- 1999: Volume 8, No. 2 Market Hitchhiking

Making money trading futures is tough. Maybe the cause of the difficulty is not the market, but your perspective? What if you begin thinking of trading as process? Stop looking for objective market profit and loss signs, dumping thoughts of zero sum game, and instead think of trading as a journey. Picture yourself alone, a market hitchhiker on an adventure composed of serial observations and trades. You are essentially a market search engine.

As a hitchhiker you confront the unknown. The unknown is the central risk element of this mode of travel. The unknown is the cause of doubt, stress, emotional upheaval, panic and consequently, loss. What if someone invented a mathematics not void of emotion, but is focused on that human dynamic? Would knowing that type of mathematics help you trade commodities? Sure it would. That someone was George Boole, at age 17, walking across a pasture he discovered the new field of "higher mathematics." Boole titled his discovery "The Laws Of Thought." To explain his discovery, Boole a self-taught mathematician, created a new mathematical language of binary algebra. The impact of Boole's mathematical logic on life in the twenty-first century will dwarf the impact Darwin's evolution theory had on the nineteenth and twentieth centuries. Boole's process logic is the architecture of all digital devices; the foundation of the computer age.

The mathematics known as Boolean Algebra is to futures trading, what trigonometry is to navigation-a perfect match of theory to application. Boolean Algebra is market math. What follows is an excerpt from The Hitchhiker's Guide To Futures and The Laws Of Thought, a book that makes the robust ideas of Boolean Logic available to the non-mathematically gifted.

Beliefs

Most people think of technical analysis as chart techniques and computer manipulations. True technical analysis is not a one-right-way practice. It's the collective name applied to all operations in logic, used to study relationships between price, time, volume and open interest. Such a broad definition is correct, but lacks enough boundaries to be very useful.

To get a better handle on technical analysis, let's consider the term as a tent over three distinct types of analysis: intellectual, actuarial and natural science. (In the same way, mathematics is a big tent over algebra, trigonometry, calculus, Euclidean geometry, and non-Euclidean geometry.)

Intellectual analysis encompasses chart analysis in which icon price patterns are sought to foretell the futures markets' price action. Actuarial analysis is entirely concerned with formulas for interpreting data.

The focus of The Hitchhiker's Guide To Futures and The Laws Of Thought is the natural science-Boolean approach to market analysis. We're concerned with the other two only for purposes of comparison.

In deciding which school of analysis best suits your purposes and personality, it's worthwhile defining yourself, appraising your way of looking at the world by asking yourself a few questions about your personality, financial situation, beliefs, and how you organize your life.

Who Are You?

What are the limits of your patience? How do you deal with stress? How much money are you willing and able to put in play? Is trading an escape? An adventure? Do you need a confidant? How do you define success? How do you define failure? What do you fear? What do you value?

Most commodity traders are successful business professionals, experts in diverse fields of enterprise. Surprisingly, when successful people are speculating, they often abandon hard won business lessons and methods. Methodologies they rely upon to make their livelihood are set aside for alien, often sophomoric trading styles. Painfully common are speculators adopting trading strategies they do not understand and are not good matches for their personalities.

Because trading commodities seems exotic and extraordinary, many new traders approach it like a peep show, frightened they'll be exposed for lacking what lawyers term "prudent-man judgment." Believing that futures markets are mysterious and dangerous, distinct from everyday life, they go whole hog and subscribe to an esoteric trading method that is, in all likelihood, at odds with their habitual ways of doing business. Confidence is central to trading success. How can anyone trade with confidence using a system in conflict with one's usual style of thinking and acting?

It's often attractive to assume that buying the latest technology is the answer to every problem, including trading dilemmas. It's appealing to think money invested in methodology is the difference between trading success and failure. Unfortunately, achieving success in the markets comes neither that simply nor that easily. Because traders have varying personalities, a packaged system that works for one may be a disaster for his best buddy.

Given enough time and money all trading systems will work, but how many traders have unlimited amounts of either? Not hitchhikers. We can't afford to wait around for the law of large numbers to pay off for us.

