in context.

[walterw 10]

Thanks Jerry for this great presentations ¡¡ they really have a tremendous educational value... I like your Newbie character ¡¡ he is the personification of a calm and relaxed in control trader... cool stuff keep it up... thanks Walter.

[Dogpile 10]

Jerry, can you explain in a mathematical or logical way why the PVP matters again for your directional bias? are you just saying that the VWAP can be considered the the 'real' point of value and so logic calls for the VWAP to be the 'eventual PVP'? Thus, if PVP is above the VWAP, expectation is for 'next PVP' to be something that is closer to the current VWAP and therefore odds favor the short side? and vice versa... is that right? if you could explain it in a different way that would be much appreciated. thx in advance

[nickm001 10]

Hey Frank, I have posted my code in Tradestation forum for calculating cumulative SD of the price , centered about VWAP. This gets you closer to what Jerry is talking about.

 

https://www.tradestation.com/Discussions/Topic.aspx?Topic_ID=66875

[Dogpile 10]

<<I have posted my code in Tradestation forum for calculating cumulative SD of the price , centered about VWAP. This gets you closer to what Jerry is talking about. >>

 

thanks nick...

 

you can see how the bands you have act more like 'keltner channels' (steadier band-width) and the bands I did act more like 'bollinger bands' (expand and contract). each has its own interesting characteristics which I have studied for years. The flaw with both of these classic indicators is that they both assume the current 'moving average' to be a point of 'value' -- but this is often way off the mark. VWAP is a much, much better estimate of current value so this is really quite a powerful concept we are discussing here. I am going to leave both sets of bands on my chart to watch the interaction just as I have always done with the classic indicators.

 

Volatility is not a constant in financial markets -- it is constantly oscillating between 'balance' (vol contraction) and 'out of balance' (price auctioning to a new point of balance). Every mathematical model must make an assumption about future volatility. This method Jerry has showed in the video uses straight historical data. If using this to trade, just be aware that this is effectively making the assumption that the 'future is like past' -- that is, expecting historical volatility to continue into the future. This assumption is loaded with risk -- known as 'model risk'. I think using both sets of bands (yours and mine) gives a more complete picture of the nature of financial markets. That is, you see the historical volatility alongside the expanding/contracting volatility-bands and this helps to show the way the market 'breathes'. See chapter 19 of the book 'Street Smarts' (Rashke) for more on this topic -- it is highly fascinating.

[Nick1984 10]

Good observation Nick. There is a solution to this which we will eventually get to in later threads having to do with how you incorporate previous days, weeks, months VWAPs and their SD into todays price action. At this point in time, our NEWBIE trader waits for the distribution to develop and also waits for the price action to touch the VWAP. But, coming up in the next thread, we will introduce a paradigm shift in NEWBIE's thinking. Stay tuned.

 

 

 

Perhaps you might want to expand on this, to give us an idea of what you are thinking about here.

 

 

Hey guys. Basically what I'm thinking of here with using regression with time as a variable is to see if its possible to get an idea of how price as the dependent variable moves in relation to volume and time i.e: for a one unit increase in time (being measured in whatever scale you prefer, 1 min, 5 min etc...) we may expect price to move between two points with 90% confindence (i'm thinking of a standard statistical 90% confidence interval here). This is obviously going to be dependent on volume as well.

 

If we have sufficient data to test how significant time as a variable is then we might be able to use time in a model to help get more precise entry points earlier on in the day.

 

My logic here is that over an average period of time data, price will tend to behave differently in various intervals over a trading time i.e: more active in the morning session compared to lunch session.

 

Then again I have no idea how to represent this graphically, and perhaps its impossible, but if you can somehow get the data to stream into some sort of logarith which computes price as a function of volume and time you can get a constantly changing estimated price based on the market stats being generated in real time.

 

Price = Beta0 + B1(Volume) + B2(Time) would be the statistical equation used i guess with your null hypotheses H0: B2 = 0 i.e time has no effect on price.

 

Once you've tested to see if the model is free from any statistical multi-colinearity etc, then you could use your estimated price based on your equation to gague whether the current market price is at "fair value".

 

I'm really sorry if that sounds very conveluted but its kind of late here and I've been up all day. If you have any questions ask and I'll try to clarify my thinking further.

