Latest issue of Technical Analysis of Charts and Commodities (May 2009), has a very interesting article titled “Do the chart patterns still work?”. It is written by Thomas Bulkowski, author of “Encyclopedia of Chart Patterns” and couple of other books. One could say he is an expert on the subject. He conducted a study of almost 14, 000 chart patterns from 1991 to 2008. Following patterns were used: diamonds, double and triple tops and bottoms, triangles, wedges, rectangles and head and shoulders variations. Author used daily chart data for his study, and I believe only stocks were used. Study was divided into two groups, breakouts to the upside and to the downside.
I don’t want to get into extreme details of the article, but the finding was interesting. According to author, reliability of chart patterns has fallen measurably over the years. While the success rate would be different for each pattern and trade direction, the group as whole is less reliable than it was in the earlier years of the sample data used for study. For example, pattern breakouts to the downside experienced about 90% failure rate in 13 out of 18 years. This is an average for all the formations mentioned earlier. No information is provided about how well (or bad) did individual patterns do. While these results were obtained using stock charts, I strongly suspect that if one did a systematic study of currencies, outcome would be very similar. For more info see the article
As I mentioned it many times before here, I don’t trade these kind of chart formations. They are never identical and virtually every time some degree of subjectivity must be used when recognizing and trading them. Head and shoulder is about the only generally recognized chart formation I bother with, but even then I don’t draw the “neck line”, just play of the highs/lows. In other words, if it is not a straight line (parallel) I don’t trade it.
Speaking about my trades, I closed the one in NZD-JPY from few days ago.
It was closed about 12 hours ago, when Asian session got quiet. There had no been too much noise to begin with. On this chart it looks like price is starting to put the top in, so I exited the trade for 65 pips gain. Short of objective, but in light of what happened next I think it was a right decision. Price made another high but is in a consolidation phase now. I’m sure yen pairs will be revisited soon.
Order from yesterday was not filled, price moved the other way. It remains on the books for now.
Here is a 4H chart of CAD-CHF. I want to buy it of a move above 0.9662, with a target of 0.9900. No rush, this can easily take a week or two to happen. As a matter of fact I will probably need to use daily chart next time it is reviewed. Also, additional buy might be considered if price drops to under 0.9500, but this will depend on how busy I am at the time and the way chart looks. After all, due to statistically high probabilities for failure I will have to avoid triangles, rectangles, wedges, flags, pennants, coils, springs, scallops, pipes, horns….
Mike K.
In that study, what was considered a failure and what success? Is it possible that pattern trading is a waste of time?
There were 3 levels of used to determine failure or success, price appreciation of 10%, 20% and 40% after the breakout. Is pattern trading a waste of time? Author, an expert on patterns, didn’t reach that conclusion.
What does this study prove? That patterns are not reliable and shouldn’t be traded?
Stock data was used for the study in article and only daily. Those charts have a lot of gaps in them, while forex charts don’t. Would that have any influance on effectivness of the very same chart formations on currencies?
Study doesn’t prove or disprove anything. It indicates that over last couple of decades patterns have probably become less reliable.
Heather, I’m sure that Forex results would be a little different. For me of note is the fact that over time these chart patterns have been loosing reliability. However, this will not last forever. Once they start being used in the opposite way, they will start becoming more reliable in traditional sense again.
Mike, what kind of returns are getting trading full time? And what do you think would be reasonable for somebody to expect after 1-2 years of trading?
Thomas, this is just part of my total activities, so not really indicative about total returns. As far as expectations, well, once you prove to yourself that you in fact make money, than your goals should be proportionate to the risks you are willing to take. I will not give you a number. You should use your discretion, but returns better than S&P 500 are certainly possible.