Trading patterns, wave theories (from Gann to Wolfe), and Price Action — all these are merely technical approaches to describing price movements. However, the underlying idea they aim to explain is based on the postulates of technical analysis. I would describe it as follows: market movements are periodic and, therefore, predictable. Based on this principle, fundamental approaches to forecasting price movements are developed, all attempting to answer the question: “Where will the price go?”
With this approach, the focus is primarily on prediction, while capital management often takes a backseat. However, the statistics of successful retail clients, provided since the end of the last decade, suggest that something in this theory does not work as expected. Simply put, market movements are far less predictable than commonly believed, and the function of capital management is significantly more critical than it is often acknowledged.
Despite the recognized importance of capital management, it is rarely discussed in depth. The usual advice is to “set profits 3–4 times higher than losses,” but in practice, this is insufficient.
An Alternative Approach
Let us redefine the problem. Assume price movements are chaotic regarding direction, meaning we cannot predict where the price will go at any given moment. However, we do know that each instrument has an average volatility per unit of time — a measure of price changes in points. This reflects the distance a financial instrument covers over a specific period.
While average volatility changes over time, there are intervals when it remains relatively stable. Thus, the task shifts: we do not know the direction of the price, but over a given period, it will cover a certain distance in one direction.
Principles of Movement
Statistical observations reveal the following:
Any directional movement is finite.
All movements have inertia.
These two principles may seem contradictory: a movement can end at any moment, yet if it begins, it is likely to continue “just a bit further.” However, they fit into a cohesive framework when market movements are analyzed through patterns based on volatility, remembering that every large movement starts with a small one.
To structure market movement analysis, you can develop your own descriptive system. For instance, I created the “square theory,” but I mention it only as an example — you can create your own approach.
Conditions for Analysis
Structurally consistent description of any price movement.
Formulation of the expected movement.
Identification of remaining possibilities (anomalies).
Verification that all potential market movements are covered.
Your method must describe any price movement. No movement should begin without your signal, and the reaction delay should be minimal.
Signal Example
The crossover of moving averages (MAs) is a popular signal example. However, despite its simplicity, this method is not universal. In certain market conditions, price movements may be significant and in the opposite direction of the MA signal. Furthermore, the responsiveness of MAs to events varies depending on overall market dynamics.
As an alternative, Renko bars allow you to clearly define the price fluctuation threshold at which a change in direction is indicated. This provides more precise signals.
Planning and Trading Conditions
When price movements are chaotic, forecasting becomes challenging, making planning a priority. It is crucial to:
Minimize losses when profits are zero.
Model price behavior, determine maximum losses, and calculate entry volumes.
Ensure that losses do not exceed profit norms over a reasonable period.
Conclusion
You must individually determine:
The profit norm.
The rate of growth in trade volumes.
The portion of profit you are willing to risk.
The key is learning to operate with zero profit to establish optimal trading parameters.
The market does not move as we expect, but we can wait until it aligns with our expectations. The number of possible scenarios must be finite to work using the elimination method.
An example of successfully applying such principles is the options market, where sellers of options have existed for over 60 years. Their premiums compensate for the time they spend waiting for their situation to materialize.
Best regards.
