Taken from the blog - interesting read!!!
-------------------------------------------
Technical Analysis RIP
A battle rages between those who say the financial markets are theoretically impossible to beat and those who say, “Hey, look at me, I’m a billionaire.” On one side are the Nobel laureates, ensconced in the University of Chicago Business School, who are renowned for developing equations describing “efficient”, that is, unbeatable markets. On the other side are the speculators who beat them year in, year out with techniques “proven” not to work. But what if there were a system that did work, a method for finding patterns in chaos, for predicting trillion-dollar markets that most people assume are random? The predictors who discover this Holy Grail will be lords of the realm. They will possess a wonder-working money machine capable of producing a sweet fountain of cash. They will be rich, famous, and free. - The Predictors
Say Goodbye to Technical Analysis as We Know It
I have been a trader for some 25 years. I have held seats on exchanges, developed complex theoretical models for trading options, engaged in sophisticated arbitrage techniques and developed dozens of trading models and systems. I have traded futures, stocks, options on futures, stock options, ETFs, Forex, Mutual Funds, Bonds, and almost every commodity imaginable including Levis blue jeans. All of my experience leads me to some conclusions about the markets, and one of them is that, as a price predictor, “technical analysis” is one of the most successful scams ever thrust on a public willing to risk almost anything for a mere glimpse of the Holy Grail.
The irony of technical analysis is that marketers efforts to sell predictive qualities to the public have been so successful that technical analysis can not be ignored. The fact that technicals predict a target price for a market, and the fact that the market reaches that price may not be coincidental. It is my belief that technical analysis is worthless in predicting future events from history, but that it can give insight into how other traders might react under various market conditions. If the S&P 500 establishes a break through a long-standing uptrend line, an acceleration of declining prices is likely to be established by traders, not because the line was there, but because everyone knows the line was there. In a certain way, technical analysis is a self fulfilling prophecy only because so many people have been sold a bill of goods.
I can see how this happened. I am, and have always been, fascinated with charts. Bar charts, candlesticks, market profiles, equivolume … you name it. In fact, I believe there is a certain artistic quality to price charts. It is easy to understand why people would be compelled to play with charts especially when the alternative would be to develop the skills to read a one-inch wide strip of paper endlessly produced by a ticker tape machine. I imagine the first technical analysis began with someone drawing a trendline on a bar chart that represented the price history of a stock of interest to them. Then came the pattern recognition techniques where multiple lines were drawn on a chart to outline recognizable forms given creative names like “bull flag”, “bear pennant”, or “head and shoulders”.
The next step in the evolutionary process was the realization that all of these lines could be described mathematically and that data could be analyzed through various applications of statistical techniques. The billions of man years spent in research since the 1950s have provided us with a plethora of technical tools that have the ability to project prices into the future using zero delay stochastic filters and Gaussian distribution models. It’s telling that the S&P 500 future (the “Spooz”) suffered a single day price move of six standard deviations only five years after its inception, something that should statistically occur once in thousands of years.
Why did technical analysis evolve as it did? I believe the answer is simple. It evolved because there was nothing else at that time to rely upon. There were no powerful computers that could crunch enough numbers to define a system as dynamic and complex as the markets. It evolved in the same way that the railroads developed as a viable form of transportation. If you wanted to get from north to south quickly, you had no choice but to buy a ticket on the City of New Orleans. In the same way as the railroads went for public transportation (please note that I still ride a train every day), the time is through for the astute trader. Technical analysis based upon Gaussian statistical models has sadly, become old and stale for the astute trader desiring an edge in this century.
The Holy Grail?
Does the Holy Grail really exist? What an irrelevant question. The fact is that it is highly unlikely we will ever know the answer to that question. However, if I answer the question, “Yes, there certainly is a Holy Grail”, it would be most difficult for anyone to argue because I may be able to prove there is a Grail, while no one can prove there isn’t one. The reason for this argument is that we have entered into a new age with the advent of powerful, generally available computers. These computers provide us a window to view systems in ways we couldn’t even imagine twenty years ago.
The reason technical analysis, as it is generally employed, does not work, is because the underlying premise is flawed. The mathematical basis of modern technical analysis attempts to define straight lines in a statistical world that assumes prices are distributed normally. The problem is that prices (like almost anything else in nature) are not distributed normally. This was proven again, like many times before, in October of 1987. Fortunately, there is a new mathematics that is 10,000 times more accurate at predicting price behavior than the methods we have discussed here.
