Predicting Volatility with Turning Point Probability

One important advantage of using turning point probability in financial market is that we can also predict the volatility of the price movement. This is useful when we need to decide our stop loss and take profit targets in our trading.

We can consider three different cases. Firstly, we can expect neutral market sentiment, where sell and buy pressure is nearly equal. Secondly, we can expect the market with bullish sentiment, where often amplitude of bearish movement could be smaller than the amplitude of bullish movement. Thirdly, we can expect the market with bearish sentiment, where often amplitude of bullish movement could be smaller than the amplitude of bearish movement. Any of these three cases can happen when we make either buy or sell entry. Hence, we will analyse these three different cases respectively for buy and sell entry.

Let us start with the case when we make the buy entry. When we try to make buy entry, the market could be surrounded with neutral sentiment. In this case, the sensible profit target could be the mean amplitude. In theory, mean amplitude is the price movement, at which we have 50% turning point probability. If you believe the neutral sentiment after your buy entry, then it is good to limit your take profit target around the mean amplitude. You can measure the amplitude from Fibonacci Probability Graph as shown in Figure 4.3-1.

Figure 4.3-1: Measuring mean amplitude and wavelength for the case of trough

When you are trying to make buy entry during the strong bearish market sentiment, it is possible that we can encounter the shortage of buy pressure even after the turning point. You should avoid making buy entry in this case most of time. However, there are the different trading styles like scalping and high frequency trading. Some of these trading strategies are only looking for extremely short-term profit. If you do not mind the short term trading, then the sensible choice for your take profit target would be the amplitude with 20 or 30% probability (Figure 4.3-2). Even one could target 10% amplitude if he knows what he is doing.

Figure 4.3-2: Measuring the amplitude and wavelength at 30% probability for the case of trough

When you are trying to make buy entry during the strong bullish market sentiment, the bullish market sentiment could add extra momentum for upward price movement. This would be our most favourite buy entry.  In that case, we can use 70 or 80% amplitude as our take profit target. If you believe the bullish market sentiment is too strong, then you can go even higher. Once again, you can take the size of profit target from Fibonacci Probability Graph as shown in Figure 4.3-3.

Figure 4.3-3: Measuring the amplitude and wavelength at 70% probability for the case of trough

The different market sentiments can affect our sell entry too. It is better if you can trade with different tactics per the case. For example, if we are taking the sell entry during the neutral market sentiment, the sensible target for your sell entry could be the mean amplitude. In theory, mean amplitude is the price movement, at which we have 50% turning point probability. If you anticipate neutral market sentiment after your sell entry, then it is good to limit our take profit target around the mean amplitude as shown in Figure 4.3-4.

Figure 4.3-4: Measuring the mean amplitude and wavelength for the case of peak

When you are trying to make sell entry during the strong bullish market sentiment, it is possible that we can encounter the shortage of sell pressure even after the turning point. You should avoid making sell entry in this case most of time. However, there are the different trading styles like scalping and high frequency trading. Some of these trading strategies are only looking for extremely short-term profit. If you do not mind the short term trading, then the sensible choice for your take profit target would be the amplitude with 20 or 30% probability (Figure 4.3-5). Even one could target 10% amplitude if he knows what he is doing.

Figure 4.3-5: Measuring the amplitude and wavelength at 30% probability for the case of peak

When you are trying to make sell entry during the bearish market sentiment, the bearish market sentiment could add momentum for further sell movement. This would be our most favourite sell entry. In that case, we can use 70 or 80% amplitude as our take profit target (Figure 4.3-6). If you believe the bearish market sentiment is too strong, then you can go even higher.

Figure 4.3-6: Measuring the amplitude and wavelength at 80% probability for the case of peak

In summary, you can always make use of Fibonacci Probability Graph to gauge the sensible take profit target. In addition, you could also set your stop loss target to meet the desired Reward to Risk ratio. Since you know the take profit target, you can adjust your stop loss level accordingly to your preferred Reward to Risk ratio. In many cases, you want to use some sensible support and resistance as your stop loss target. Even in this case, it is still wise to check how wide this stop loss target is using the Fibonacci Probability Graph.


About this Article

This article is the part taken from the draft version of the Book: Predicting Forex and Stock Market with Fractal Pattern. This article is only draft and it will be not updated to the completed version on the release of the book. However, this article will serve you to gather the important knowledge in financial trading. This article is also recommended to read before using Fractal Pattern Scanner, which is available for MetaTrader or Optimum Chart.

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https://algotrading-investment.com/portfolio-item/fractal-pattern-scanner/

Below is the landing page for Optimum Chart

https://algotrading-investment.com/2019/07/23/optimum-chart/

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