Consider someone who decides to build his or her house on a foundation of sand. Such a house would surely fail the test of time and eventually need to be rebuilt. This is much like many of the systems of trading you see today, where constant optimization is required because the foundation for the system itself is not solid. Re-optimization is much like rebuilding the house. If a system does not rely on optimization procedures to shore it up, then it may rely on a wide margin for error that falls under the heading of ‘lead/lag’.

However, if someone were to build his or her house on a foundation of rock, such a house would surely stand the test of time. A system based on the realities of the markets would not require any optimization at all. It would have no ‘lead/lag’ to deal with. In itself, it would be perfect and would be the image of the market itself. But before you get too excited, no such system exists today. Yet, enough is known today to create a system that requires very little shoring up like the minor repairs one might do on a house (minor optimization that can hold for greater periods of time, or a very small lead/lag margin for error.)

The KEY to such a house (system) lies in the clues found all around us. Yet so many pass by these clues without a second thought while blinding looking at things without relevance to the task at hand. Especially today, with the advent of the modern computer and its binary requirement of function (i.e. on-off, 1 – 0, true – false, yes – no), and its decision algorithms based on using logical (AND) and (OR), (NOR) and (XOR), our minds focus on the Black and White and tend to ignore the Gray that transitions the two. This is where many of the clues needed for a proper market model is to be found.

Consider the simple rotation of the earth as it revolves around the sun. We all take this simple thing for granted, simply going to sleep at night when it gets dark, then awaking in the morning where there is light once again. We know that the sun warms one side of the planet while the other side cools off. The transition is not one of instant heat then instant cold, like a light switch that turns on a light and then can instantly turn it off. There exists a transition between the two extremes that most do not consider. Even if the earth did not gradually rotate, but simply flipped over like a sunbather tanning on a sunny day, the side with the sun would not instantly go from cold to hot. It would surely heat up much faster, but still must go through a transition from cold to hot, thus passing through a point simply defined as ‘warm’.

Before I get more to the point of this article, another example may be needed. Consider the light switch itself. When we turn it on our off, we only think in terms of Light or Dark, On or Off, Power or No Power. Just like a computer, these are the things we are comfortable thinking about. What about the light bulb itself that is being controlled by your simple On/Off action? When you turn off a light in a room, touch the light bulb. You should instantly find that it is still hot, although it is not longer powered on. After some moments, it will gradually reach room temperature, which is what we would expect in the off state. But there is a transition between the two extremes that must take place.

Now, when we think about commodities for example, we know that many require the simple necessities of life. These necessities are light, heat, water, air and food. Although they require these things, they must be regulated (transitioned) if to successfully go through the complete pattern of sow, reap and consumption. Too much light and heat, water and food can destroy or greatly alter the pattern. Although man intervenes in this process to increase or decrease yields, nature has this regulatory function already built-in. As the saying goes, “Let Nature take its course”, the earth gradually turns exposing the earth to different degrees of sunlight, revolves around the sun to gradually transition from one season to another, and exposes the earth to external planetary forces that has an effect on water bodies everywhere on earth, whether it be in the seas, plants or people.

The clues provided by nature itself is in a magnitude greater than man currently can fully comprehend. All this means is that we may be a long way off from actually creating a system-model that completely emulates market patterns, which in itself is the result of natural phenomena. However, the clues we get from paying closer attention to the transitioning process of the seasons and other non-binary functions of our galaxy will greatly aid us in developing a system-model that better relates to what we see in price action. If one does not base their system-model on natural laws, which is the true foundation of life and the various graphical attempts to chart life (such as price charts), then the foundation that they build their system-model on will not take into account the important transitions of life and will likely fail during these periods.

A study of natural cycles is very important in building on a solid foundation. Although it is possible to digitize natural function to determine past and future cycle patterns using a computer, if the proper input is not afforded the logical algorithm, you will get garbage out. If you try to look at things as simply on or off, true or false, then an important component of input, the transition itself, will be overlooked and the result again would be garbage out.

The world around us is not digital it is more analog. Computers run on analog power before it can create digital models. Modems for communication take analog modulation and demodulates it to digital. If we are to create a system-model of market behavior that best describes actual market events, we will need to understand more of the analog nature of the markets before we can successfully digitize it. This leads us once again back to natural law and the cycles that affect what it is we are looking to electronically model, market price action.

Come to look at the markets as a result of events all driven my natural laws. Discover the natural events that govern why the market may move up or down in a given period of time. Do not stop at the obvious events such as the weather or the emotions of man. Dig deeper into the subjects that most take for granted, such as what controls the weather or influences the emotions of man. If you simply try to apply digital logic to a two-dimensional representation of the markets (price charts – time and price) and ignore the reality that markets are not two-dimension but multi-dimensional just like the people who trade them, then your results will fall short of the ideal.

You are not without clues as they are all around you. All that is required is that you have an open mind and do not quickly dismiss ideas and concepts just because they may be alien to you. There is much in this world alone that has yet to be discovered. To dismiss them or take them for granted will only prolong your search for a market-model you can rely on with great confidence. Look for these clues as you would for buried treasure, and you will gain enlightenment along the way to help you in trading the markets as you continue your search for that elusive ‘Holy Grail’ system.

Note: About the Author
Rick J. Ratchford is President of ProfitMax Trading Inc. He is a full-time commodity trader for his own account as well as assisting other traders. He has been a computer programmer for more than 20 years and a trader since 1990.