 

I have no idea how to code stuff, and I'm hopeless with computers, so if anyone does understand what I'm on about and thinks its possible let me know and we can try to test it.

[Nick1984 10]

<<I have posted my code in Tradestation forum for calculating cumulative SD of the price , centered about VWAP. This gets you closer to what Jerry is talking about. >>

 

thanks nick...

 

you can see how the bands you have act more like 'keltner channels' (steadier band-width) and the bands I did act more like 'bollinger bands' (expand and contract). each has its own interesting characteristics which I have studied for years. The flaw with both of these classic indicators is that they both assume the current 'moving average' to be a point of 'value' -- but this is often way off the mark. VWAP is a much, much better estimate of current value so this is really quite a powerful concept we are discussing here. I am going to leave both sets of bands on my chart to watch the interaction just as I have always done with the classic indicators.

 

Volatility is not a constant in financial markets -- it is constantly oscillating between 'balance' (vol contraction) and 'out of balance' (price auctioning to a new point of balance). Every mathematical model must make an assumption about future volatility. This method Jerry has showed in the video uses straight historical data. If using this to trade, just be aware that this is effectively making the assumption that the 'future is like past' -- that is, expecting historical volatility to continue into the future. This assumption is loaded with risk -- known as 'model risk'. I think using both sets of bands (yours and mine) gives a more complete picture of the nature of financial markets. That is, you see the historical volatility alongside the expanding/contracting volatility-bands and this helps to show the way the market 'breathes'. See chapter 19 of the book 'Street Smarts' (Rashke) for more on this topic -- it is highly fascinating.

 

On the point of volatilty, I'm not market statistics whiz but I would assume that when you're modelling price that the volatilty would statistically be left out of the model as isnt the volatility simply the equivalent of the squared sum of errors in a statistical model which = 0 under standard statistical theory?

 

Reason I say this is that it depends on how you define volatility. If you take something like Black-Scholes or the CAPM and figure out the "true" value of an options or futures contract, then the distribution of all other prices around this are simply the errors around the true population mean. These errors then become unexplainable and statistically insignificant. The volatility of price around the population mean would be due to factors such as human emotions and psychology that drive markets in the first place and this cannot be quatified unless you have a telepathic link to every single market participant and a brain capable of disecting all that info!

 

Once the "errors" are factored out of the model, then you have to then decide on what variable actually effect price. So far we can gague that yes volume does have an effect of price (no i haven't proven this statistically but just going by observation) by way of adding "momentum" to the markets.

 

I also believe that time effects price as well but I can't prove this and I don't work as a statistician to be able to try and test this on my own.

 

Man i feel like I'm ranting now lol. I should go sleep!

[jperl 11]

Jerry, can you explain in a mathematical or logical way why the PVP matters again for your directional bias? are you just saying that the VWAP can be considered the the 'real' point of value and so logic calls for the VWAP to be the 'eventual PVP'?

 

 

 

 

I don't use Market Profile terminology to describe the Volume Distribution function. Throughout these threads, I have not offered an explanation of why the PVP is where it is or why it moves from point to point. I don't use terms such as "value", or "value area". The fact is, it doesn't matter. I just accept the statistic for what it shows.

 

 

The PVP serves two purposes:

1)It acts as a Hold Up Price or HUP for short. A point where the market pauses before continuing on or reversing

2)Along with the VWAP it defines the skew of the market. How much the market deviates from a symmetric distribution.

 

For a NEWBIE trader, the skew of the market is his lifeblood. He needs to know how skewed the market is before he will enter a trade. And he will only enter a trade in the direction of the skew.

 

The extent of the skew is defined by the difference between VWAP and PVP

skew = VWAP - PVP

so if the skew is positive NEWBIE takes long trades only

if the skew is negative NEWBIE takes short trades only

and if there is no skew (skew close to 0) no trade

 

It doesn't get any simpler than this.

 

Eventually NEWBIE will learn how to take trades against the skew. But for now he needs to understand the basics

 

Thus, if PVP is above the VWAP, expectation is for 'next PVP' to be something that is closer to the current VWAP and therefore odds favor the short side? and vice versa... is that right?

 

This is a Market Profile interpretation, that somehow markets if they are "out of balance" (that is skewed) will somehow move back into balance (market skew = 0).

