Chop and Signal Smoothing

When I was younger I used to hang out at this 7–11 and for some strange reason, the clerk there always said to me: “An idol mind is the devils workshop”. Those were the days, and I’ll never forget Alberuni for making me think about — what the heck that meant. Today, I address the psychological behavior of the idol mind. In the chart below, as the price is going down, people are thinking “is this the bottom?”, and perfectly, chop is the term used in order to fake these people out so they make bad decisions resulting in enhancing other people’s money.

Chop: An idol mind is the devil’s workshop

In my last forecast, I addressed this concept of chop:

Latest price action is “chop”, in my opinion. In a low liquidity market, small scale price movements can be forced using relatively large buys on various order books. Applying this method allows for “liquidation hunts” in derivatives markets like Bitmex, Bitfinex, and Deribit. The Chop, a sudden move in (either) direction forces stops, liquidations and panic sells… ...during this somewhat predictable consolidation period of about a month in length, there really is nothing to do except force these small plays in order to make the market during such times, and it’s easy.

Q: Strategically, how does one safely navigate making decisions while scam-like price action exists?

There are a couple things to consider. First lets consider the logical constraints for chop. Aside from it being designed to be unpredictable, It probably exists under the umbrella of the following rules:

  • Forced events counter the direction of market sentiment
  • Forced events go with the grain of market sentiment.
  • The range of price action is within a boundary which should not affect the overall market in larger time frames.
  • A chop market exists during indecisive times.
5 point bear flag with associated chop incidents A and B

The most effective chop is the scammy kind. For instance, what happened in the last couple of days. Bitcoin was past point 5 of a bear flag. People see this kind of chart pattern and expect the price action to go down, because it is nearing the end of the TA pattern. The agenda here is simple, build shorts by inflating the price a little bit. But “we” need to buy those shorts from someone, and they will come in the form of liquidations from people who shorted at point 5 with high leverage. So even with the TA of an uber-bearish chart, the price somehow magically lifts from its fate, into a gotcha moment during circle A.

10 second candles + volume

There is one way to detect such a scam. Watch the volume, in real time. You will notice that some strange occurrences of PA coincide with super low volume and almost no counter trades. The volume barely breaks out from the existing consolidation pattern. After the “injection” takes place, there is almost no residual activity or response from the market. This absence of the decay of such an event is noticeable. If you do not see actual market responses to these buys, (or sells) it might be a scam.

So, we know how to watch for it “manually”, how about the times when it causes us to go against out guts, and change our opinion of the overall market state? These are plays of psychological warfare, and while some of them are legitimate plays, many are only intended to mess with our minds.

The psychology that rolls out at point 5 of the aforementioned bear flag is, “It didn’t dump”, “It isn’t dumping” but most importantly “I’m bored”. Keep these in mind as they are very important tools used in this psychological warfare.

Enter signal smoothing. This is the process of disregarding your candlesticks for a line chart. It is the act of reducing random noise from the data input which you analyze. A line chart is averaged so that the peaks and valleys only represent the price action at a blurry, poorly visioned state. Essentially, it dumbs the small things down to the point where they have less influence in your analysis.

Signal smoothing: Use a low moving average as the input to your indicators in order to eliminate the overall effects of chop.

In this view, our liquidation run on longs at B is gone. While it might not have been a great decision to be long here in the first place, at least you can have a clearer understanding of where the market is headed. Lets pump our smoothed signal into a couple EMAs and see what comes about. Here is a reference chart that does not have the effect applied:

SnowSignals without signal smoothing applied.

And here is the same data with signal smoothing applied:

SnowSignals with signal smoothing

Applying signal smoothing as the input to your indicators yields interesting results. Coincidentally, they also remove most chop at larger time frames. The SnowSignals platform also responds much more decisively when given averaged data. You can see that incident B is reduced to a single bear crossover. All said, when averaging data, timing can cause issues when actually entering and exiting a position so you need to stay cognizant of the current price action.

To summarize the benefits of signal smoothing, the act of analyzing pre-averaged data works to eliminate the psychological effects of chop. It also makes indicators more obvious because there is less noise in the input. It is best used on volatile assets at times of low volume and indecisive price action. It can be used in order to determine appropriate prices and to make better trading decisions.

SnowSignals is a custom built model that is based on Graphic Analysis. It is used for making decisions, and for forecasting future price action. The analysis provided by the tool is based on evaluating the health of an assets’ recent price and volume history. It can be integrated into automatic trading applications, or utilized as a visual tool for making decisions the old fashioned way.

The method is applicable to many (and all) forms of trading, for example, high frequency trading, trading on any interval, predictive analysis or any data that shows trend-like behavior. For Financial Instruments, the model works on any exchange that allows programmatic access to candlestick data. The method can be adapted to ANY and ALL trading spaces.

For more information please contact the author.