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Volatility Reflexivity & Mean Reversion Mark Whistler
Volatility Reflexivity & Mean
Reversion
Mark Whistler
ON TARGET
ON TARGET
Over the Next Hour We Will Touch On ... Volatility Reflexivity & Market Psychology Volatility Reflexivity
Over the Next Hour We Will Touch
On ...
Volatility Reflexivity & Market Psychology
Volatility
Reflexivity
Indicator Failure | Information Failure
Market Understanding Failure
Four Types of Volatility Defined
Volatility
Defined
Market Volatility | Price Volatility | Period-Mean
Volatility | Probability Volatility
Probability Volatility
Volatility Expansion = Trending
Probability
Volatility
Volatility Compression = Lateral
Trading
Mean Reversion
Trading Mean
Reversion
Two Types of Mean Reversion
Identifying Opportunity
To Unlock the Mystery ● We must first be willing to think critically (with an open
To Unlock the Mystery
● We must first be willing to think critically (with an open mind) about
why what we’ve been told is reliable Is truly reliable.
● We must check the math.
● We must not accept vague terms like “overbought and oversold.”
● We must be willing to consider the possibility that 95% of the
information, media, analysts and economists present is wrong.
We Must Then Be Willing to Deconstruct
Everything We Know ...
● We must be willing to put in the time
● We must have a thick skin
● We must be willing to consider the fact that the information
believed to be true, may have been
bad from the start ...
We Must Be Willing to be
Patient While Putting the
Pieces Back Together ..
irst Piece of the Puzzle to Unlock What is Volatility Reflexivity?
irst Piece of the Puzzle to Unlock
What is Volatility Reflexivity?
• • The imperfect understanding of markets and trading by individuals, media, and professionals creates volatility
The imperfect understanding of
markets and trading by individuals,
media, and professionals creates
volatility ...
"Volatility" is really opportunity and can
be spotted through generalizations.
Volatility
Reflexivity
George Soros and Reflexivity • "Human understanding is often incoherent and always incomplete." • "People base
George Soros and
Reflexivity
• "Human understanding is often incoherent
and always incomplete."
• "People base their actions not on reality but
on their view of the world. And the two are not
identical."
• "Therefore, outcomes are liable to diverge
from people’s expectations."
• "Events that have thinking participants cannot
be understood without taking that divergence
into account."
Influenced by Karl Popper Popper's Model of Analytical Science Initial Final Generalizations Conditions Conditions
Influenced by Karl Popper
Popper's Model of Analytical Science
Initial
Final
Generalizations
Conditions
Conditions
Initial Conditions The Problem with Popper's Model Confirm Outcome The Theory of Generalizations Generalization must be
Initial
Conditions
The Problem
with Popper's
Model
Confirm
Outcome
The Theory of
Generalizations
Generalization
must be
TRUE
Overbought and Oversold Investopeida.com Defines Overbought as ... 1. An asset that has experienced sharp upward
Overbought
and
Oversold
Investopeida.com
Defines
Overbought as ...
1. An asset that has experienced sharp upward movements over a very short period of
time is often deemed to be overbought. Determining the degree in which an asset is
overbought is very subjective and can differ between investors.
2. Technicians use indicators such as the relative strength index, the stochastic
oscillator or the money flow index to identify securities that are becoming
overbought. An overbought security is the opposite of one that is oversold. 1
Influenced by Karl Popper Popper's Model of Analytical Science For Example ... Stochastics Selloff Market Rally
Influenced by Karl Popper
Popper's Model of Analytical Science
For Example ...
Stochastics
Selloff
Market Rally
Pending
Overbought
Initial
Final
Generalizations
Conditions
Conditions
Reversal
What if the Final Conditions
are not met though?
Why Generalizations are so Harmful! Initial Conditions AKA Expectations Must Have Vehicle "Generalization" To Link Our
Why Generalizations are so Harmful!
Initial Conditions
AKA Expectations
Must Have Vehicle
"Generalization"
To Link Our
Expectations to the
Outcome ...
When Trying to Figure Out
What Went Wrong?
• When we depend on generalizations, we can never
question the generalization that was the vehicle
linking our expectations to the outcome
...
Otherwise,
we would see the GENERALIZATION was the
problem from the start ...
• So we look at everything else that could have been
...
• The Generalization ...
the problem
Except the problem itself
...
