Saturday, March 6, 2010

Mandelbrot, Once More

“We cannot know everything--we can only think of the world as a black box. We can see what goes in and what comes out but not what happens inside; we can only draw inferences about the odds of input A producing output B. Seeing nature through the lens of probability theory is what is called the stochastic view.”

--Benoit Mandelbrot

Does this not hold true for all of us? Schrodinger’s Cat may be dead or alive. We learn so much as we progress through our lives, yet somehow more and more questions arise. The black box to me, from a trading perspective, is the price bar. It’s time interval does not matter, but when we look at it on lower and lower time frames chaos seems to unfold. How peaceful that daily bar can look--so simple, so straight, with its open and close; but when we venture deeper into it all hell breaks loose.

What’s a trader to do? Quantum theory tells us the best we can do is predict the probability of events occurring. I believe this also holds true for traders. The best we can do is determine the probability of an event occurring and then rely on our risk management strategies, particularly our money management. We really cannot know everything. We can never know what is going to happen in the market, but we can model the possibility of events occurring. The other thing we can do is to know, ahead of time, what we are going to do when and if the market price goes to x, or if it goes to y.

The market is complex and dynamic. Those peaceful price bars hide underlying chaos. Nonetheless, with perseverance, discipline, and solid research those price bars can also reveal order. It tends to lie in the probabilities.

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