Volatility Reflexivity & Mean

ReversionMark Whistler

ON TARGET

Over the Next Hour We Will Touch

On...

Volatility Reflexivity & Market PsychologyIndicator Failure | Information Failure

Market Understanding Failure

Volatility

Reflexivity

Volatility

Defined

Probability

Volatility

Trading Mean

Reversion

Four Types of Volatility Defined Market Volatility | Price Volatility | Period-Mean Volatility | Probability Volatility

Probability VolatilityVolatility Expansion = Trending

Volatility Compression = Lateral Trading

Mean ReversionTwo Types of Mean Reversion

Identifying Opportunity

● 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..

To Unlock the Mystery)

First Piece of the Puzzle to Unlock)What is Volatility Reflexivity?

Volatility Reflexivity

• The imperfect understanding of

markets and trading by individuals,

media, and professionals creates

volatility...

• "Volatility" is really opportunity and can

be spotted through generalizations.

• "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."

George Soros and

Reflexivity

Influenced by Karl PopperPopper's Model of Analytical Science

Initial Conditions

GeneralizationsFinal

Conditions

Initial Conditions

Confirm Outcome

Generalization must be TRUE

The Problem

with Popper's

Model

The Theory of

Generalizations

Overbought

and

Oversold

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

Investopeida.com

Defines Overbought as...

Influenced by Karl PopperPopper's Model of Analytical Science

Initial Conditions

GeneralizationsFinal

Conditions

Market Rally Stochastics

Overbought

Selloff

Pending

Reversal

For Example...

What if the Final Conditions

are not met though?

• 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 problem... Except the problem itself...

• The Generalization...

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?

How We Most Often Perceive Markets and Trading...

Fact Fact Fact = Outcome

We commonly believe information, trading opportunity, technical events, trends, etc... Move in a logical, sequential flow...

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

= Outcome

"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."

Fact

Perceptions

Fact

Understanding

Expectations

The Alchemy of Finance | George Soros | Page 41

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...

Imperfect Thinking (Perceptions) of

Market ParticipantsHow 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.

Volatility ReflexivityWe 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 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 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...

• If we have linked a perception (expectation) to an outcome, and we have identified such... We must ask why we have linked our perception to the 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 FactsFundamentals, News, Politics and Technicals

Analyze Perceptions

Both Our Own and That of Other Participants

Are Perceptions Biased or

Warranted?

Analyze ExpectationsAsk Where Facts and

Perceptions May be Linking Expectations to an Outcome

Is Price Influencing

Perceptions, or are

Perceptions Influencing

Price?

Is There Really Opportunity or

Risk Right Now?

Price Influencing Perceptions• Can be both retail and institutions

• Most often though, technical signals are a derivative of price influencing perceptions... Meaning, retail traders are reacting to price movements...

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

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:

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 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 VolatilityPrice 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 VolatilityMean 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 informs us of

"total possible

probability" at any given

moment...

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) 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...

Why Standard Deviations Expand and

Compress, and What the Occurrence Means!

Identifying Trending Versus Lateral Trading

Action...

To Trade With the Trend or Mean

Reversion?

Three Types

of Mean

Reversion

• Price action mean reversion occurs when random volatility strikes after a news announcement...

Price Action

• "Reload Mean Reversion" Occurs when Institutions Allow Prices to Fade Back to Mean in Order to Obtain a Better Fill

Reload 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

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

Opportunity!

Questions?

Volatility Reflexivity & Mean

ReversionMark Whistler

Thank

You!