Chaos theory has only been in existence since the early 1990s. The fact that its discovery and development coincides with the computer revolution is not coincidental. Chaos is a new mathematics that explains curved lines rather than straight ones. In other words, Chaos addresses non-linear complex systems. The markets are proven to be non-linear complex systems.
Ceres
Ceres is the traders bar located on the ground floor of the Chicago Board of Trade. In its heyday, Ceres was arguably one of the world’s Meccas for traders to meet and discuss anything and everything having to do with trading, not to mention that Ceres provides the most potent liquid refreshment available anywhere. I met Erik Long in Ceres many years ago. When I was introduced to him he was talking with a commercial real estate broker who was seeking Erik’s ideas on the theoretical valuation of unimproved real estate. I sat and listened to Erik’s ideas on predictors in a non-linear world. I was totally fascinated by what he had to say and the eloquence with which he said it.
Long after the real estate broker left us, Erik and I were still talking. I took the position that undeveloped real estate could be valued in exactly the same way as a deep in-the-money call option. He was debating my ideas at a much higher level than anyone before and hitting every curve ball I threw at him out of the park. Erik Long and I formed a friendship that evening that will last a lifetime, not to mention the money we will make together by employing his ideas to trade the financial markets.
On October 16th, Spooz will introduce market price predictive technology that heretofore only existed in the most secretive corners of deep-pocketed institutions. For the first time, Spooz will be proud to introduce the public to chaos theory and fractal time series analysis in the same form as it was applied shortly after chaos was developed in the early 1990s and technical analysis, as we knew it, can rest in peace.
The Spooz Holy Grail
I can hear some of you thinking, “Nice story, Paul, but let’s cut to the chase.”
Spooz looks for technologies that are in their early stages of development but that have a huge potential in the market place.
1. October 16 - Fractalz³ EOD – This product represents for its target market a first-to-market advantage. Spooz currently has a multi-faceted marketing plan that will pre-sell this product directly and through brokers. The introductory price will be $89 per month including end-of-day (EOD) historical data from the Spooz servers. The markets covered will be domestic equities, options, futures and Forex. Although Fractalz³ has been operational for some time, Spooz will utilize the auto update feature extensively. Spooz will supply technical support for the brokers and direct sales. The marketing plan will be supported by email, web advertising, value added resellers, brokerage distribution channels and direct sales. See www.fractalz3.com.
2. Early Q1 2007 – SpoozToolz v. 2.0 – This product represents a first-to-market at almost every level, with the possible exception of low latency, institutional proprietary trading. (In reality, we will achieve entry to this market because we believe it will come to us as a result of our middleware component that removes the lion’s share of the processing requirements from Excel. This middleware provides the ability to create large spreadsheets containing complex math at high computational speeds. The SpoozToolz Application middleware is, in and of itself, a potential enterprise product offering.) The product will be offered at an introductory price of $89 per month. The marketing plan will be supported by email, direct mail, trade publication advertising, value added resellers, brokerage distribution cannels and direct sales. Our research, together with other industry knowledge, leads us to believe that it is possible for sales of this product to become explosive in the latter half of 2007. Spooz has conservatively projected 2007 sales at approximately $7 million, however, we believe the potential exists for them to be far greater.
3. Early Q1 - Fractalz³ v. 1.00 – This product will employ the same math as the EOD product except that it can be applied to bid/ask data and market depth. It will utilize SpoozToolz as its electronic execution platform, will employ Excel as its GUI, and will communicate with SpoozToolz through the SpoozToolz Application API. Fractalz³ will become the first “third-party” application to Spooz.
4. Early Q1 – Extended Options Module – This product is another “third party” application that allows options traders to build complex trading models by employing several different theoretical valuation models, or for that matter, your own if you are fortunate enough to have one lying around. This application will allow users to calculate and graph risk sensitivities and complex positions in an Excel environment which, again, provides a first-to-market advantage. Extended options will be deployed in the form of a modular plug-in and priced as an add-on to the base $89 SpoozToolz.
As of this writing, all development is on schedule and multiple patents are being penned.
By the end of Q1 next year, Spooz will launch several software products that will establish the underpinnings of a complimentary product portfolio that will appeal to a huge global market, and this, represents Holy Grail for Spooz.
www.spooz.com
AI
