Weekend Review: Embracing the Overlooked Financial Approach Ignored by Wall Street Experts
In the world of stock trading, a new methodology has emerged that promises to offer a fresh perspective on predicting market trends. This approach, known as the Markov-based options trading methodology, applies the principles of a mathematical model developed by Russian mathematician Andrey Markov.
The Markov Chain principle, at the heart of this methodology, predicts future market states based solely on the present state without dependence on past states. This is achieved by using a transition matrix to estimate probabilities of price movements, enabling traders to assess likely future market trends and price actions in a probabilistic, state-dependent manner.
The Holy Trinity: Troitsa and Proverka
To bring further clarity and rigor to this methodology, the Russian terms Troitsa and Proverka have been integrated. Troitsa refers to the "Holy Trinity" of three critical components for strategy evaluation:
- The null hypothesis: The baseline assumption or model of market behavior.
- The alternative hypothesis: The competing theory or expected market behavior based on the Markov or other modeling.
- The expected payoff: The anticipated trading outcome or profit if the alternative hypothesis proves true.
Proverka, on the other hand, means a validation check or audit of the predictive signals generated by the model—specifically, testing the empirical viability of the signal's predictive power and reliability in real trading conditions.
Together, Troitsa and Proverka form a disciplined framework whereby traders formulate hypotheses, then rigorously test these hypotheses through empirical validation, translating Markov chain probabilities into practically actionable and statistically supported trading decisions.
Applying the Methodology
Let's consider the Equinor (EQNR) stock as an example. Over the past 10 weeks, the market has voted to buy EQNR stock four times and sell six times, resulting in an unusual sequence of 4-6-U with an upward trajectory. The null hypothesis for Equinor is only 48.7%, but with the 4-6-U sequence, the odds improve dramatically in favor of upside.
The author suggests considering the 24/26 bull call spread expiring Sept. 19 for Equinor (EQNR). If the bulls maintain control for the next two weeks, the expected median performance for EQNR stock is an additional 3.82%.
Similarly, Transocean (RIG), an American drilling company, has seen an upward bias in the past 10 weeks with a sequence of 6-4-U. With the 6-4-U sequence, the odds for RIG stock improve to 57.14%, and the median expected performance assuming the positive pathway is 6.69%. If the bulls can hold on for the next five weeks, speculators may anticipate an additional 3.08% of performance.
Overcoming Epistemological Flaws
Traditional methods of teaching options are often found confusing and irrational by the author. This methodology seeks to overcome the epistemological flaws of traditional western methodologies, offering a more straightforward and intuitive approach to options trading.
Discrete-event analysis is compatible with the features of the website Premier, making it an ideal platform for implementing this methodology.
Real-World Examples
The 4-6-U sequence has materialized 18 times since January 2019 for Equinor (EQNR), leading to upside in the following week with a median return of 2.5% in 61.11% of cases. On the other hand, the sequence 6-4-D (6 buys, 4 sells, downward trajectory) has materialized 38 times on a rolling basis since January 2019.
Eli Lilly (LLY), a pharmaceutical giant, has been experiencing a drop due to modest late-stage trial results for its obesity pill. In the past 10 weeks, the market has voted to buy LLY stock six times and sell four times, resulting in a downward trajectory. The chance that a long position in LLY stock will rise on any given week is 60%, but the author's alternative hypothesis is that the chance of upside is actually 68.42%.
Conclusion
The Markov-based options trading methodology offers a unique and promising approach to predicting market trends. By modelling market state transitions probabilistically, defining the essential hypothesis-payoff structure underlying trades, and validating these hypotheses against data, traders can make more informed and statistically supported trading decisions. This approach is distinct from solely relying on "Greeks" (options sensitivities) because it emphasizes probabilistic modeling and empirical validation of predictive signals, which can be more informative for probabilistic risk-reward assessment.
The integration of the Russian terms Troitsa and Proverka in the Markov-based options trading methodology provides a disciplined framework for formulating and testing hypotheses, ultimately translating Markov chain probabilities into actionable trading decisions.
With the application of this methodology to stocks like Equinor (EQNR) and Transocean (RIG), traders can improve their odds in favor of upside and make more informed trading decisions, overcoming the epistemological flaws seen in traditional Western methodologies.
