Let us look at this hourly chart on XAU/USD (Gold). The average range, if you had bought at the low and sold at the high (which is not possible in most scenarios), would be only 700 pips.
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This is not to mention that you will be subject to long hours of wait, doubts, worries as the market go in your favor and against you repeatedly.
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You will naturally wonder where to place your stop and profit taking points. If you put stops too closely, it can wipe you our with a spike only to go your intended way, and you'll be pissed as hell. But if you put stops too far, it will create huge unnecessary losses. You might also be prone to putting sub-optimal profit taking points and miss out big moves, or, you might be putting an overly ambitious profit taking point that doesn't fill.
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More often than not, technical traders will use some form of support & resistance, fibonacci levels, or whatever level derivatives to time it - almost always watching the price turn ambigious and even seem to purposely miss the profit taking fills within a few pips!
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And assuming you can are willing to subject yourself to all these nonsense and stress, the most you can extract out of this ranging market is only a few hundred pips in a few days.
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The question to ask this is: IS THAT THE BEST YOU CAN DO? IS THAT WHAT PROFESSIONAL BANKS AND TRADING FIRMS DO?
Now let us look at this minute chart, also on XAU/USD (Gold).
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Very noisy for the buy-and-hold trader eh?
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What if you could trade all these noises, buying and selling all the noises in between?
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Are you aware that HFT firms can make tens of thousands of even hundreds of thousands of pips within such a small market range by trading the swings in between?
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I'm sure we all want to do this, but we can't!
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Firstly, these firms spends millions on infrastructures such as ultra-low latency co-location servers, radio dishes (Yes radio waves move faster than optic fibre instructions to exchanges), billions of dollars of capitalisation, paying millions in salary to top Ph.D employees, enjoying literally no commission and spread in trading conditions, before they can achieve this.
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The result is millions of trades scalping fractional pips within hours. Most people cannot afford to do that.
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But what if, we can just do 5% of that, in a way that can be done manually by humans, without the requirements of the above?
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How many pips do you think you're going to make in a few hours of work? What are the general principles to how this works?
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There are two types of bell curves.
1. Poisson distribution
2. Gaussian distribution
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In normal distribution, it is a bell curve with a moderate bell shape and thin tails. This means that most of the data lies within 2 sigmas (standard deviation) of the mean.
You can think of the prices that fluctuates rapidly around a “pivot” as these samples, akin to particles surrounding an atom.
Of course, we know that, these particles do not exactly orbit around in a perfect circle.
At times, when the vibration frequency changes, the path of orbit skews towards an oval.
Similarly, price has a tendency to spike (perhaps due to news or other important future expectations), then consolidate for a while before moving again.
Think of these spikes as the “pivots”, by which, according to the central limit theorem states that most samples will fluctuate around them.
Then we have 2 distributions coming in, namely Poisson and Gaussian, in subsequent sequences.
When price spikes, the curve becomes leptokurtosis, in simple terms, a fat tail and a gentle bell shape.
This is due to the fact that most prices are now in the outlier zone, beyond a few sigmas from the central line.
When these happen, the prices becomes “unstable”, and start to return to heteroscedasticity. In simple terms, this means it starts to show variancy regression. Prices start to change their orbit shape, around a moving pivot, and regresses to the mean.
In other words, volatility increases and decreases at different times.
With enough data, the law of large numbers determine that most of these variancy will regress.
Therefore, based upon this theory, we can assume that prices will at some point in time regress back to central line, or “pivot”.
In trading terms, this would be considered a “high frequency trading”. You can think of it like a micro grid trading, where both buys and sells are simultaneously put on.
The concept of winning edge lies primarily in a net gain.
So we put on an even number of buys and sells.
Two things can happen.
1. Price fluctuates around the pivot rapidly, giving gains to most of the hedges.
2. Price continues strongly in one direction.
The first scenario is easy, as all the buys and sells will take profit or stop out with a minimal loss, as defined by a tight stop.
The second scenario is tricky, as some of the orders which are incorrect in direction will get stopped out.
The solution is rather simple to the above scenario.
When the trades in the correct direction made money, and reach profit target; instead of waiting for the incorrect trades to stop out at default stop loss, it coincidentally closes itself when the correct direction trades make money.
This ensures that you have partial loss on the incorrect trades, and if you press on with more trades on the correct ones, it will net a balance.
The beauty of this is that since the profit target is larger than the stops, even if you have 30% accuracy, you will end up with a net gain.
In other words, buy when oversold, sell when overbought, where overbought and oversold are calculated from the distance of price from some mean, and the distance takes current volatility into account.
Another beauty of this is, unlike traditional grid trading where one hopes the market will turn back in his favor (and if it does not, completely ruins the account), it closes within a short time frame. This means it does not allow losses to run. Only profits run.
Given enough time to play out on statistics, the probability of net profit is extremely high.
A study of short term data from 2008 to end 2022 suggest a high Z-score and confidence levels for this phenomenon to happen, even during “black swan” events.
This is a very complex concept explained in a simplified manner.
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We have perfected the actual practical trading method on HFT that is possible to do by human traders in our course.