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Image rights with Philip Kahler.

Text comes from the book: “Trading strategies” (not only) for extreme situations. Use greed, fear and panic to your advantage ”(2009), published by Münchener Verlagsgruppe (MVG), reprinted with the kind permission of the publisher.

Here writes for you:

Philipp Kahler is a finance and stock market expert and writes regularly in Traders' Magazine about trading with automated systems. He also organizes seminars for beginners and professionals on this topic. Another focus is the constant further development and optimization of trading software, which Kahler had already successfully used in proprietary trading at Bankgesellschaft Berlin

Stock market and financial strategies for extreme situations: make money despite uncertainty

Anyone who wants to earn money on the stock market in extreme situations must also understand the stock markets in theory and know their uncertainties. What is it about?

Market theories

There is a quotation from Sir Isaac Newton in which he complains that he is now
can calculate the course of the stars and planets, but not the madness
of the masses. He did this after spending almost all of his capital in the
"South Sea Bubble" had lost.
A few centuries later, the Long Term Capital Management Fund (LTCM) overtook
same fate. Although guided by statistical models by gifted mathematicians, including Nobel Prize winners Myron Scholes and Robert Merton, the lost
Fund all of its capital in the end. Private and institutional investors believed in the risk-free 40% of the capital invested, which in the end had to
The central bank step in to save the financial system.
In the summer of 2008, the mortgage crisis is far from over, and again a number of banks and funds are on the brink of the abyss.

Such events indicate it
that our ideas about the nature of the price development are still very much in their infancy. Indeed, the first scientific paper on the subject of the stock exchange did not appear until 1900: the "Théorie de la Speculation" by the French mathematician Louis Bachelier. He explored the question of how courses are developing - not where they are going
develop, but what a price development looks like in general. this is a
Question of principle. For example, is it twice as risky if you have one
Share lasts for two weeks instead of just a week? How likely is it that
the stock will move more than 10% tomorrow? What risk do I take in the run
of the year if I risk 1000 euros on the market every day?
In order to be able to answer such questions, it is advantageous to have a theoretical
Model of the market. This model can be used to make predictions about
set up possible future course developments and then use these results
check the validity of reality. Such predictions can be, for example, an estimate of the volatility or well-founded approaches to position sizing. But I have to disappoint you right at the beginning. Unfortunately there is one
Model of the market not yet. Despite multiple attempts by the best minds, there are still people
not even close to a correct theory about the market. And yet there are some
Theories about systems similar to the market, so that one can use these theories to at least form a rough picture of what might happen tomorrow. Interestingly, many of these theories arose in the context of fortune knights and gamblers.
Only in the recent past has the topic "Methods of Speculation"
also set on the curriculum at universities.

Random Walk

The random walk is one of those theories that can be used to explain key market characteristics. The natural scientists among you know the random walk as a special case of the Brownian movement. However, the issue here is not the molecular movement, but the price development.
In order to clarify this basis of the description of courses, I would like you to
prompt a game. The game is a simple toss of a coin: every time "heads" appear, you win one euro; if »number« appears, you lose one euro. Write down
Your account balance after each run, then you get a random walk chart.

This curve now has some properties that you can also observe on the market
can. For example, consider the emerging trends. They look something like that
like the trends on the price chart, and yet they only came about by chance. As
Long sequences of "only red" or "only black" appear again and again in roulette
in this game it is apparently not unlikely that heads or
Number occur several times in a row.
You will also see formations like those seen on the stock exchange. Wasn't on the chart
multiple double bottom formations? Do you see the head-and-shoulders formation? Knows
Doesn't every trend have minor corrections that could possibly be used for acquisitions?
You see the patterns, I see the patterns, and yet neither of us see anything that's inside
used in any way for a successful trading strategy. The curve is -
and the name tells us that - a random walk. Whether the next point up
or goes down depends solely on whether the next coin toss is heads or tails
shows. Even if you as a person immediately see the supposedly suitable patterns for trading, they cannot be traded due to their random nature

You can describe the random curve using the methods of charting, but you cannot benefit from this description. and
however, this curve has properties that you also use on the market
can. Think of your money management here. If you are not a very good but a disciplined trader, your trading will be something like this curve
look. Sometimes you win, sometimes you lose. Good phases alternate with bad ones,
"In the long run", however, your depot swings around the zero line.
Fortunately, as a retailer, you don't have to dig too deeply into the mathematics of chance. Most of all, it is important for us to understand the implications of the theories. So many a trap can be avoided. The following applies to the random walk:
that this randomly created curve looks very similar to the stock market, but it does
nevertheless it is only an illustration of chance. You can't have a curve like that
trade successfully with the classic methods of technical analysis. Any trading approaches that you would test with such a curve would become random again
Walk lead. Just because something looks like a stock market doesn't mean it has to be a stock market. But since you cannot rule out that the stock market is controlled purely by chance
you have to consider whether your trading strategies are based on a characteristic of the market that is not just controlled by chance. Just because you get the
Seeing patterns does not, unfortunately, mean that they can also be used for a successful trading strategy.

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The expected value

In connection with the random walk curve, I would also like to introduce another term that will be used later: the expected value. It shows the average result I'll get if I play the game long enough. In
in this case the result is clear: it is zero. No matter how skillfully you play this game,
in the end you will have lost everything you gained in the meantime
had. For this reason, this coin tossing game is also known as a zero-sum game.
One game that is almost a zero-sum game is roulette. If there weren't any zero,
then it would be a zero-sum game. Through the zero - if it appears, the bank wins -
this game receives a slightly negative expected value. The average wins
Bank per run 1/37 of the bets placed on the table.

