Every trading method has an implicit underlying assumption | stockbee

10/04/2013

Every trading method has an implicit underlying assumption

Every trading method has an implicit underlying assumption. Some of the assumptions are based on observed market behavior and some are based on beliefs. If the underlying assumptions behind your trading methods are sound and based on structure of the market then they work. More importantly they can be replicated by others.

 Above all assumptions based on market structure persist  and those edges do not degrade. The tactics might change but the structural phenomenon do not change. On the other hand many trading beliefs are just beliefs , they are strongly held beliefs and do not work unless you adopt same belief system.

One of the most enduring phenomenon in the market for hundreds of years has been that price tend to move in direction of range and volume expansion. The magnitude of follow through might differ based on market conditions but this phenomenon has  persisted on individual stocks for hundreds of years.

Look at the following examples of stocks that had large range and volume expansion near start of their big moves.






In each of the above case at the beginning of the move there was abnormal magnitude of range expansion and volume expansion. These stocks had in many cases highest traded volume or range expansion in their life time of trading or in years. That one day big move has translated in to start of a new momentum phase lasting weeks or months and of big magnitude ranging from 50% to over 1000%.

On a day to day basis not many stocks exhibit this kind of above average range and volume expansion. By focusing on those stocks you can find big winners.

The underlying structural phenomenon in these cases are :


  1. Stocks move in direction of range expansion
  2. Stocks move in direction of volume expansion
  3. Surprisingly good news leads to big range and volume expansion
  4. Such surprise does not result in just one day move, it can kick off a mufti month /week move 
  5. The up move has number of 3 to 5 day momentum bursts
Now this is a repeatable phenomenon in market. And it has big edge. If you believe that to be true then you can build trading methods around it by using a set process. Like this there are number of structural phenomenon in the markets and trading methods have been developed to exploit such phenomenon. 

Lot of time new traders base their trading methods on questionable assumptions and as the assumption holds no water , the trades based on those methods do not work.

The starting point for any trading method should be to thoroughly examine your assumptions and how valid they are. 

What are the underlying assumptions behind your trading method?

If you can not answer that question easily, then its time to reexamine your approach. 


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