Why I won't trade patterns

Ok, traderNik, let's see if I can answer these questions. My response may actually give you more questions than answers but those questions may be answered in the example I'll post in a little while:
------------------------------------------------------------------------------My latest summary of your approach (I realize now when you posted that link to Anek which said 'This is the trigger - a short on a break of support', you didn't mean that you were shorting, you meant that pattern guys are shorting that break, right?).---------->>>> Right, that's a classic short trigger out of whatever kind of technical analysis books you may have read. I read Technical Analysis of Stock Trends, by Edwards and Magee. When I started studying the stock market I went straight to the bible.

1. Prices through the day are randomly distributed (The F Distribution, although I am just inferring what that means, I have almost no sadistics beyond normal distro and understanding fat tails and mean reversion).---------->>>> Most often the price movement for the entire day resembles and F-Dist with normal dist's within that curve. However, I have seen days that are normal and days where the F-Dist has two fast tails, one skewed left and one skewed right. This kind of day is extremely rare.

2. Occasionally, there occur pockets of normally distributed price events. These can (sometimes? always?) be described as the 'patterns' under discussion. ----------->>> Sometimes but you can find an area that trends for a while (lets call it an hour) consolidates for 20 min's (another normal distribution) and then resumes the trend. If that price action were taken into consideration it would look normal with a very high peak around the mean. So there can also be normal distributions within normal distributions. The problem with using statistics to analyze the market is what time frame do you use? This is only something that can be answered with experience. It's not something you can program a computer to do. This is the art of trading. Remember, I'm looking for a trading method that is supported by science but it requires an artist to interpret that science and make decisions based on that information.

3. When prices break out of these patterns, that represents an event in the tail of the normal distribution. These moves are faded in anticipation of a reversion to the mean. A trade is not always entered - the art of it comes in deciding which breakouts to fade.-------->>>> Pretty much right on here. But, again, a move out of a normal distribution could easily be a continuation back into either the F-distribution or the larger normal distribution I spoke of earlier. You have to look at the big picture as well as the small one. I have an example of this I'll post a little later.

Is that accurate?

If this is accurate, what will be really interesting is whether you always wait for the pocket of normally distributed price events. After all, sudden, long, unidirectional moves occur without having 'broken out' from one of the traditional patterns. Do you ever choose to fade these? I know a lot of guys are trading by fading these moves almost exclusively, a technique which requires a lot of patience and the willingness to be wrong small and re-enter.---------->>>> I'm not completely sure what you are referring to here but this doesn't sound like something I'm trying to do. I'm not usually interested in being wrong a number of times on small positions to eventually be right on 1 bigger position. My goal is to be right 100% of the time, but naturally I will never accomplish that. The point of making that statements is, I will not take a trade unless there is a very high probability I will win.
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Someone mentioned on this thread that my edge may be coming from avoiding losing trades by passing them up. That's partly true but my true edge comes from turning losing trades into winning trades by managing my account and risk wisely. I think the example I post later will turn the lights on.
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Oh, and I think you asked on anther post if I am tracking the data. The answer is yes. In grad school we had to write a C++ program of our choice so I decided to write a program that would calculate Z-scores, for example, on a given data set. I have a couple of programs that crunch numbers all day long. When I get a Z-score 2.575 (99% significance) I get very interested in the price movement. The trick here is knowing which time frame to use and how many bars to use. Statistical analysis of the stock market is flawed because it is non-stationary - i.e. always moving. You can typically find your starting point by looking at the last turn in the market but how do you find your ending point? This is usually a bit of trial and error. There is no X+Y=Z answer for this. It takes a lot of judgment. Again, this is something I'll explain with that example a little later.

 

Standing aside and being on the sidelines is not an edge. You may notice during those times traders are making money.

certainly stick with and repeat your view. On the otherhand traders do work to learn to make money. If they do achieve this, then they have what is called an edge.

 

See, this is where we disagree.

I don't want it all, I dont even want be first second or third. I just want a chunk of it with low risk,preferably near the middle.

Anek

 

You make a very interesting point cd23.
When my stops are hit, I am in the market.
If I notice the pelaton filling in behind me I enjoy the ride.

If they dont, then I wiggle out for a tic or two or three.
My fees are low and it is always a brand new day.
Standing aside by pulling my stops is not an option.

regards
f9

 

Looks like this post is too long.....I had to post it in 2 or more sections so read along to the next section(s).
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Ok, first off…I am going to be speaking fairly harshly about patterns. It’s not my intention to criticize your method or offend you if you are profitable trading patterns. My sole purpose for creating this thread was to provoke your thought process and perhaps get you to consider <i>another way </i>, especially if you are a losing trader.