The stock market is also a game with a slightly negative profit expectation. In theory, it's a zero-sum game. The money is only redistributed between the winners and losers, nothing arises or disappears. In practice, however, you pay the broker fees and the bid-ask spread for every transaction. This leaves the
The stock market will become a game with a negative expected value for you. The higher the too
fees paid and the higher the bid-ask spread, the more negative the expected value. Especially for private traders there is the choice of a very liquid market and one
Brokers with minimal fees in the first place. With the conditions of most house banks, you would have to be a clever professional to deal with many transactions
to come to a positive expected value after expenses.

Efficient Markets Theory

Closely related to the random walk theory is the theory of efficient markets. she
means that the current price always shows all available information. This is
written quickly but has a huge impact on how we beat the market
want. The next course is always formed on the market where the majority of capital willing to buy is just as convinced of its advantage as the sellers are of theirs
are. However, if all available information is shown in the course, then you can
no matter how you do it, you have no advantage over the other market participants
work out. This would mean the end of trading and a return to the buy-and-hold approach. Well, the markets are not quite as efficient, but they are usually much more efficient than we are
Is dear to dealers. In order to understand market efficiency, we must first deal with
deal with the term information. Information can, for example, be one more
not be common knowledge. For example, are you a well-informed one
Dealer and use your information network to get something out of the boardroom
interesting AG, then you may come into possession of
Inside information. Let's ignore the fact that speculating with such information is not legally flawless; let's concentrate
on the effects of your actions on the market.

After learning that an AG takeover is imminent in the next few days, start buying today. By buying now, but not buying a new one
If there are reasons to sell the stock, you drive the price of the stock up. You will do this until the share price is where you expect the takeover offer to be. Whether or not the trade will turn out to be a profit is another matter. What is important here is that you have established market efficiency yourself. Even if the
Information about the upcoming takeover offer still not general
is known, you have already driven the price so far that from the information
no further profit can be made from the takeover. So it's all the information
even if it has only one market participant, it is included in the price of the share.
However, information is not only hard economic facts such as dividends, orders and company profits, but also all that can be derived from the past
Information. For example, this can be the information you get from an indicator or a price pattern.

The efficiency of the markets

A vivid example of this market efficiency is a trading system based on the RSI indicator. The indicator was published by Welles Wilder in his 1978
Book New Concepts in Technical Trading Systems is presented and is next to the simple
moving average one of the most famous and most widely used indicators. However, unfortunately, it seems that this indicator is the theory of efficient
Markets. If you consider the performance of a classic RSI system,
So »buy with a cut above the 30-line, go short with a cut
the 70s line «, then you can quickly see that the best times of this system are clearly
are over. Until the RSI was released, it seemed like a trading approach like this made good money, but it has been since the indicator was released
apparently not that easy anymore. One reason for this can be market efficiency

How is the information from an indicator converted into a changed market behavior
transfer? At first glance, this does not seem plausible, and yet the process is
such a market adjustment relatively easy.
When all traders know that if the RSI breaks above the 30 line, they will
should buy, then the price will increase due to the increased number of buy orders
this point in time rise briefly. Instead of receiving the lower price that would come about without this effect, all market participants now buy at a price that is a few ticks higher. The same effect occurs when the indicator has the counter signal
there and the positions are closed or rotated. Even at this point
you get a worse price again than would be the case without the other RSI traders
would have been. At some point, the situation will be reached where the use of the indicator in this way of interpretation is no longer useful. The information is in the
Course taken, the markets have again demonstrated their efficiency.
Of course, this does not end the game. The indicator does not work
more, since the information "buy at an average above the 30 zone" is included in the price, then many market participants will switch to another indicator

As a result, however, the price jump at the next RSI signal is no longer quite as large,
under certain circumstances trading the signals will soon be worthwhile again. Then, however, the other dealers will presumably again establish the efficiency.
The efficient markets theory is also the sword of Damocles of trading systems.
As soon as a system is traded by too many people, it will almost certainly lose its performance. This can also be done if you have a system with too
large volume. If you want to buy so many contracts on each signal that you push the market up a few points yourself, that's who you are
Trader who creates the market efficiency. You can also see this behavior in successful hedge funds.

The problem of large funds

This is a common problem with a large, systematically traded fund.
The trading system had been functioning on a "smaller" scale for a few years before the
Fund went public in 2003 and began raising funds. With the excellent performance of the underlying system, this was comparatively fast
possible. But see for yourself what happened: Hardly was the fund with significantly more
Money than in previous years, the problem arose of accommodating this high volume in the market. And so this trading system began to influence the market with its large orders. Accordingly, the performance broke
together. You would have earned significantly less since 2003 than you actually did in 2003

If a lot of people are withdrawing their capital again, the performance will probably be too
start again. The trading system can trade the market again instead
to take the next course yourself.
The theory of efficient markets is also the basis for the random walk. if
all available information is already mapped in the current course, then can
you cannot make a statement about the next course. In this case, you could also do one
Flip a coin to see if long or short would be a better position. In order to
but you are back at the Random Walk. Every next point is there too
completely independent of the previous one. No information from the past can give me
say something about the future.

So if the theory of efficient markets were always correct, then one might think
save trading. There would be no viable way to gain an advantage over yourself
to provide the other market participants and a better performance than the
Achieve average performance of the market. That would take us back to buy-and-hold strategies after all attempts to make money from trading.

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