Teaching You to Trade Stocks 91: The Two Layers of Interior-Exterior Relationships in Trend Structure 1

2007/12/17 21:40:15

(The text colors are only for visual distinction between sections and carry no other meaning.)

Judging trends is like a Chinese medicine doctor diagnosing illness. The highest level is treating before illness manifests; next is treating when illness is about to emerge; and by the time illness is fully established, it's merely patching things up after the fact. But the vast majority of people are still fantasizing even when the disease has become terminal — these are the ones who always end up as sacrifices in the market.

The existence of levels can be compared to levels of disease severity. A 1-minute level might be a minor cold, while sometimes a 5-minute decline is enough to constitute a small epidemic. As for 30-minute or daily-level declines, they basically correspond to sub-intermediate or intermediate corrections — roughly equivalent to something like tuberculosis. Weekly and monthly declines? You don't need me to spell that out. If it's a quarterly or yearly level decline, even if you're not dead, you're at least in a vegetative state.

Pre-illness → approaching illness → full illness — the corresponding boundaries are the first, second, and third-type buy/sell points at the respective levels. Note: for upward movements, missing out is also a kind of illness. The illnesses of rising and falling are relative.

How to diagnose which stage the illness is in follows the same principles as Chinese medicine. For example, the lung and large intestine have an interior-exterior relationship. Note: the "lung" in Chinese medicine doesn't merely refer to what Western medicine calls the lung — it's a corresponding functional system. For instance, the nose belongs to the lung system, so nasal problems may be related to the large intestine. In Western medicine, these two things would be considered completely unrelated.

In trends, the current movement corresponds to a similar two-layered interior-exterior relationship. Among the components we previously discussed in trend decomposition, there are two types: 1. Those that can form hubs. 2. Those that cannot form hubs.

The first type includes line segments and trend types of various levels; the second type includes only strokes. Strokes cannot form hubs — this is the biggest difference between strokes and line segments and all higher-level trend types above line segments.

Therefore, the corresponding judgments of strokes on K-line charts of different time periods constitute an interior-exterior relationship for diagnosis. The most ordinary things often contain the greatest truths. What inevitable conclusions does the simplest stroke contain? One of the most obvious and useful conclusions is:

Chán Zhōng Shuō Chán Stroke Theorem: At any given moment, on any time period's K-line chart, the trend must fall within a definite stroke with a clear direction (upward stroke or downward stroke), and the position within the stroke can only be one of two situations: 1. In the process of fractal construction. 2. In the process of extending into a stroke after the fractal construction is confirmed.

Based on this theorem, for any current trend, in any time period, we can precisely define the current trend using an array of two variables. The first variable has only two values — let's use 1 to represent an upward stroke and -1 to represent a downward stroke. The second variable also has only two values — 0 represents the fractal construction phase, and 1 represents the process of the fractal being confirmed and extending into a stroke.

For example, (1, 1) represents an upward stroke in extension, (-1, 1) represents a downward stroke in extension, (1, 0) represents an upward stroke where a top fractal structure is forming, and (-1, 0) represents a downward stroke where a bottom fractal is forming.

At any given moment, there are only these four states, and these four states describe all current trend conditions. More crucially, these four states cannot be connected arbitrarily. For example, (1, 1) absolutely cannot be followed by (-1, 1) or (-1, 0) — it can only be followed by (1, 0). Similarly, (-1, 1) can only be followed by (-1, 0). Meanwhile, (1, 0) has two possible successors: (1, 1) or (-1, 1). And (-1, 0) has two possible successors: (-1, 1) or (1, 1).

With the above analysis, we can easily perform more complex decomposition. Consider two adjacent time period K-line charts, for example 1-minute and 5-minute. If the 5-minute is in a (1, 1) or (-1, 1) state, then any previous fluctuation in the 1-minute has little value, because no matter how large such fluctuation is, it hasn't reached the degree of changing the 5-minute (1, 1) or (-1, 1) state. This provides a very clear filtering function for 1-minute fluctuations. If you're an operator who cares at minimum about the 5-minute chart, you need not concern yourself with these meaningless fluctuations at all.

