{x} | Trading.live

The Austrian economist Friedrich Hayek posited that while in the natural sciences, people first understand the macro world through concrete experience and then use abstract methods to understand the micro world, in the social sciences, this cognitive order is reversed. In finance, for example, individuals' behavior is first understood through human experience, and then the macro whole is abstractly constructed. Hence, applying traditional natural science methods to study finance often poses challenges, such as defining and handling market liquidity risk, which many economists struggle with when building financial models. Liquidity risk, in particular, is difficult to deal with as it involves an abstract concept that lacks an accurate definition or quantification.
For general individual traders, designing a trading model does not necessarily require advanced finance knowledge as most do not manage large funds. However, traders must understand the principles and limitations of the trading model they intend to use. The trading model is part of the trading methodology and represents the abstraction of trading assumptions, which aim to describe the essence of things and discover the principles of the world's operation. The establishment of a trading model relies on the analogizing of two similar things, which means the model inevitably simplifies and reduces the dimensions of the world.
To illustrate, let's consider a relatively simple trading model that solely relies on the RSI indicator. This method follows the traditional use of the RSI indicator, as depicted in the figure below.

The above chart displays the daily price changes of a particular stock. To simplify the RSI indicator, we have only used a single RSI line for demonstration purposes. According to the RSI indicator's design, a value of 50 implies a balance between bulls and bears. When the value reaches 80, it signifies an overbought market, and the price is expected to drop. When the value falls to 20, it means that the market is oversold, and the price is expected to rise. Following these guidelines, we would buy at the green arrow and sell near the red arrow on the chart.
The trading model discussed earlier is easy to understand and provides traders with clear buy and sell signals to execute. Any model that can provide clear signals can be termed as a trading model. However, a trader's profitability is not determined by the type of trading model they use but by their understanding of the model they are using. Like a soldier must understand their weapon, traders must know their trading model's principles and limitations before using it for trading. The principles refer to the profit assumptions of the trading model, like the RSI trading model mentioned earlier. The RSI assumes that prices will not continue to move in one direction, and when they do, the trading indicator will signal oversold or overbought conditions. It is not sensitive to time factors and is less sensitive than indicators like KDJ and MACD. These are some of the principles and assumptions of the RSI indicator to consider before using it for actual trading.
The limitations of a trading model stem from its flawed assumptions. Simply put, trend models are only effective in trend markets, not sideways markets, while range-bound models work in the opposite way. As we mentioned earlier, the RSI indicator assumes that price movements in one direction will lead to a pullback or rebound (an RSI value above 80 indicates a shorting opportunity, while an RSI value below 20 indicates a long opportunity). This kind of thinking is typical of oscillating thinking, which assumes that prices will "revert". Now, let's take a closer look at what a typical trend model looks like.

The chart displayed depicts the weekly K-line chart of a specific stock, and the line illustrated in the graph represents the 60-period