How We Most Often Perceive Markets and Trading ... Fact Fact Fact = Outcome We commonly
How We Most Often Perceive
Markets and Trading ...
Fact
Fact
Fact
= Outcome
We commonly believe information, trading opportunity,
technical events, trends, etc
sequential flow ...
...
Move in a logical,
For example, "When Stochastics trade above 80, the
currency must be overbought, and thus, a reversal is
pending " ...
But this type of thinking fails to consider how higher
prices might change some traders opinion to: Higher
prices mean the currency is breaking out to a new range,
or the beginning of a trend ...
Theory of Reflexivity Expectations Fact = Outcome Understanding Perceptions Fact "The actual course of events is
Theory of Reflexivity
Expectations
Fact
= Outcome
Understanding
Perceptions
Fact
"The actual course of events is likely to differ from the
participants’ expectations and the divergence can be
taken as an indication of the participants’ bias."
The Alchemy of Finance | George Soros | Page 41
Imperfect Thinking (Perceptions) of Market Participants How Participants Are Influenced By and also Impact Markets Cognitive
Imperfect Thinking (Perceptions) of
Market Participants
How Participants Are Influenced By and also Impact Markets
Cognitive Function
• Participants Perceptions Are
Dependent on the Situation
• Example: One may not consider
taking a position long, unless an
upward trend were in place.
Passive Function
• The situation is influenced by
the participants perceptions ...
• Example: Higher prices may
lead participants to perceive a
"breakout" and thus, take
positions
long
...
Which, in-turn,
drives prices even higher ...
Volatility Reflexivity We must take another step beyond Soros' Theory of Reflexivity, to remain clear, balanced,
Volatility Reflexivity
We must take another step beyond Soros' Theory
of Reflexivity, to remain clear, balanced, and
profitable during stressful short-term trading ...
Step 1 Unlinking Our Expectations from the Outcome • We must cognizant of our own thinking
Step 1
Unlinking Our Expectations
from the Outcome
We must cognizant of our own thinking and
emotions, constantly asking ourselves if we have
possibly linked our expectations to the outcome ...
If we have, we must ask ourselves if our
perception of reality has become skewed, or
biased, based on the fact that we are expectant
of a particular outcome ...
If we find we have linked our expectations to an
outcome, we must identify the Generalization (the
vehicle), which may be causing the problem ...
Step 2 Separate Facts from Perceptions of Broader Market ... • Ask ourselves if price is
Step 2
Separate Facts from
Perceptions of Broader
Market ...
Ask ourselves if price is influencing perceptions,
or perceptions influencing price?
Ask ourselves if perceptions are being influenced
by facts, or perceptions?
Step back from the situation and attempt to
"weight" the situation in-terms of "expectations
aligned", or "uncertainty persists" within markets.
Step 3 Be Fully Prepared to Change Our Minds, Should the Situation Warrant Such ... •
Step 3
Be Fully Prepared to
Change Our Minds, Should
the Situation Warrant Such ...
If we have linked a perception (expectation) to an
outcome, and we have identified such
...
ask why we have linked our perception to the
We must
outcome?
We must then ask what other possible information
we might be (consciously or unconsciously)
ignoring, to keep our expectations cheerfully linked
to the outcome ....
Be prepared to close our position (winner or loser)
should the facts | perceptions show our expectant
outcome is likely flawed ...
Analyze Analyze Facts Analyze Expectations Perceptions Fundamentals, News, Politics and Technicals Both Our Own and That
Analyze
Analyze Facts
Analyze Expectations
Perceptions
Fundamentals, News,
Politics and Technicals
Both Our Own and That of
Other Participants
Ask Where Facts and
Perceptions May be Linking
Expectations to an Outcome
Is Price Influencing
Perceptions, or are
Perceptions Influencing
Price?
Are
Perceptions
Biased or
Warranted?
Is There Really
Opportunity or
Risk Right
Now?
Perceptions Versus Price Perceptions Influencing Price • Can be both retail and institutions • Most often
Perceptions Versus Price
Perceptions Influencing Price
• Can be both retail and institutions
Most often though, perceptions influencing price
are institutions seeing risk, or potential future
value gain or loss, and are taking action
Price Influencing
Perceptions
• Can be both retail and institutions
Most often though, technical signals
are a derivative of price influencing
...
are reacting to price movements ...
perceptions
Meaning, retail traders
Another Piece of the Puzzle What is Volatility? • As currently discussed, defined, and thought of
Another Piece of the Puzzle
What is Volatility?