Furthermore, if the 5-minute is (1, 1) and the 1-minute is also (1, 1), then it's impossible for the 5-minute to change from (1, 1) mode within the next few minutes. For the 5-minute to change from (1, 1) to (1, 0), at least a (1, 0) or (-1, 1) must appear on the 1-minute chart, and in the vast majority of cases, a (-1, 1) must necessarily appear.

Therefore, from the perspective of the three-stage illness diagnosis, for the 5-minute stroke state, a change in the 1-minute stroke state that could potentially alter the 5-minute stroke state represents a pre-illness condition. For example, for a 5-minute (1, 1), a 1-minute (1, 0) is a small warning, but if this warning only appears within one 5-minute K-line, it's insufficient to damage the 5-minute structure, so this warning won't cause substantial impact. However, if this 1-minute (1, 0) is confirmed, then a significant warning is established — this is progressing toward approaching illness.

But when a 1-minute (-1, 1) appears and leads to a 5-minute (1, 0) forming, that's the progression from approaching illness to full illness. When the 5-minute (1, 0) is also confirmed to be developing toward (-1, 1), the illness is confirmed.

This kind of analysis can equally be applied to the relationship between daily and weekly charts. For example, the recent market trend shows (-1, 0) on the weekly chart, while the daily chart currently shows (-1, 1). This condition is the third-worst situation in a decline, because the worst is weekly (-1, 1) with daily also (-1, 1); the second-worst is weekly (-1, 1) with daily (-1, 0). For the second and third worst situations, skilled traders can still operate; as for the absolute worst case, even skilled traders should just sit it out. Currently, the primary thing to wait for is a (-1, 0) signal on the daily chart, and if when this signal appears the weekly can still maintain (-1, 0), then the fourth-worst situation will emerge — meaning a possible turning point may appear. Whether it does, the market will tell us. The current market is at its most delicate moment — why? Because once the daily (-1, 1) extends to the point of breaking the weekly (-1, 0), it will become the worst trend state, namely weekly (-1, 1) with daily also (-1, 1). In other words, the current market faces only two choices: the 1st-worst or the 4th-worst, that's all.

For record-keeping, we can maintain a real-time medical chart for the market at any time. This record is a matrix, classified by 1-minute, 5-minute, 30-minute, daily, weekly, monthly, quarterly, and yearly levels. This matrix has 8 rows, each row being the state array for the corresponding level. The possible configurations of this matrix number 4 to the 8th power — a considerably large number representing all possible states of the trend, which is to say, all possible states of the illness.

Of course, with massive computers, we can monitor all stocks' conditions in real-time. Note: each state doesn't randomly transition to any other state — the possible transitions are extremely limited. From this, one can analyze which transitional states among the possible changes offer the greatest profit potential — such transitions are inevitable. Then use large-scale machines to monitor all stocks, buy at the corresponding states, sell at the corresponding states, and a perpetual money-making machine is constructed.

As for which state transitions have the highest efficiency, that's a purely mathematical problem. Knowledge is power — this is one example.

Of course, for ordinary people, there's absolutely no need to build such a machine or study such problems. Because we can simply focus on three consecutive levels, for example 1-minute, 5-minute, and 30-minute, and this corresponds to 64 states. Here, we connect with the I Ching. Many people use the I Ching to study stocks, but they're all confused about it. In truth, if you really want to use the I Ching for research, this is where to start — this is the proper path. We'll discuss this slowly in the future.

Quite a few people probably get dizzy dealing with daily fractals, weekly fractals, this stroke and that stroke — but this is really the simplest situation. Nowadays there are few good Chinese medicine practitioners, because medical students get confused when they see all the generating and controlling relationships, the interior and exterior of this and that, so the future of Chinese medicine is worrisome. It's not that Chinese medicine has any major problems — it's that there are too many dull-witted and inflexible people nowadays.

Of course, the interior-exterior relationship of strokes alone is insufficient to precisely diagnose market trends, just as merely understanding the relationship between the lung and large intestine won't cure anyone. What appears as pre-illness within one set of relationships might be revealed as full illness when examined from another set of relationships. Therefore, we must study additional interior-exterior relationships.

More importantly, different interior-exterior relationships have generating and controlling relationships between them, just like the generating and controlling relationships between different systems in Chinese medicine. Only at this level can one claim to have barely begun to touch upon the art of diagnosis.

These subsequent issues will be discussed later. I'm tired today — going to sleep.