My trading philosophy is based on a few assumptions, some of which you may disagree with:

1. The market is mostly random. Technical Analysis does have some value but the majority of the movement of the market can be explained by randomness.

2. Statistics is a very useful tool for analyzing randomness.

3. 95% of traders lose so if the market is falling what should you be doing? Buying!

4. You cannot time the market so perfectly that risk and money management can be ignored. In fact, if your method is based primarily on timing you will lose. I suspect there are many who will disagree with this but remember, this is what works for me and not necessarily you. If you can time the market and win with 1 trigger then more power to you. I can’t.

5. Trading is not about being right or wrong. You can be wrong and still make money. You can be right and still lose money. If you have ever been right about a trade and lost money – I suspect everyone falls into this category – it’s probably because you don’t believe the market is random. Randomness does generate patterns.

6. The only way to win in the market is to have a thorough understanding of probability. This is where traders make their biggest mistake. If they go back and look at 100 ascending triangles and 78 of them won they assume the next ascending triangle has a 78% probability of winning. This is flat out wrong. You cannot make that kind of assumption because 78 won previously. Each pattern like that is an independent event and the probability of winning must be quantified as such. The only way to quantify the probability of that trade is to throw it into a data set and run a statistical analysis.

7. The financial markets are nothing more than data. Most view the market as buyers and sellers, which is true of course, but what it really comes down to is data.

8. The best type of trading defies logic, is counter-intuitive, and defies conventional wisdom. Traders assume others lose because of a lack of discipline, which can be true. I have had the opportunity to study a lot of traders and poor discipline is only partly the cause. The primary reason traders lose is because they essentially do a slight variation of the same thing, which usually centers on patterns. Go Google some stock picking services. 95% of them offer patterns. Don’t you think you should be doing something different?

9. No matter the method you choose you will lose if you don’t fully understand yourself. Natural born traders don’t exist. We have to train our minds to think and act like traders, much the way we taught ourselves how to read charts. I would not be where I am now if it were not for “Trading in the Zone,” by Mark Douglas. I have the science of trading down cold. I have to constantly work on myself to maintain my edge. If you want to win and stay a winner you do to.
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Alright, enough on the assumptions…let’s get to the trading.

There are five trades on this chart, each highlighted with an alternating black or red box.

On a different thread, Don Bright talks about opening orders with specialists. I am very interested in the behavior of the market during the first ½ hour because that’s where the overnight orders get executed, or where the market feels the after-effect of those orders having been executed. Pay very close attention to how the market behaves at 10am ET. My charts are CST so add an hour to them. Many economic numbers are released at 10am and they tend to reverse the market following the buying/selling during the first ½ hour, not always of course.

My first trigger was premature but based on other information (statistical) I felt the downside risk was low so stopping out would have been the wrong thing to do – i.e. I’m not trying to time the market perfectly, just get me close. I can fix my deficiencies with other methods – i.e. money management. This trade defies conventional wisdom. Once this trade moves against me and goes to a new low I should be stopping out. I disagree. The market popped up as I expected and I took my profit. I’m fully aware at this point that I’m peeing into the wind so I’m a “Profit Taking Fool” here. I’m all out up there at 1570.50. What a great way to start the day – with a profit. Just take the darn thing.

The next trade is simply a continuation of the first one but at a lower price. In fact, if you look at my first trade there is a blue line down there. I still wasn’t stopping out, I was buying more because the information I had was very, very reliable. At any rate, my next trigger was at 1568.25. The market moves immediately in my favor (I’m long the exact bottom down there – i.e. I had very, very reliable information on these triggers) so I’m a profit taking fool and get out with a partial. Here comes a very important concept. Remember, I’m not concerned with being right. Frankly, I don’t care if the market goes up or down. I’m just here to make money. Arguing with the market is futile. Once I take that partial I have “freed myself from the burden on having to be right.” If the market goes down from here I put the contracts I just sold back to work, at a lower price. If the market heads up I take more profit. This way, I put myself in a position to win if the trade moves for me <b>and</b> if the trade moves against me. Now how powerful is that edge? I can turn a losing trade into a winning trade with money management, not timing. As it turned out, I’m all out at a higher price. Could the market have gone higher yet? Anything can happen <<<-----three magic words. The market could have gone to the stratosphere after this exit and I wouldn’t have cared. I only care about what I take, not what I miss.

