Download Bar Pattern- Keeping It Simple PDF

TitleBar Pattern- Keeping It Simple
TagsTechnical Analysis Market (Economics) Profit (Accounting) Stocks
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Total Pages6
Document Text Contents
Page 1

42 • September 2001 • ACTIVE TRADER


P eople often undere s t i m a t ethe effectiveness of simpletrading methods, focusingm o re on advanced tech-
niques — in essence, equating complexi-
ty with profitability.

Part of the problem is our fascination
with technology. There are many soft-

ware programs that allow you to design,
test and execute trading strategies. The
multitude of indicators, pre - p a c k a g e d
trading systems and technical analysis
tools these software platforms offer are
of great benefit to the trading public, in
that they give individual traders the abil-
ity to perform research and analysis pre-
viously in the domain of financial insti-

H o w e v e r, this access to technology has
a downside. In some ways, it has fooled
many traders into believing the more
complicated a trading strategy is, the bet-
ter its chances of success. This is not nec-
essarily the case. We will show that sim-
ple trading rules have real value and can
result in profitable systematic trading
a p p roaches that are easy for all traders to
implement and execute.

F i g u re 1 shows a price pattern formed by
four consecutive daily bars. The bars are
n u m b e red from 0 (the most recent bar) to 3
(the most distant bar). The most recent bar
is also re f e r red to as “today,“ bar 1 as “yes-
t e rday“ and so on, as shown in Table 1).

We are not concerned with all price
points (open, high, low, close) for each
bar: For bar 0, only the value of the high
is important; for bars 1 and 2, only the
lows; for bar 3, both the high and low.

TRADING Strategies

While software packages that provide the latest bells

and whistles are fine, they sometimes obscure the

benefits of a simple trading approach.

Short-term strategies based on price patterns are a

robust alternative to complex indicators and formulas.

s i m p l eKEEPING IT


Page 2

ACTIVE TRADER • September 2001 • 43

This is because the objective of this four-
day pattern is to determine when three
consecutive lower lows are followed by a
high above the high of the last bar. This
simple pattern is called the “3L-R“ (three
lows followed by a reversal).

The 3L-R pattern can be used to enter
short-term trades. A new position is
placed at the open of the next trading
day following the confirmation of the
pattern. One of the advantages of this
type of pattern is that it can be described
in simple language. In this case:

Buy on the open if:
• yesterday’s low is lower than the

low of two days ago;
• the low of two days ago is less

than the low of three days ago;
• today’s high is greater than the

high of three days ago.

The rules above describe only the
logic of the pattern; they are not useful
trading rules by themselves. A m o re
complete trading rule must include the
market to be traded and risk-reward and
money management parameters. A sam-
ple trading rule based on 3L-R would be
to buy 100 shares of stock XYZ with a
profit target of the entry price plus 7 per-

The results of trading the 3L-R pattern on Intel using an 8-percent stop-loss
and profit target. Results shown on a per-share basis.


Source: TradeStation by TradeStation Group

The results of trading the 3L-R pattern on Dell using an 8-percent stop-loss
and profit target. Results shown on a per-share basis.


Source: TradeStation by TradeStation Group

Generic price
patterns —
patterns good for
trading everything
with a high
probability of
success —
do not exist.

Page 3

44 • September 2001 • ACTIVE TRADER

cent, and a stop-loss of the entry price
minus 7 percent.

F i g u re 2 shows the historical test
results for the 3L-R pattern on Intel
(INTC), using profit target and stop-loss
levels of 8 percent. The number of share s
traded, 100, is the same for all trades
because the object of the test is to study

the profitability of the basic pattern.
Note that other than risk-re w a rd

parameters, this kind of pattern has no
other elements that can be varied. This
avoids “curve-fitting“ a system, a com-
mon practice of tailoring trading rules to
produce excellent results on past price
data. However, fitting leads to optimized

results that often fail in real trading. That
price patterns cannot be fitted is another
advantage they have over other popular
a p p roaches such as moving average
crossovers and indicators.

The results in Figure 2 show the pat-
tern had a historical profitability of 74.14
p e rcent for the period between January
1990 and April 2001. A total of 58 trades
w e re executed; the pattern never pro-
duced more than three consecutive losing
trades and, at one point, had 13 straight
winners. Figure 3 shows the test re s u l t s
for another stock, Dell Computer (DELL),
with the same 8-percent pro f i t - t a rget and
stop-loss levels. The profitability in this
case was nearly 69 perc e n t .

Skeptics often question the robustness
of simple, pattern-based trading tech-
niques during extended declining mar-
kets. Figure 4 shows the 3L-R trades for
the period between October 2000 and
April 2001, when INTC declined more
than 50 percent. The up arrows indicate
long entries; the down arrows indicate

Of the five trades made during this

The 3L-R pattern produced several entries (up arrows) and exits (down arrows).


Source: TradeStation by TradeStation Group

Intel (INTC), daily

October November December January 2001 February March April








In some ways, technology has fooled

many traders into believing the more

complicated a trading strategy is,

the better the chances of success.

H o w e v e r, simple trading rules can

produce profitable systematic trading

approaches that are easy to understand

and execute.

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