• As currently discussed, defined,
and thought of by media,
traders, and educators ...
Volatility is a generalized term
covering erratic price action,
risk within returns, and/or fear
within markets ...
• There are really four types of volatility ...
• Most important thought, volatility is
probability ...
Volatility for Active Traders The four types of volatility that affect common trading and markets are:
Volatility for Active Traders
The four types of volatility that affect common trading and
markets are:
1.
Market Volatility
2. Price Volatility
3. Mean-Period Volatility
4. Probability Volatility
Volatility is
Not an
"all-encompassing"
word!
Market Volatility "The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term
Market Volatility
"The CBOE Volatility Index® (VIX®) is a key measure of
market expectations of near-term volatility conveyed by
S&P 500 stock index option prices. Since its introduction in
1993, VIX has been considered by many to be the world's
premier barometer of investor sentiment and market
volatility."
Price Volatility
Price volatility is a both a cause of, and
derivative of market volatility, probability
volatility and mean-period volatility. While
price volatility is really nothing more than
an extra description of the total low-to-
high range of prices in any given period
measured, the label is required to
separate "price action" from the other
three volatility descriptions ...
Mean-Period Volatility Mean period volatility is simply the paradigm where shorter- term distributions will likely show
Mean-Period Volatility
Mean period volatility is simply the paradigm where shorter-
term distributions will likely show greater volatility than that
of their longer-term counterparts. In addition, the shorter the
period measured, the greater the volatility of the same
mean measured. For example: A 50-period mean on 15-
minute chart will show greater volatility than a 50-period
mean on a 4-hour chart.
Probability Volatility
• Total probability of potential Price
Volatility, Mean-Period Volatility at any
given moment.
• Influences and influenced by Market
Volatility
• Significant "real time" tool in helping us
identify opportunity or risk within
markets and trading ...
Probability Volatility • Expansion and Compression of Standard Deviations • Is a leading Indicator • Specifically
Probability Volatility
Expansion and
Compression of
Standard Deviations
Is a leading Indicator
Specifically informs us of
"total possible
probability" at any given
moment ...
Standard Deviations • • Measurement of Probability Expand and Compress • Identify When Trending is About
Standard Deviations
Measurement of
Probability
Expand and Compress
Identify When Trending
is About to Begin, or
Lateral Trading is in
Effect ...
Standard Deviations • Shape of distribution does not matter ... • Distribution (just like the mean)
Standard Deviations
Shape of distribution does not matter ...
Distribution (just like the mean) is not static, rather, it is dynamic like prices
and time ...
Probability remains intact, because the distribution moves AND standard
deviations (volatility bands) expand and contract ...
Fatal Flaw of Assuming Static Distribution ...
Fatal Flaw of Assuming Static
Distribution ...
Why Standard Deviations Expand and Compress, and What the Occurrence Means!
Why Standard Deviations Expand and
Compress, and What the Occurrence Means!
Identifying Trending Versus Lateral Trading Action ...
Identifying Trending Versus Lateral Trading
Action ...
To Trade With the Trend or Mean Reversion?
To Trade With the Trend or Mean
Reversion?
• Price action mean reversion occurs when random volatility strikes after a news announcement ... •
• Price action mean
reversion occurs
when random
volatility strikes after
a news
announcement ...
• "Reload Mean
Reversion" Occurs
when Institutions Allow
Prices to Fade Back to
Mean in Order to Obtain
a Better Fill
Three Types
of Mean
Reversion
Reload
Price Action
Reversion
• Uncertainty, or Fair Value
Mean Reversion Occurs in
Lateral Markets and can
be Spotted Through
Volatility Compressing ...
Volatility
Compression
Mean Reversion
Mean Reversion Opportunity
Mean Reversion Opportunity
Probability Volatility Compression Equals Mean Reversion Opportunity!
Probability Volatility Compression
Equals Mean Reversion Opportunity!
Don't Fear Lateral "Chop" Anymore! It's Really Just Volatility Compressing and is Filled with Mean Reversion
Don't Fear Lateral "Chop"
Anymore!
It's Really Just
Volatility Compressing and is
Filled with Mean Reversion
Opportunity!
Questions?
Questions?
Thank You! Volatility Reflexivity & Mean Reversion Mark Whistler
Thank
You!
Volatility Reflexivity & Mean
Reversion
Mark Whistler