Head and Shoulders pattern, garbage?

Discussion in 'Technical Analysis' started by Daal, Oct 22, 2009.

  1. Daal


    Apparently it doesnt stand to empirical tests. But I'm open to contrary evidence


    Moderator's Notes

    I was very curious how the article author determined that "head and shoulders trading is unprofitable," so I looked at his entry and exit strategy.

    (1) The entry is a close below the neckline on the daily chart.

    (2) The exit rules (for the Cliff's Notes version just read the bold):

    So, in all the author's supposedly thorough research on how to trade a head and shoulders, he apparently missed Bulkowski's "Encyclopedia of Chart Patterns" which actually explains how to trade this pattern.

    The entry and exit strategies used in this study are rather inept. They are missing all of the fundamental pieces required for a profitable trading methodology. Exit rules need to be designed specifically for the problem at hand, with the belief that history in some way will repeat itself. Quantitatively, we study the successful patterns and also the losers, designing entries and exits to take advantage of past behaviors. While many poo-poo this approach with the epithet "curve fitting," it actually does produce profits if done correctly, and the market behavior after each entry taken is characterized in order to determine if history, indeed, is in some way repeating itself.

    So specifically for head and shoulders, to trade it profitably one must abide by these rules:

    (1) Do NOT wait for a confirmed breakout. The proper entry is as price is NEARING breakout. Yes, it's an art. This is one thing the human mind does far better than computers: pattern recognition.

    The author of this paper enters on a daily close below the neckline! This is quite late and it also convolutes the stop (see below).

    (2) Stick to the profit target unless you have a quantitatively justifiable reason to get out (such as a time stop based on how long past winners have taken).

    The author of the paper exits at the first trough unless he's less than 25% to the profit target; he exits at the second trough regardless of the profit target. These rules are arbitrary feel-good rules and are not based on past performance, as they should be.

    (3) Use a proper stop. In this case, just above the neckline or the lower of the two troughs, whichever is higher.

    The author uses a 1% stop according to his entry price. So sorry, but the market does not care where your entry is. The stop needs to be placed according to where H&S patterns fail, not how much money you might lose. THEN you adjust your size in order to risk 1% of your account, for example.

    So, in summary, yet another paper using a lousy trading algorithm and thinking they've shown an aspect of TA doesn't work. Spare me.

  2. TA is great for pointing things out after the fact.
  3. Pekelo


    We shall see, there is one on NDX right now....
  4. Pekelo


    Although fundamentals screwed up the pattern (good earnings last afternoon) and we opened 10 pts higher than the NDX's right shoulder, it got adjusted rather quickly and currently we are 18 pts lower.

    So yes, the pattern worked.... :)

  5. Unfortunatley... all you guys are using Technical Analysis wrong.
    which is why you guys are on here posting how it doesnt work....

    So tell us how you trade then? from your instict? nonsense!
  6. There are two types of TA chartists:

    A) A trader that post a chart to show where price will be in the future based upon their technical analysis.

    B) A trader that post a chart to show where price was at (hindsight) based upon their technical analysis.

    I've seen both types of traders at many different forums online...I prefer the A) types because the TA is explained prior to the price action completes especially when the A) types follow up with another chart to show what happen afterwards like the B) types.

    I use charts without any indicators.

    The moderator's (PetaDollar) editing notes cast a common theme about those that publish test results...

    The flaws in their price analysis and trade methodology (garbage in) is why the results (garbage out) are what they are.

    garbage in and garbage out

    More importantly, they rarely get into why these types of price patterns works for some and not work for others.

    It's not the price patterns alone being used by profitable traders. They have other key ingredients (boring stuff) that allow them to profitable trade price patterns:

    * Market Experience
    * Money Management
    * Discipline
    * Team Collaboration (these guys aren't doing this alone)
    * Proper Capitalized
    * Proper Trade Environment (at home or office)
    * Other et cetera

  7. pupu


    You can use historical charts to sell or disprove any TA based strategy.

    You just show the ones that worked historically and ignore the ones which didn't.

    A bit like the carlton sheets in some way if ya know what I mean
  8. You are absolutely correct.

    But if you can learn to read a consistently created chart in real time you can see it occur as it happens.

    Garbage in . . . Garbage out!
  9. Concur . . .
  10. speres


    U need to know a bit more about a h & s pattern than just saying, oh theres a h & s pattern I'm shorting the neckline. You didnt think it was going to be that easy.......
    We know its a trend reversal so you need to look for signs whether your getting distribution and all the indications of a reversal
    #10     Oct 25, 2009