Decision Tree Analysis

 BarroMetrics Views: Decision Tree Analysis

At the end of trading on November 18, I wrote in Video/Forum service:

“The CPI came in within expectations and the market produced a Neutral Day response, both in terms of bar charts and in terms of the Market Profile.

Against the current structure:

  1. A Ranking of ‘0’ (see Nature of Trends) and
  2. The market having attained 78.6% of AB i.e. at a point where Crude could return to the Primary Buy Zone

we have amber signals that I cannot ignore. This is especially true of the R0 structure since if correct will produce a very strong move up.

The question is how best to protect the position? The profits have not covered the cost of my stop; and while amber lights are on, there are insufficient reasons to exit. So, I’ll raise my stops to just under 76.37 (the start of the directional move).”

I received an e-mail asking how I arrived at my decision. At close of trading on Nov 18,  my Crude Oil longs had:

  1. Open profits of $6000.00
  2. An initial stop of $12,000
  3. The strong possibility that the market would move down.

In response, I felt that I had the choice of :

  • Doing nothing
  • Exiting enough of my positions so that the stop would be covered by the remaining contracts
  • Raising my stops
  • A combination of the above.

In this type of context, a ‘go, no-go’  situation, I like to use a decision-tree analysis.

For the sake of simplicity, I’ll reduce the options to ‘doing nothing’ or ‘exiting all’. In this blog, I’ll show and explain the Decision-Tree. On Monday, I shall explain my thinking.

2009-11-20-decision-tree.jpg

Figure 1 Decision Tree

As Figure 1 shows, I took the view that whichever option I took, the market could respond by either moving up or down and  in moving up or down, I could make a profit or a loss.

Based on the figures I in-put into the spreadsheet, the better option was to stay in. In the decision, staying in and raising my stops was what I decided to do. On Monday, I’ll explain my thinking processes.

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