Firstly there perhaps needs to be clarification on a number of points which people, when writing, might assume others automatically consider being correct or matter of fact. The matter of the ‘coin tossing’ itself is one such instance. One or two have to my mind correctly pointed out that coin tossing itself might not be 100% random due to simple human mechanics – A human who is asked to repetitively toss a coin will develop a method and possibly a characteristic which may cause a potential imbalance in the results. It’s just the same as a professional golfer or a snooker player who constantly practices his shots – his / her aim is to program some kind of ‘repetition’ which, when called upon, the player can repeat ‘at will’.
As a result we perhaps need to clarify that in reference to a ‘coin toss’ we mean a method of deriving a result which is one of two possible outcomes which has no bias one way or the other (or does that contradict what’s already written?)
I guess what I mean is that we are trying to assume that there is no human influence over the ‘coin toss’ outcome?
Yeah, I don’t want to get hung up on the mechanics of coin tossing. Even the choice of coin tossing was perhaps inappropriate as I mentioned in a previous post, as most seem to think they know what probability is all about based on the elementary stuff they’ve done on coin-tossing and dice-rolling. Maybe I should have cut straight to the chase and initiated the thread based on the originating aspect for me which was futures options pricing anomalies on commodities. But then, I figured we might get stuck in that specific and narrow area of trading rather than the wider aspects of subjective probability which is where I wanted to be headed. This issue impacts all trading – not just the initiating area.
If what I have presumed so far is true then I have to say that I am sceptical (to put it mildly) that ‘price has memory’ in terms of the tossing of coins.
I would have been too a few weeks back. But I hypothesises that the theory we currently hold to be true is only a theory. A convenient theoretical theory true, but one that increasingly shows itself to be inaccurate in practise in areas related to trading, at least.
Of course I am willing to learn a new trick here!
You are in the minority unfortunately.
A number of posts have been made which refer to some kind of ‘regression to the mean’ in terms of a longer series of coin tosses. Mathematically this isn’t correct although a regression can and does on occasion occur. If we spin our coin 50 times and find that we have 30 heads and 20 tails then this does not mean that the next 50 spins should yield 30 tails and only 20 heads – the probability is that there will be roughly 25 heads and 25 tails in the 50 spins. Statistically there is just as much likelihood of another 30 heads and only 20 tails as there is of 30 tails and 20 heads. On that basis I cannot consider that any kind of ‘price memory’ exists in terms of coin tossing.
The regression thing is much vaunted and as you say, it is achieved in reality far less often than classical (frequentist) probability theory would allow. I think the ’price memory’ thing causes problems when folk try and decide what it is that’s doing the remembering. It isn’t the coin…
I would agree that people in general under estimate probability in given situations – trading is clearly one of those areas. As a result loss occurs.
Understatement of the millennium. People are incredibly arrogant in their expectations of what probability ‘means’ in any given situation. I’m going to pose a question later in this thread that if enough respond honestly (I can list now those that wont but will pretend they did) will show just how far probability does not serve those who feel they have sufficient grasp of it based on their current understanding of classical probability theory.
Having read the thread I am having trouble in relating ‘coin tossing’ directly to trading. The thread has made me think about certain aspects of trading, and indeed coin tossing, more deeply. The more I think about it the less relationship they appear to have to each other. Initially it was suggested that trading was a matter of simply predicting which way something would move pricewise. My 10 years plus of experience has taught me that trading is so much more than that.
As mentioned. It was a bad choice with which to initiate this inquiry. Apologies.
Randomness of price movement is a seriously interesting area to examine. I generally find that the smaller the timeframe the more random the price action is. This I would speculate is because short term price movements are caused by day to day ‘technically’ based buying / selling where as the larger time frames (weekly / monthly) are dominated by more ‘fundamental’ based buying / selling.
I wouldn’t disagree.
I therefore find it quite hard to compare any kind of price movement to a series of ‘coin tosses’. Whether or not coin tosses are random or not does not seem even remotely significant to me. My feeling is that market movement is not random.
What is it then?
That is not the same as saying that market movement is totally predictable. I do however have a number of ‘tools’ which I feel allow me personally to understand why certain things happen to prices. I study two forex markets fairly closely – EUR/USD and GBP/USD. Obviously these two markets are driven, in the longer terms, by completely fundamental news flow. However, in the short term, this isn’t always the case. One only has to examine the size of intraday swings to realise that these swings clock up tens if not hundreds of more pips in terms of size than the fundamental moves if studied on a weekly chart. This can only be caused by short term speculation and in my opinion this apparent randomness can be quantified if studied closely enough.
If they are driven by fundamental news flows, what moves them when there is no related news? If it is, in the shorter timeframes as you suggest, mere noise, that noise would surely be random – and therefore largely cancel out. But it doesn’t. Even when there is no direct news the shorter timeframes will develop significant (probabilistically) moves which are rarely resolved or regressed to the prior mean.
Something moves the price quite interpedently of fundamental news flows.
Nice post Steve – appreciate your thoughts.
