Why Coin Toss Patterns Do Not Predict Market Returns
Summary
The discussion contrasts a fair coin betting idea based on recent head and tail sequences with a proposed short duration Dow futures trade triggered by an up, down, up price pattern during an uptrend. For a fair coin, each toss is independent, so prior outcomes do not change the probability of the next result. A progressive betting schedule therefore cannot create an edge from that pattern alone.
Financial returns differ from coin tosses: their distributions need not be symmetric, asset prices can have drift, and volatility changes over time. The answer describes markets as shifting between momentum and mean reversion as supply, demand, and sentiment change. It argues that simple patterns in recent bars are not, by themselves, a reliable basis for predicting the next move, and points to recognizing changing market behavior as a challenge. The discussion provides no data or tested trading results, so it is conceptual guidance rather than evidence for a particular signal.
Key ideas
- In a fair coin toss, previous outcomes do not alter the probability of the next outcome.
- A progressive wager cannot produce an edge from independent toss patterns alone.
- Asset returns can have drift and distributions unlike a fair coin.
- Markets may shift between momentum and mean reversion, limiting simple pattern rules.
- The proposed Dow futures pattern is not supported by performance evidence in the discussion.
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Full text
# Coin Toss System # Coin Toss System Coin Toss Runs Calculator The expected number of runs for two consecutive heads or tails is 3. Is there an edge if we place a progressive constant size bet(limited to 3 times)for consecutive appearance of H or T only after pattern HTH or THT appears, Or is `prob=0.5` always? Say Dow is on a daily bar chart 'uptrend', i.e. 50MA above 100&200MA, Is it a better to long (a day duration each time), e.g. mini-Dow futures until two days UP in a row the day after a 'Up,down,up' daily bar pattern occurred? ## Answer by Matt Wolf (score 3) https://quant.stackexchange.com/a/4444 1) The probability of a H or T of any next coin toss (fair coin) is always 0.5 because coin tosses are independent of each other. 2) Stock markets, or for that matter any asset, are an entirely different game. First of all the expectancy is not 0.5 of, for example, experiencing an up or down day tomorrow in a stock simply because the distribution is different and because stock prices exhibit a drift component. Additionally, financial asset returns and especially their volatility exhibit co-integration properties of varying degrees. Thus, it does not pay to compare coin toss expectancy with asset return expectancy. 3) Changes in stock index levels as well as individual stock prices are the strict result of supply-demand imbalances and such imbalances are partly a function of varying and shifting sentiment on the macro side, industry sector side, and individual company side. Sometimes stock price imbalances can carry on for a prolonged period, at other times the market exhibits a strong drive to move the price back into what the market views as fair value regimes. Such switches from momentum back to "mean reversion" and again back to momentum are what experienced traders are the most concerned with and attempt to assess in order to maximize the expectancy of their placed bets. I have not heard of long-term successful "market operators" to generate profits off the back of predicting what the next tick/bar/day is gonna be purely as a function of the up/down pattern of past returns. What I observed on the other hand makes a successful trader is the ability to assess as early as possible shifts in co-integration patterns after they occurred. Just my 2 cents.
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