Profitable ETF Trading Strategies: what is the nature of the market?
What is the nature of the market and why do we care? Based on your belief in the nature of the market, which may or may not be supported by evidence, you should be applying a specific strategy for successful trading.
Based on the academic research into complexity and complex adaptive systems, you can make a strong argument that the market could be any one of the following mutually exclusive environments.
The market could be: simple, complicated, complex, chaotic or random.
It turns out that there is evidence to support all of these judgments. Each different category has an appropriate strategy to follow in order to “solve the problem” or “find the way” in the market.
Here is a brief working definition of each category, and the kind of strategy that is could be appropriate.
Simple: laws of cause and effect are well known, and time tested; simple rulesets and nothing fancy works best here. Don’t overthink! Tic-Tac-Toe is simple and there’s one best way to play.
Complicated: Cause and effect rules are known, but there may be so many moving pieces that prediction is time consuming. It is knowable but hard; your strategy should be to optimize a ruleset that reflects the situation and you apply computing power so make predictions that have validity.
Complex: there are many moving pieces, and many relationships, and in open systems the rules may change periodically so that you cannot hope to fully understand, you can only aspire to manage within established boundaries.
Chaotic: on the border between complex and random, the situation morphs so quickly that patterns cannot be established and boundaries are not useful. Appreciation of our human limitations and seeking to minimize risk above all are the best strategies. Each trade is unique, no pattern is reliable.
Random: in truly random processes, once the distribution percentages of possible outcomes are calibrated, and preferably known, there is a optimal strategy that requires the laws of large numbers to achieve the expected average return over time. This is the casino strategy: they don’t know who will win on any given hand of poker or blackjack or pull of the lever, but they know that over the course of millions of opportunities each year they are mathematically certain of making money.
Some will say that market shows all of these faces at different times, and I will agree. If you take this position, then it is very important how you decide to classify the market and how often, so that your strategy selection is in tune with the market’s current mood.