Probability Cone

This is a discussion on Probability Cone within the Technical Analysis forums, part of the Methods category; anyone ever used this? it's a new one on me & i was wondering whether it is useful tool....

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Old May 19, 2003, 12:15pm   #1
Joined Jun 2001
Probability Cone

anyone ever used this? it's a new one on me & i was wondering whether it is useful tool.
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Old May 20, 2003, 10:26am   #2
 
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Following is an extract from Metastock help file explanation...hope it is useful..

...................Text quote from Metastock software.....
ODDS Probability Cones (which are greatly influenced by recent price volatility) provide you with a visual guide to the most probable range of future prices. This range (i.e. the cone's width) is determined by recent volatility in prices, the number of time periods projected, and the probability percentage (e.g., 68% confidence, 90% confidence, etc.). The more volatile the security prices, the wider the expected range of future prices and hence the wider the cones. The cones always widen from the apex even if recent volatility is very low, because as time increases, the better the odds of a significant price move.

By default, the cones show the expected range of prices given a 68.26% probability (this is equivalent to one standard deviation). This means that there is a 68.26% probability that prices will remain within the cones over the specified time frame. By increasing this percentage, you can control the width of the cones. As you might expect, higher percentages result in wider cones.
The original use of this type of analysis was intended to help option traders determine the best strategy to implement. From a probability standpoint, an option trader would prefer to sell options with strikes that lie outside the cones and buy options with strikes that lie within the cones.

The cones also have equal value for the analysis of regular long and short positions. All else being equal and assuming you are confident in your price directional forecast, you would prefer to establish a long or short position in a security with wide cones rather than one with narrow cones. Of course, this assumes that the recent calculated volatility will continue or rise. If you expect volatility to drop, then you should reconsider.
........................................end quote.......
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