Tuesday, August 18, 2009

Dragon Bones

Faux-fact: Way back in the pre-Zhou dynasty in cHiNR (pronounced, "China") there was a practice of carving runic messages into turtle shells and heating them over a fire until they cracked from thermal stresses. Then an old man with one eye open much wider than the other and likewise off-center behavior would analyze the way that the shell fractured in order to determine the answer to whatever cryptic message was scrawled onto the shell. Then the emporer or whatever (China has not nearly as continuous history as Chinese historians, PRC, and other Sinophiles would have you believe) would make his interpretation of the old man's word and choose the path to righteous destiny!

These bones were burried for future generations to dig them up and hawk as a miracle ingredient in traditional Chinese medacine. And they were called:

Dragon Bones!

Well, thousands of years later, and perhaps not yet too much brighter, here we are divining buy and sell signals from the stock market. There are websites hawking advice, possibly mafia gimmicks, and maybe tried and traitorous buy-and-hold tonic.

If you've been keeping up with my posts, you should have a decent feel by now for the concept of limited determinism. The rugby pile at the knife edge on the beach head in the bar room full of singles who want to be first, but don't want to be desperate. The chaotic cow that has absolute authority to vanquish the magician back into the realm of his game. The magician and Leeroy Jenkens battling it out unceasingly inside the circus tent that flows withing the chaotic probability zone.

What I'm really getting at is that there are places where the stock market's movements are absolutely limited by the price elasticity --- as well as places where bar room politics and magicians tricks and cameo appearences by Leeroy take over.

I have tried numerous times and many ways to figure out the correct analogy for how to make use of the serendiptitious patterns that emerge from the chaos whenever the stock market is trading well within the realm of price-elasticity, the places where limited determinism is more like conditional determinism, which is a paradox in itself.

The technical patterns, Leeroy effects, and magic shows are fun to watch. Inevitably there is a contention point, and that contention point will lead to the development of a new pattern, a new trend, a new wave to ride on. The capability of the wave to sustain itself is many times, by virtue of being well within the chaotic trading range, purely up to the surrounding chaos, which was itself decided in a nearly arbitrary fashion and wholly lacking of discernable sense to the average Vulcan.

In the end, the chaotic movements of the stock market are in so many ways just like the dragon bones. The charts almost even look like the cracks as they split through the dragon bones. How can this completely unreliable process provide any opportunities to make rational trading decisions at all? I give you my final answer:

The shape of each crack is arbitrary
The existence of cracks is absolute

What I mean by this is that you don't have to find meaning in the cracks, but never for a second think that just because there is no higher order that you can afford to ignore them.

And this is how the emporer rolls. Yes, the months and weeks leading up to a contention point should theoretically have no impact on the prices traders are willing to buy and sell shares at. At the contention point, the fact that the knife can fall either way would seem to suggest that there is no significance to the result. The cracks could have gone North and South or East and West and the old man still would have given his answer to the emporer just as if there was some greater meaning to it. The emporer's word is final. The follow-through of his beauracracy is like wise absolute. The follow through of the stock-market is no different.

When trading in the chaotic regions, try to spot the serendipity. Say not, "the stock will trade this way," but "if the stock trades this way, it would be likely to follow through this way." Then once the knife falls, if it falls in such a way that you think it has momentum and the blessing of the chaotic cow (it's well towards the middle of its price-elasticity curve) ride the storm until the next contention point. Better yet, if the pattern is stable, wait for the pattern's reinforcing signal, whether it's a linear uptrend or a moving daily average, and then make your move.

When dealing with a pattern that has room to run, it tends to do just that. That tendancy is strong enough to overcome the times that you will be wrong or a Leeroy event will pop up. No trade is ever 100% certain, but even with pitiful diversification (keeping a 50% cash position is diversification in my book), if the trades you're going after are the ones that you're 90% certain on, and you've tested and matured your ability to know when you can be right and when you can't, the mathematics will take over and you'll be sitting pretty at the end regardless of a few Leeroys throughout your trading career.

I'm almost absolutely certain that I'll get one of these tests soon enough a la NVDA. I'm waiting for it to fall back to its strength. When it gets there, I'll show a prediciton and we can watch it play out.

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