Feedback on Correlation Pattern Matching
Previously, I discussed the importance of feedback in understanding and learning and that is one nice aspect of blogs - getting feedback from readers. Michael wrote a nice entry about the last article over at Taylor Tree, a blog that discusses “the mechanics of system trading such as money management, position sizing, etc.” - good stuff! He describes an interesting pattern he calls Melba Toast, but I don’t think that the simple pattern matching I described would be the best way to identify this pattern. I need to look at more Melba Toast examples.
I got some really good questions from Thomas Czaszyski, who writes a stock investment and research blog. Thomas asked the perfect question:
This head and shoulders, I understand how to get it and everything now, but what does it mean?
Exactly! Now, I know the classic chartist answer, but I am not interested in regurgitating the same answer a chartist would give. Luckily, Scott pointed us to the book Encyclopedia of Chart Patterns, so I would recommend Thomas check that reference. Or do a quick look at head and shoulders described by chartists. Thanks for the pointer to the books Scott - I certainly want to take a look at how everything was quantified. My major concern is - how did they identify the patterns? Were humans finding the patterns?
Also, to Thomas - good luck with Princeton! Don’t be surprised if you find that most academics don’t truly understand the stock market and trading, let alone technical analysis.
If I remember correctly, MIT did a study on technical analysis and found that some patterns did make money. They didn’t say whether or not on a risk-adjusted basis the patterns were better, but it was an interesting study nonetheless.