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Probabilistic Modeling for Trending Markets

by | Tips & Strategies

Many mathematicians start with the same, single assumption when they commence any probabilistic modeling: the probability of a market moving higher or lower on any given day is 50%. Though this may seem oversimplified, it is actually quite true to practice if you look at the performance of a few Small Exchange markets in the last year:

Market Symbol % of Days Higher % of Days Lower
Small Technology STIX 49% 51%
Small 10YR Yield S10Y 51% 49%
Small US Dollar SFX 52% 48%
Small Metals SPRE 49% 51%
Small Crude Oil SMO 58% 42%

Source: dxFeed (https://dxfeed.com)

The uniformity of these statistics may seem unbelievable especially when you consider markets like Small US Dollar are pushing new highs since Summer 2020. It goes to show that even the most trending markets have reversals; that is, nothing can go straight up in price.

SFX \ Small US Dollar

Probabilistic Modeling: Do Market Trends Reverse?

In theory, a market can move in any direction for any amount of time. In practice, markets tend to lose steam after spending multiple days traveling in the same direction. Take the last year of action in Small US Dollar, for example:

Average 1-Week Move After…
2 Days Higher 3 Days Higher 4 Days Higher
2 Days Higher -0.3% -0.5%

Source: dxFeed (https://dxfeed.com)

While the memorylessness property may dictate that a market’s historical price action has no bearing on the current day’s movement, it’s hard to argue with the data – markets could have a greater tendency to reverse course after multiple days in the same direction. 

How to Trade Market Trends

Many traders will ride a trending market in the same direction using a short-term time frame, and this strategy would have worked quite well in the Small US Dollar market that moved higher nine days in a row leading into last Wednesday, April 13th.

SFX \ Small US Dollar

Traders willing to hold positions for more than a few hours could find greater success in the contrarian angle – going against the trend. And, if you use small enough products like the Small US Dollar or Micro Euro futures, then you can better withstand those trends if you don’t catch the top or bottom. Even better, you can sell out-the-money options against these trends for less initial risk and a higher probability of profit.

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The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

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