Remember, this blog is like a whiteboard – we are kind of brainstorming here…
I am beginning to play around with quantifying the predictability of patterns, such as the head and shoulders pattern. There is a lot of analysis, running of data and thinking that needs to be done, but I wanted to talk a little about what I am seeing so far. To really understand the usability of certain patterns, you really need to slice and dice the data in various ways to understand what tendency the market/stock/index/whatever might have after a pattern presents itself. As an experiment, I pulled closing data from about a thousand stocks that I had over 10 years worth of data. Presently, I am just trying to get a handle on the H&S pattern across ALL stocks, so I figured I would ignore individual stocks and just look at some global numbers.
I decided to be very simplistic (and practical) and look at the seven day H&S pattern. I am making a HUGE assumption in this next step – I am assuming the general tendency of the pattern will play out within seven days (again, seven to match the length of the pattern). In the future, I plan on looking at days one through pattern length X 2 – or something of that nature – to give use a better understanding of how a pattern evolves once it is recognizable. So, here are some early numbers:
- The average stock showed a 7 period head and shoulders pattern every 349 trading days
- That equates to about .4% of all stocks having a head and shoulders of length 7 at any one time
Okay, those make sense. It seems that patterns like this are relatively rare.
- It seems that only about 400 stocks out of 1000 had a tendency to move DOWN seven days after an H&S pattern
Okay, let’s dig just a little here:
- Of the 400 odd stocks that showed a tendency to go down after an H&S pattern, the average seven day loss was 1.7%
- Of the 600 remaining stocks that showed a tendency to go UP after an H&S pattern, the average seven day gain was 2.45%
Okay, that is just a little taste. I have plenty of work ahead of me to really see what is going on. Also, if anyone sees any problems in my logic or has questions about how I am calculating things – let me know. I am skipping a lot for ease on my part and trying to get to the deeper issues, but details can be important and that is where the mistakes can be made!