So far, random price movement has been depicted as a bell curve. The flatter the curve, the more volatility of the price action because the data points are more spread out. The steeper or narrower the bell curve, the less volatility in the market — the data points are in a tight pattern.

Now, how is this affected in actively traded market? It is, of course, possible to take a snapshot of the current price activity and make some projections. When doing this, however, there are three things that can go awry. First, even if the third standard deviation is used, there is a one in 369 chance that the next data point will be outside of the parameters. Second, one could anticipate a positive move and actually experience a negative one. In other words, the analysis of the direction of the next move could be incorrect. Third, the trader could be using an incorrect volatility value.

The volatility value changes whenever a new data point is added. Now, the change may be virtually immeasurable if the new data point falls within the first standard deviation, but it occurs nonetheless. It is for this reason that price modeling should be thought of as a snapshot or single frame in the price discovery process. Underline the word “process,” because price discovery is indeed an on-going process.