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Discussion in 'Strategy Building' started by Gordon Gekko, Jan 30, 2003.

1. ### Gordon Gekko

i'm not smart enough to even understand it really.. for example, after reading the following, i could not in my own words explain it to someone else. lol can someone please explain this in simple terms?

specifically, i'd like to understand this part:

"In spite of the volumes of rubbish in classical economics texts, the Efficient Market Hypothesis is NOT TRUE. There is now overwhelming evidence to the contrary. Moreover, mathematical analysis of financial time series shows that the market is NOT normally distributed, it is more like a Pareto-Levy distribution. Unlike normally distributed time series which have computable moments, the market distribution is NOT well behaved - for example, the Pareto-Levy distribution has INFINITE variance! In other words, financial time series are NOT STATIONARY and they are NOT LINEAR. Consequently, EVERY filter you will ever find in any book on signal processing, be it a simple moving average or an advanced Kalman tracking filter, is about as much use as a chocolate padlock in financial applications! What is not written in two inch high letters on the first page of these books (but what is always tacitly assumed), is that the signals are STATIONARY and hence LINEAR filtering is applicable. This is generally true for signals in communications equipment but it is NOT true for signals arising from natural phenomena, especially the markets.

What is required for the markets is NON-LINEAR analysis. This is, of course, MUCH more difficult both theoretically and practically than the simple linear cases, so textbooks don't bother with non-linear stuff; it is just too difficult. Likewise, vendors of technical analysis software generally use what they can find in the literature, at most tarting up the algorithms a little here and there. But these algorithms don't work! Gauss proved three hundred years ago that the best estimator of a random process is its moving average. If the markets are random, then moving averages should make you money every time. But they don't. Now you know why."

2. ### TGregg

Non-linear literally means not a straight line. So would that suggest oscillators?

3. ### inandlong

I will jump in here with one post only because the Efficient Market Theory discussion can go on forever.

Linear or not, the market is efficient if you view it in the context of it being the one place where all information of any type is distilled to one thing that is available to all.... the price.

Distribution, mathematical models, blah blah blah blah blah can be put aside except for mental exercise when you recognize the above fact. Regardless of what you know, or think you know about any equity or commodity, it is all factored in to the current price. Thus the market is efficient.

Bring on the models now, and the other theories.

4. ### cheeks

Very well said.

5. ### Walther

To Gordon
The way I understand it says that usuall TA like MA, Stoch and such will not work consistently, but it is easily understood and for this reason also marketed as usefull and easily implemented. I agree with that.
That is nice, but how do we overcome " inefficiency "( or fundamental flaws ) of traditional TA ? Answer is that there has to be some nonrelated "add on" to filter out " fundamentaly flawed " signals created by traditional TA .
Walter

6. ### profitseer

it means the market is not efficient. It is inefficient. So therefore, it is ok to try to beat it.

It all started when some professor's wife complained that his part time trading had become a gambling addiction.

So he took a bunch of market statistics and compared them to a roulette wheel to prove his point.

She had the last word however when she compared equity trading curves to casino winnings and found them to be nearly identical.

There is still some small debate over the free drinks in the casino vs the cost of software for trading. So some still insist one is better than the other.

(Interestingly, it was the free drinks which caused the professors wife in the end to side with the inefficient market theorists.)

The only way to tell for sure is to trade for a while, then go to Las Vegas and see if there is a difference. If there is no difference, then you have to come up with some kind of theory which states that the numbers which come up on a dice roll can be forecasted using past history.

Otherwise, everything is efficient and there is no use in trying to beat it.

8. ### profitseer

well seriously, I don't know what non linear analysis is. I suppose if you could use it, it would work better than linear analysis. But linear analysis works fine.

Everytime I point and click, someone is bashing ma crossovers. Set you ma's up and watch what happens when they cross. Are prices more likely to stop right there and reverse, or continue on?

Even if they only continue 50% of the time, that's all you need.

No matter what I'm trading, no matter what I call it, it is always some variation of the ma crossover. I'd like to see this system which makes money on the wrong side of the ma.

The trader can't make money, he can only screw things up. The market can make the trader money if he doesn't screw up. And for the market to make the trader money, the trader has to be on the right side of the ma.

So the ma tells you which side of the market to trade, and all you have to do is try to not be too late getting in and too early getting out.

And that's just linear, imagine what a trader could do if he was a non linear analyst!

9. ### maxpi

He's saying that if you are really, really smart you will never be able to solve the problem but I you are dumb, persistent and lucky you might make it.

Max

10. ### Monsoon

assuming the markets are a random walk.. where does the effect of psychology factor in? are peoples views and feelings random or just so opposed that one half cancels the other?

#10     Jan 31, 2003
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