Different systems require varying amounts of risk capital. A perfectly sound, safe trading system may require a tremendous amount of capital to cover its assumed margin of error. The amount of money an individual trader has must match the type of system he trades. Try on actuarial, intellectual and natural science analysis systems according to the following financial requirements and see which fits best for you.

Actuarial analysis is only suitable for very deep pockets-insurance companies, commodity pools, brokerage houses and other financial institutions, or very wealthy individual traders-because of large "draw downs" (the to be expected and budgeted for parameter of money loss, before a trade recovers to profitability). Actuarial science is based on statistical "laws of large numbers." Applying a slow-moving average trading method requires a lot of money. A faster-moving average tightens the risk parameters and requires less money for proper implementation. Put another way, leasing a Jaguar with only the resources for a Ford payment promises a crisis. Jumping in over your financial head is a circumstance the trader creates, not the market.

The intellectual school of trading can be cheap or expensive. More often it's expensive for novice traders who aren't accustomed to reading more subtle danger signs that cautions the more experienced trader.

Both actuarial and intellectual traders are focused on long-term profit objectives, whereas the natural science approach focuses on risk control and survival, immediate concerns. The hitchhiker knows that if he's correct in the short-term, the long-term will take care of itself.

Natural science trading is for the fleet of foot, i.e. hitchhikers, who expect they'll need a series of rides (trades) to reach their ultimate destination. A hitchhiker is more interested in the direction a ride will take him than the driver's destination. (He certainly isn't going to accept a lift in the opposite direction from where he's heading.)

Natural science traders don't have the luxury of a long-term view because most often they don't have enough money to hang on until the trade turns profitable. Rather the natural science trader assumes that if he trades short-term correctly, the long-term will take care of itself

The focus of actuarial and intellectual schools of trading is on profits. How much money is to be made following their rules. Risk is the principle focus of natural science analysis. When done with intelligence, futures trading can be afforded by those with hitchhiker wallets.

The Hitchhiker's Guide is unique in dividing technical analysis (the big tent) into three categories: intellectual, actuarial and natural science. There are many good books promoting intellectual and actuarial methods of trading (though they may be called by other names). The intellectual and actuarial schools, therefore, will only briefly be critiqued. Books on intellectual approaches are generally identifiable by the word "charting" in their title while actuarial texts are recognizable by the use of words like "averages," "statistics" and "finance" in their titles. Natural science is the subject of "The Laws Of Thought" aspect of The Hitchhiker's Guide To Futures and is unique both in substance and title.

Natural Science

The natural science approach to market analysis is based in Boolean logic, that is, Boolean algebra. On hearing this, a typical reaction is "Uh-oh, that has to be complicated. After all, this is the stuff of graduate school seminars, the premier subject of higher mathematics!" Well, just hold on because we're going to make Boolean logic very straightforward and applicable to the markets in such a way that it can help you make money.

It's the process of thought, not the answers, that is the focus of Boolean algebra and logic and also of Natural Science Market Analysis. If anyone of less stature than George Boole-the father of binary logic that runs every digital device we have today-made the claim that he had discovered the laws of human thought, we would next expect him next to claim to be Napoleon. But behind every genius, there is a simple thematic idea tying the work together. For Boolean Algebra and Natural Science Market Analysis it is the equal sign.

Of course, math and equal signs also play a role in the intellectual and the actuarial schools of technical analysis, but these perspectives incorporate elements outside of the market experience to define equivalence. The natural science perspective searches for inherent balance.

Intellectuals and actuaries believe that their ideas can impose the semblance of order on market action. For them, rules are primary, market experience is secondary. Their rules are universal, whereas market action is transitory. Intellectuals start with ideal forms and searches to define the market in their own language library. They watch for significant patterns, e.g. "hammers" or "head and shoulders," to appear on charts. Knowledge for the intellectual is the accumulation of facts-how much they know.

And actuaries? They assume that given enough number experience the rules of statistics are the defining rules governing market behavior. To them knowledge is formula.