The next trade was simply a momentum trade. I felt a shift in momentum so I bought into the move. Picking tops and bottoms are one of my methods but not my only method. I will follow the market when I feel the time is right but I prefer to lead the market if given the opportunity. This was a simple entry on strength at 1569.25 and exit at 1570.50 – the last high minus 1-tick. I do respect technical analysis. The market went higher, no big deal.
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Now this next one reinforces my philosophy on timing. You can’t time the market. If you look closely you’ll see a red line above my trigger at 1572.75. In fact, you’ll see two of them. The first one was my initial trigger to get short. The market didn’t go that high so do I just sit there and do nothing? A missed trade is one of the most frustrating things in this business, at least for me. I don’t argue with the market, I took the trigger with a market order at 1572.75 – I traded what happened, not what I wanted to happen. Once that order triggers I cancel the original order. Now comes the important part…..since I had to take a trigger I didn’t want I need to protect it with an order up above. Yes, selling more is a form of risk management. I know, this defies logic and goes against conventional wisdom. If you want to win you have to know when to break the rules. I was not comfortable in this trade for the reasons just stated so I took a quick partial at 2 ticks. If the market went higher (remember, I don’t care about being wrong or right, just winning) after this partial is taken I am minimizing my drawdown by a large amount. Having this trade go against me now would have been a <b>good</b> thing. As it turns out it didn’t go against me so I took the rest down at 1569.50. Stay flexible, trade what happens, not what you think or want to happen. That’s all I did here. And yes, you can pick a top and a bottom. It’s hard to do but if you manage your account wisely you will do it.

This last trade was a tricky one. There is big time support at 1568.00. Where do you think the stops are? Where do you think the shorts will sell? What happens after stops get run? The market reverses. That was a head and shoulders top, yes? I don’t trade patterns, I fade them but only when the conditions are right and my trade is supported by other methods. So where do you think I’m buying?

<b>Side note:</b> If you take all that data from the high of 1573ish to 1565ish it would form a normal data curve with a very high peak and very flat tails. Where are my orders to open positions? You bet, in the tails.

Once I sense the stops have been run I’m going long, but that has to be supported by the statistics. It was so I’m long at 1567.00. It goes lower. Do I stop out? No, I buy bottoms; I don’t put bottoms in, or least I try not to. Now look at those lines below this bottom. I was buying more at 1565.00. Had the price fallen past this level it would have gone parabolic down. Parabolic moves are exactly how the highest probability tops and bottoms are put in. When those occur I’m buying aggressively. At this point I was hoping for a collapse in price even though it would have been a bit uncomfortable with the lots I was holding. It was well within my risk tolerance so I accepted it. That parabolic down didn’t occur (which is one reason I’m not stopping out down there – you don’t know, you simply don’t know what will happen next!) so I place another order to buy more at 1565.50. The market moved away from that order so it wasn’t filled. Once I’m showing a profit I’m taking a partial at 1567.25. Again, I don’t care about being right or wrong, I’m just here to make money. If we do down from here I put those contracts back to work at that lower price I was hoping for. If we go lower I win, if we go higher I win. Price went higher and I won. Again, the target was the last high minus 1 tick. For some reason I subtracted 2 ticks here. I’m not sure why.

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Now here’s another important concept. Look at the volume pattern as the price was falling at 12:30. Volume is increasing – sellers are getting washed out. These sellers no longer exist when the price recovers and heads back up. That’s a WHOLE bunch of sellers who no longer have the capacity to sell because….they already have! Think about this….if they have already sold……? Now look what happens to the price once it gets going. It expands with rapid force. Why? Because the sellers have left the building. The supply to absorb this move up has simply vanished. If you see a volume surge as the price is falling you know you’re near a bottom. Look at the volume pattern as the price was rising around 14:00. Again, it’s expanding – traders are peeing themselves chasing the move. The majority of the volume occurs at the tops (in this case near the top) and bottoms of the market, and the areas where most traders lose. Most traders are trend followers (you can’t win being a follower) and lose because of it. Look closely at the price action in the blue box. Is there a pattern in there? I can’t say for sure but I’d be willing to be there is. Did price retrace back to 1571 after breaking out at 1572.50? Where stops hit on a <i>winning</i> trade up there. Obviously I don’t have the answers to these questions but it wouldn’t surprise me if traders got washed out there. They just got wrecked by randomness.

One last quick thought….there’s another trigger up there in the 1574/76 area that I would have taken around 14:00. I had to run out so I couldn’t take that trade but it worked perfectly.

Closing thought: This post was intended for the 95% who aren’t winning on patterns but it seems to have attracted the 5% who are winning on patterns. If you find yourself in the 95% then perhaps it’s time to start thinking about choosing a different way. I’m not saying you <b>can’t</b> win with patterns but that method isn’t supported by science. Perhaps there is anther way?

Breaking all the rules and winning because of it…..Profit Taking Fool!

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disregard the post I just made - I deleted it. Don't respond until I've had a chance to read these posts!

 

The wonderful thing about trading is there is no <i>one</i> way. There are as many ways to trade as there are traders. You just gotta find the groove that suits you. I'm always interested in <i>how</i> other traders <i>do it.</i> The market is one big puzzle with a whole lotta solutions!