I've heard many successful stories about using classic TA patterns like double bottom/top, wedges, breakout etc... Some even say that the successful rate is about 80-90%. Is there any one backtested those patterns for more than 1000 trades on different time frame and can confirm that they truely give an obvious edge?
Andrew Lo at MIT (paper on website) and Thomas Bulkowski in his books and on web site http://thepatternsite.com/patternz.html IMHO to really trade patterns you have to understnd what is giing on when a pattern forms - by knowing this and reading the price action you can also recognise price action that doesn't correspond to a text book pattern.
The beauty of patterns.... which typically represent some form of consolidation / indecision.... is they provide a pause for you to think about and prepare your entry. A failed break is nearly as good as one that doesn't fail. Either way, you're in at the beginning of the next move.
Double bottom is not a trade signal. Simply, it's like an alert for someone to look for their trade signal if/when such appears at a double bottom. Thus, a profitable trader using double bottoms does not buy "randomly" whenever it appears. They need a reason to buy that double bottom regardless if that reason is discretionary or rule-based. My point is this...you really need to backtest the actual rule-based trade signal when it occurs at a double bottom or double top. For example, lets pretend one trader uses only bullish engulfing patterns at double bottoms... Another trader uses pivot point retracements at a double bottom... Another trader uses an indicator divergence (e.g. stoc, rsi, macd et cetera) at a double bottom... Another trader uses volume breakout at a double bottom... Simply, if you truly want to test double bottoms or any other classic TA pattern... You really need to know exactly what is the actual trade signal being used (if it appears) by someone when they trade that classic TA pattern. That's the main reason why everybody has different results trading double bottoms/tops or any other classic TA pattern. Those that say they don't work are obviously using a different trade signal than those that say they do work. Therefore, to do proper backtesting... Your going to have to categorize double bottoms/tops into sub-groups based upon the actual type of trade signals being used to signal a trade (if the signal appears) at a double bottom/top or at any other classic TA pattern and based upon other variables (see exit signal discussion below). Testing them without the actual trade signal is pointless and a waste of time/energy. Analogy...classic TA is like a F1 car. You can't just say were going to test the tires and nothing else to determine the overall performance of the car. Nor can you say were going to test the aerodynamics of the care and nothing else to determine the overall performance of the car. Thus, to test the overall performance of the car... You need to test everything involved with that car including the driver ability to race that car. Sure...that type of testing can be done but it's exhausting and in the end you'll develop a new understanding about why one trader's performance is different than the performance of another trader that trades the exact same classic TA pattern in the same trading instrument. Also, even if two traders are using the exact same classic TA pattern via the exact same trade signal... There trade results can vary tremendously via how they exit the trade. Lots of stuff to think about if you really want to test why someone is profitable versus someone that's not profitable. Last of all, many years ago I gave a great example with results of how trading results can different tremendously based upon the exit signal if everything else was the same when one trader compared his results to the results of another ET member. One guy had a 32% win rate while the other had a 75% win rate...both using the exact same classic TA pattern, exact same entry signal, exact same trading instrument, exact same time frame, exact same data vendor via the exact same trade execution platform... The difference was the exit signal. Unfortunately, Baron (ET owner) deleted the thread because it was too old and inactive (no post to it for many years). Change any variable in someone's trading plan and they will have different results. Your edge is not one lone variable...it's the interaction of many different variables within your trading plan. Mark
OK, to be more easy to test and compare, we set standard measures, for example: Double bottom, buy the break out, exit the trade at the same height from the neck, or exit the trade when price break the bottom. In this setup, the profit/risk ratio is 1:1, so if it could not provide more than 60% of the successful rate, then it is not impressive.
Price action LEADING up to classic TA pattern is they key. How you define and comprehend PA is up to you to learn. Patterns will print again and again, but the CONTEXT that printed them will be the determing factor in whether they work.
That's my point... You've just described your trading approach to trading double bottoms. Someone else using something easier or more difficult will have different results that has nothing to do if it's simple or complex. Simply, you are not testing the reliability of double bottoms/tops. Instead, you are testing one's trading plan in trading double bottoms/tops regardless to the simplicity or complexity of the rules or discretion within the trading plan. Therefore, if it's win/loss rate is less than 60% via your reliability measurement... It's your trading plan that's not reliable and not that double bottoms aren't reliable. Therefore, someone with a completely different trading plan of double bottom/top will have different results (better or worse) in comparison to your results. Understanding that reality will help you understand your backtest results along with helping you improve your trading of double bottoms if that's your goal... Hopefully that is your goal because anything else is pointless. P.S. Get rid of the neck line exit strategy especially in low volatility trading environments (big hint). Mark
Pattern TA is a subjective art. anyone who tells you differently has something to sell or is deluded. surf