There is no evidence to support this assertion. And as far as intraday trading is concerned it isn't necessary. A NEWBIE trader simply needs to trade in the direction of the skew and avoid trading when there is no skew.

An Advanced trader can do many other things (Trade against the skew, trade when the skew is 0) but NEWBIE is not ready for that yet.

[Dogpile 10]

thanks Jerry, I think we are saying the same thing but using different terminology. I interpret what you said to be that newbies expectation is for the market to tend to want to revert towards a symmetric distribution from a skewed distribution. I am not saying has to be perfectly symmetric -- just that skew will change. Therefore Newbie should trade with the expectation that the market will tend to lose whatever the curret skew in the direction of a normal distribution. If this is right, then it is the same thing that I was suggesting but just that I was using different terminology.

[jperl 11]

thanks Jerry, I think we are saying the same thing but using different terminology. I interpret what you said to be that newbies expectation is for the market to tend to want to revert towards a symmetric distribution from a skewed distribution.

 

Actually just the opposite Dogpile. If NEWBIE is trading long (skew > 0) for instance he wants the skew to increase further, not decrease. If he takes a trade at the VWAP, he doesn't want price action to just sit there which would decrease the skew. He wants price action to move away from the VWAP in the direction of larger skew.

[Dogpile 10]

<<He wants price action to move away from the VWAP in the direction of larger skew.>>

 

wouldn't a move in the direction he is trading tend to just re-set the skew at a different place. ie, the PVP changes... there is still going to be a skew, just a different skew. this is what happened in the video you just showed, no?

[jperl 11]

wouldn't a move in the direction he is trading tend to just re-set the skew at a different place. ie, the PVP changes... there is still going to be a skew, just a different skew. this is what happened in the video you just showed, no?

 

The skew would reset, only if the market stalled with a build up of volume to move the PVP. It takes a large volume to do this. NEWBIE, being the alert trader that he his would notice this immediately. So if he was in a short trade (negative skew) and the skew reset and turned positive, he would bail out of his short position as shown in the video. What he is hoping for of course is that price action will take the market to the first SD before the skew resets. In either case, he takes money off the table.

[darthtrader 10]

Jerry, with what you have shown so far I take that you would trade a super strong trend day different? Watching the diamonds today it didnt seem like there would have been a chance for NEWBIE to take a trade with whe he knows so far with how much price was tanking? It was pretty cool to see pvp change though,go below vwap, skew change right basically at the low of the day.

[Guest cooter]

If you take something like Black-Scholes or the CAPM and figure out the "true" value of an options or futures contract, then the distribution of all other prices around this are simply the errors around the true population mean. These errors then become unexplainable and statistically insignificant.

 

Failure to account for, or even hedge against these "errors" may be expedient, until you have that "black swan" event that wipes you out! :cry:

 

[jperl 11]

Jerry, with what you have shown so far I take that you would trade a super strong trend day different? Watching the diamonds today it didnt seem like there would have been a chance for NEWBIE to take a trade with whe he knows so far with how much price was tanking?

 

That's correct Darth. NEWBIE would have not taken any trades today based on his present knowledge. But NEWBIE is about to graduate from trading 101 in the next thread. Based on the knowledge he is going to receive there, he would have made a killing today.

[JayRemy 10]

That's correct Darth. NEWBIE would have not taken any trades today based on his present knowledge. But NEWBIE is about to graduate from trading 101 in the next thread. Based on the knowledge he is going to receive there, he would have made a killing today.

 

I caught this thread couple days ago and I cant stop reading and re-reading. I'm learning market Profile myself at the moment and you really have me jperl. This stuff looks like dynamite. But please, please dont tease me any more - I need part V

 

Keep it up - I'm loving it!

Jay.

[Dogpile 10]

<<This is a Market Profile interpretation, that somehow markets if they are "out of balance" (that is skewed) will somehow move back into balance (market skew = 0). There is no evidence to support this assertion. >>

 

I am not saying this with respect to skew but markets are well-accepted to come in and out of balance by technical experts. If you don't call this evidence, then I am sorry you don't see it. There is obvious coiling/balancing action here at the 1522.00 level.

 

http://bp0.blogger.com/_5h-SWVGx6Ms/RqfSmOvXa6I/AAAAAAAAAV8/W9MY6-aw6wk/s1600-h/July+25+ES+Coil+Break.bmp