How the Chaos Theory is used in forex trading
The financial markets are entirely based around number fluctuations, so it comes as no surprise that mathematical theorists have attempted to map their theories to them. The end goal is of course to be able to successfully predict market movement in order to maximise profit. If you can apply a mathematical system to your method of financial trading successfully, then this becomes easier.
One of the most interesting approaches that can be applied to forex trading (currency speculation) is the Chaos Theory. The Bill Williams Chaos Theory is the most widely recognised use of the idea. Williams asserts that the results of trading are not just influenced, but determined by human psychology. The ability to reveal hidden determinism in market events (which appear to be random) therefore results in profitable trading.
According to Williams, technical analysis is not a reliable method of profit-making, because it cannot ‘see’ the true market. Other types of analysis are also regarded as useless in the nonlinear dynamic model that is the real market.
The system Williams suggests involves understanding the market structure, which he breaks down into the following five inherent dimensions:
- Fractal (phase space)
- Momentum (phase energy)
- Acceleration / Deceleration (phase force)
- Zone (phase energy / force combination)
- Balance Line (strange attractors)
These different dimensions produce signals which the trader should then operate by. In terms of the charts used, these signals are illustrated by a variety of bars and moving averages, which are likened to the jaw, teeth and lips of an alligator. The behaviour of the alligator then determines the course of action that should be taken by a trader.
Some regard the application of Bill Williams Chaos Theory to the forex market as just another system, but it is certainly an interesting approach.