Hey, there pheonix 101, i will try my best to reply to
this good post of yours. Of course, commentaries and evaluations are welcome.
You are the highlighted in dark, bold italics.... my response is interspersed inbetween.
'phoenix101' wrote: this guy seeks out historical analog chart patterns that match current patterns...sometimes I see how he gets the pattern, sometimes not.....
NEMENCINE's response: The book
Methods of a wallstreet master by victor sperandeo did that. He talked about how he went through historical patterns and tried to use that to trade. The book might lent some insight. The main thing that concerned me with this approach is the fallacy of technical analysis: just because a pattern has occurred in the past, doesnt mean that its present occurrence right now bodes towards the same thing. Let us take support and resistance levels(S/R levels). Just because an S/R level worked in the past, doesnt mean it will work again when a S/R level shows up(i assume you know this already, phoenix101).
The reason for that is the change in fundamental reality.
If a stock forms a solid congestion S/R level at $58 today before a breakout, and price later comes back to $58 after a runup...you have 50/50 chance of experiencing a bounce. If the fundamental reality of the company situation is the same as was last time:you will most likely get a bounce...if the fundamental reality is completely different, dont be surprised if price slice through that level like a hot knife through butter.
The reason is because these technical levels(s/r, channels, wedges, triangles, head-and-shoulder, etc) are created by fundamental traders bleeding their orders into the market over days and weeks. Trying to prevent the market from running away as they accumulate position... they fractionate their orders in at those levels... when the market comes back to retest those levels(with fundamental situation still ceteris pauribus) their resting, remaining orders gets triggered: providing the bounce due to
market memory. This is also why you want a fresh pattern to use...not one that has been tested by price action...because those latent orders would have been eroded.
The thing is that orders that are fractionated into these levels follows a herding behaviour on the level of market microstructure...they cascade in due to liquidity disequilibrium and latent and pending interest, of course, generating episodic volatility in the process. All these leads to the
concavity of price orders that follows
power laws characteristics at these s/r levels, all following a herding behaviour. Which leads to one question: is there a way to different between herding behaviour that leads to fakeout or good breakout?
At the end of the day, Fundamental traders create the patterns in the market, technical trader (and
HFT traders)creates the noise in the market. in fact, all technical patterns are simply a combination of two things: support and resistance and regression lines(or colloquially known as TRENDLINES).
For a more rigorous treatment of the subject matter:
#1.
Price Formation in Financialized Commodity Markets:the role of information.
#2.
Avalanche dynamics and Trading Friction effects on the Stock Market.
#3.
How market slowly digest changes in supply and demand.
In a nutshell, the main question, in my humble opinion is: when this pattern was created, what was the macro/fundamental reality? are they similar now? otherwise, the pattern is immaterial.
I was quite interested in why technical analysis seems to be 50/50 chance of succeeding, that is why i started asking myself the question: when you read market history and market wizards books and past market gurus...why do some of them have longevity? and others dont? why was the gann method or elliot wave or wyckoff patterns worked like a charm for some times, then stop working? why was the moving averages crossover a sure money maker during the 80s but stopped?
I realized that the market, despite her inefficiencies, the market have the tendency to neutralize a method after a time: trading history is full of carnage of trading methods whose bones are scattered across the field of trading battles. This means, the method that was effective worked because the fundamental reality of that time makes it permissible. Breakouts are prone to failure, however, during 2008, breakouts in the forex market works like a charm...the market is like a big immune system adapting to whatever you throw at it. She doesnt allow an exploitable edge to stand for too long...maybe 10 to 15 years. It is absolutely critical to know why and when a method can or cannot work. That is also one of the limitation of backtesting.
'phoenix101' wrote: I don't know how he finds patterns but I've just started testing out my own thing in Excel to match current 30, 60, or 90-day patterns in Excel to historical data (still iffy, just using CORREL function for now against years of daily historical prices)......
NEMENCINE's response:there is a book that conducted exhaustive pattern test on the market:
Encyclopedia of chart patterns by thomas bulkowski
. Mr. bulkowski ran hundreds of statistical studies on hundreds of market patterns over decades of data. The conclusion, that i take from that encyclopedia is to trade with the trend as much as possible. respectfully, that your patterns hardly matter. what matters is that you are trading with the trend. why do i say this?
On page 438 of the second edition, chapter 28, you will see a bullish pattern called the "thorn bottoms"...it is a bullish pattern...this bullish looking pattern--as the author freely admit--it is a bullish pattern the author pulled out of his arse. I shit you not. Well...let us see what he did next, shall we? He then examine this bullish pattern in bull market vs bear market, i,.e, trend vs counter-trend. In trending market, the bullish pattern performed 66.66%...and reach its intended price target 76% of the time(using measured move to determine price target). In counter-trend market however, the pattern only performed 31.5%. result: trend vs counter-trend = 66.66% vs 31.5% .
Mr. Bulkowski then turned the pattern upside down: inverting it thereby creating its opposite(the "horn tops" pattern)...a bearish pattern...so, he then run a trend vs counter-trend analysis...this is on page 451, chapter 29. Results? In a trending market it performed at 47%...in a counter-trend market, it performed at 19%. Look at that disparity in trend vs counter-trend : 47% vs 19%.
My point? TRADE WITH THE TREND. Even if you pull a technical pattern out of your behind...in a trending market aligned with the polarity of that pattern...it is pretty much guarantee...it will score...with a good R/R...you are in business.
Mind you, the "horn bottoms" is not the only technical patterns mr bulkowski made up out of thin air and ran statistical tests on...there was the scallops...the bump and run reversal top/bottom...there is even a complex form of head and shoulder that he created...and the list goes on...
Now, take a wild guess at the performance of these patterns when traded with the trend vs countertrend?
You know the answer to that...i dont even need to post the results.
Trade with the trend. Here is a video by dennis gartman that makes the point well:
http://jny.kewego.com/video/iLyROoafJo27.html
'phoenix101' wrote: John Carlucci has an interesting indicator for when the market is tradeable or not tradeable. I've looked at the Canadian version of this indicator and seems to be a little bit of a different animal. This spurred me to look into "my own" indicator but it's often like looking at a Rorschach test and seeing something different. I was studying for a while the different patterns that form in the A/D % Index and it's MACD, Sto, how different things worked when MA was above 0, moved above/below ......
NEMENCINE's response: speaking for me only: using indicators is not compatible with my psychology. It is not my trading style. For technicals, i simply use price action, trendline, support and resistance levels. that is pretty much it for me.
regards,
--Nemencine
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. The relatively high volume along with a stop limit will help you from losing your shirt while waiting for a 2-3 day runup.