To the Boolean, knowledge is finding meaningful associations between the known and the unknown. Knowledge is developed by the overlapping of what we know onto areas of uncertainty. Boole defined algebraic process as, "The habitual registration of the exact limits of one's knowledge, the incessant calling into consciousness of the fact of one's own ignorance." In other words, you have to know what you know to know what you don't know! Algebra is plotting the relationship between the known and the unknown.

The natural science approach is subjective, and does not look outside the market for definition. It doesn't take the intellectuals course of seeking an outside source, like a dictionary, to identify market meaning, nor does it search for meaning on a different plane of reasoning, as do actuaries. Natural science argues the market is a reflection of itself. The market is its own best circular argument. "Everything that goes up must come down" is a simplistic example of a circular argument. Natural science starts with market action and from observation searches behavior for symmetry. Again, the market is a locked room mystery. If this were a crime investigation, what we know would be termed "evidence." In natural science analysis, we call it "expressions." When the mystery is solved, that solution comes in the form of an equation.

Linking Facts to Thought

The puzzle of trading is not finding facts, but what those facts mean. It is wise to be suspicious of any trading promoter offering a methodology that concerns only one type of fact-for example, price or time-as the sole element. If a trading program is price, price, price, with no reference to time, volume or open interest, it may work for a short while, but ultimately will fail because it doesn't tell a complete story.

A single, statistical element trading system performance is happenstance (random) rather than rational. For example, using the Fibonacci summation series to time markets, excluding all other market input, is happenstance. (Fibonacci is a summation series that progresses as follows: 1+1=2, 1+2=3, 2+3=5, 3+5=8, etc.) A trading system based solely on the cost of production, or solely on past price performance as the basis for forecasting a commodity price, also is happenstance.

Why is it Happening?

Boole makes the case that the imprint of human symbolic thought resonates in everything humans do. Once man grasps an algebraic symbol from nature, that symbol takes precedence over the actual thing in nature it represents. It is a law of thought that we are drawn to the simplest (correct) explanation. For example, the concept "round" comes from the shape of the sun. Once an algebraic symbol is grasped, the symbol becomes reference, replacing in our minds the thing in nature, in this case the sun. From then on, even on a sunny day, if a person tries to explain "round" to another, he will try to make himself understood by drawing a circle in the dirt rather than pointing to the sun. This is a principle law of Boolean Algebra, the one of Boole's primary "laws of thought."

Accidental Occurrences

Thought patterns transcend race, location and creed. There are patterns, numbers, calculations and charts that resonate in markets. The lack of conscious knowledge of the laws is not a handicap because this is all intuitive. The unexpected can only happen and be unexpected if there is a context of set expectations.

Do not try to develop a universal method of analysis. Concern yourself with "single set analysis." The inherent flaw of developing a unified theory of market analysis is that the process takes on a life of its own and defeats the purpose of trading successfully. Often very smart traders become mesmerized by trading techniques and forget to watch the market. The goal is to be a successful trader, not a trading system builder.

There are no penalties for doing single set analysis and later discovering what happened conformed to broader law. Being right in the short-term affords opportunity to be right long-term. You can't make money being correct about the market's long-term behavior if you've been wrong about its short-term behavior. You've already been forced out of the market! But it's frequently profitable to be right short-term and wrong in the long-term.

Boolean or natural science market analysis is defined by thought process, not by the tools used to implement market analysis. Any technical market tool that concerns the four statistical elements of price, time, volume and open interest are proper techniques of natural science market analysis. Elliott waves, Fibonacci indicators, stochastics, Bollinger Bands, moving averages, trend lines and any other technique that meets the definition of technical analysis can be used. Boolean perspective works not because it obeys divine market laws, but because it is in agreement with markets.

Chris Stanton is the author of The Hitchhiker's Guide To Futures and The Laws Of Thought. He can be reached at cpstanton@mindspring.com or write Erasmus Press, 1050 Minneapolis Grain Exchange, P.O. Box 15086, Minneapolis, MN 55415.