Chaos Theory

When a rookie trader goes through troubles in trading, the first idea springing to mind is that forecasting a price dynamic is a “must know” for successful trading on Forex. However, after judging the actual situation, it is clear that a trader should be equipped with theoretical knowledge for a long-term forecast, in particular fundamental analysis. Technical analysis is needed for a short-term outlook. Assessing a situation, a trader notes that a market moves up and down with long cyclical waves during a long period. When we look at a chart, we notice that short-term patterns. Those patterns tend to repeat on a regular basis at peaks and dips. Thus, watching repeated patterns of various kinds enables a trader to reckon a profit which is possible only in case the right decision is made at the right time. Most beginners assume that Forex is like a mechanism operating in cycles. Logically, if a trader can absorb all patterns and cycles, he can easily gain big profits. So, to achieve this aim, a trader sets to study the forex market and digests all available literature. Importantly, 75%% of traders lose their deposits in full within the first year of operating on Forex. Speaking about a longer period, almost 95%% of traders lose their money. Only few of them are curious if there is an efficient theory that recurring periods of similar prices appear with an underlying order. Traders experience a failure because they created the illusion of Forex principles. Such traders find it difficult to clear up the misunderstanding. Hence, they are doomed to failure. To make things worse, the forex market operates in such a way that makes a trader even more confused. The chaos theory does not make it possible to study the market by mathematical and statistical methods. Besides, it disrupts a discovery that periods or cycles replay at a certain pace. The chaos theory is a mathematical concept of analyzing nonlinear dynamic systems, in particular markets. In practice, the chaos theory proves that market prices are usually shaped at random with minor dependence on a trend. A degree of trend impact is determined by a particular market and a chosen time frame. To explain chaotic systems, scholars use fractals, objects bearing a feature of self-similarity. In other words, their parts are similar to the whole object. Besides, another feature of chaotic markets is sensitivity to original conditions. It makes dynamic markets difficult to forecast. A lot of traders and Forex strategists believe that intraday trading is like random noise trading, which means a waste of time. Therefore, intraday traders inevitably end up losing their deposits. On the other hand, experts think that long-term price dynamic is not erratic. Market participants are capable of gainful trading on the grounds of daily and weekly charts if they follow a trend. The logical question arises here. Why are short-term price fluctuations erratic? Why do long-term dynamic consisting of short-term fluctuations on the same market follow a certain pattern? The answer is tricky. A system does not exist in a short-term period. But a system shows itself in the long run. There are no short-term periods and repeated short-term cycles which are meaningful for making a forecast. Related to financial markets, proponents of chaos theory believe that a price is the very last thing to change for a stock, bond, or some other security. Thus, the possibility to predict a future price in the short term using technical analysis is virtually close to zero. There is a scientific fact that intraday traders are initially doomed to failure. Likewise, those who reject this fact are exposed to financial losses. Does it mean that the forex market is chaotic and all traders will inevitably lose all their money? Of course, it does not. A trader can analyze a long-term market trend to gain a statistical advantage. Trend-tracking systems are designed to do it. It explains why good trend-tracking systems operating on diversified markets yield annual profits and why intraday traders incur losses in the long run. It is hard to foresee when exactly a trading system will bear fruit. A trader had better develop one’s own trading strategy rather than make it match it someone else’s. To avoid it, the same rules should be applied to all markets and a trading system should be tested on the utmost of trading floors. If a trading system makes profits on a variety of markets, it means that such a system is not a copycat. To increase chances for profits and curb risks, it would be wise to streamline a trading system, a content of an investment portfolio, and an account size. It is hardly possible to foresee for sure what market will have a perfectly clear trend in the nearest six months although there is a method of assessing a disposition of different markets to a trend from the historical point. To diminish short-term risks, it is important to diversify them. A trader should control a ratio of potential losses to a deposit size as an efficient method of diversifying risks. In most cases, traders do not know if their trading strategy will gain advantage. So forex participants use trading strategies which cannot be backtested in principle. They hope that information discovered from books is written by a renowned trader whose strategy has already proved its efficiency in practice. However, a trader should be aware that Forex could be a dubious business that might cause a serious loss without the right approach. Read more: http://www.mt5.com/ms/articles/chaos_theory_and_market_reality/