Why do I see "Trends" in Randomly Generated Data?

Discussion in 'Data Sets and Feeds' started by Rahula, Feb 21, 2008.

  1. Rahula


    I've created an excel file I call "random chart generator". The weird thing is that most of these charts look exactly like market charts and you can apply all kinds of TA tools like moving averages, and trendlines to these charts.

    If you don't believe me, see for yourself. Type in =RAND()*(-1-1)+1 into excel in column A. Then create a rolling sum of column A in column B. Then create a chart based on column B values and add a moving average.

    Now what to make of this? I suppose when most people see a 7,7,7,7,7,7 result in the lottery they see a 'trend' even though it is just as random as 23,42,11,14,33,8 lottery result - both events have an equal probability of happening.

    Now if the markets are random and the market closed up,up,up,up,up,up,up,up,up,up,up,up 12 days in a row - most people would likely be talking about it as a n-sigma event or a "black swan" even though it is just as unique and random an outcome as a up, up, down, up, down, down, down, up, down, up, down, down 12 day series of closes.

    Now doesn't a random market assumption mean that both mean reversion and trend trading strategies don't have any science to back it up and at the end of the day it all comes down to luck?

    I know, scary thread.
  2. slacker


    Why do I see trends?
    From my notebook of thoughtful quotes, that I agree with, found on the web:
    Recently described in a book titled "Mean Markets and Lizard Brains" by Burnham; he describes the natural desire to find patterns where no pattern exists.
    However, building a 'superstition' around signal analysis and cycles can be fun if not profitable.
  3. you see trends in random data because even in random events, the same thing will by chance happen over and over thus creating what looks like a trend, a trendline, etc.

    human auctions aren't random though.
    This will turn into another thread where losers bash "ta", then degenerate gambler wannabe traders who use stochastics and moving averages defend it, then the bashers who are smarter than the gamblers yet not smart enough to be traders feel vindicated in their theory that no one can make money in the market from price alone (because they couldn't when they tried) by seeing the stupidity posted by the suckers and scream about how random the market is.

    the market can be random at times, more often then not I have no idea what's going on. But even in those times, I can know that it's trading too randomly for me to find an edge. And just becuase I can't see it doesn't mean someone else can't.

    stock charts have a few key differences than random up/down sequences charted... they can look a like, but looking at a very large sample the differences are clear.
  4. Rahula


    slacker - nice post. You reminded me of another thread with this post:

    I think it would be extremely hard (maybe even against one's nature) to think without making any of the above errors.
  5. Rahula


    Okay so lets say an equivalent of 10 heads in a row happens in the market you're asked to bet on the next outcome.

    Suppose you believe trends (patterns) do exist and forecast a higher probability of the trend continuing. Then the correct action is to trade the trend.

    Now suppose you believe trends don't exist OR trends do exist and have no predictive value. Now the correct action is to not act play the random game at all.

    Therefore mean reversion strategies aren't worth it under either assumption.

  6. correct.

    it's only after one enters a position that trend has any significance, that being a personal one. prior to entry, its merely pretty lines on a screen.

  7. Let's say one guy has been buying a stock up all day. It's been in a range, there's a seller at 55.60 that doesn't want to break, and a buyer at 55.55. The futures start tanking really hard, the 55.55 buyer pulls his bids back to 55.40. Some people panic out. However, the seller wants to sell at his price, 55.60. The buyer wants to buy as cheaply as he can, but outside of the panic, isn't getting filled much at 55.40. you feel the selling drying up. You go long 55.43 playingg off the 55.40. The stock goes back into the 55.55-55.60 trading range. That's mean reversion. I just pulled that scenario out of my asshole but if it doesn't make sense to you you shouldn't be wasting money trading in a live human auction where you believe mean reversion has no value.

  8. your talking tape reading, not seeing trends on a chart. right?

  9. I hate these kinds of threads and I don't know why I am posting. Nothing ever gets accomplished on either side of the argument.

    Flipping a coin has nothing to do with markets. Markets are controlled by human emotions.

    Human emotions cannot control a coin flip, but human emotions can be predicted.

    Trends do exist and they are tradeable.
    Profitably trading with high levels of consistency is not luck.
    #10     Feb 21, 2008