Thursday, May 8, 2014

Profitable Patterns: #JBFC

ChartDNA offers two approaches to market analysis. The first is to analyse a pattern found in an asset, as a means of predicting what may follow. This could done for an index, or a stock in your portfolio.  In this case, you are looking at the most recent 4 to 10 bars traded. The second is to build profitable patterns, and then screening your pattern against a watchlist of stocks to look for new trading opportunities.  ChartDNA supports over 7 million combinations of patterns, in addition to different match strengths, offering a rich diversity of opportunity.  We at ChartDNA will be regularly providing new patterns for users to try, saving time and effort for you.

Sometimes, the two aspects come together, as happened today.  Today, the $SPY exhibited a 4-day sequence #JBFC.  This pattern offered good near term prospects, and decent trade performance, making it a good screening candidate too.

ChartDNA's analysis will give you trade statistics and a five-bar forecast. You can look at the values on a mouse rollover of the histogram.  The relative height of the histogram bars, red and green, will give you an indication of the best way to trade it: higher green bars suggest it may be a better long trade, higher red bars, a short.

ChartDNA calculated the probability for a higher close using the open price of the first bar ("Day 1") after the pattern completes. This is because the earliest time you could act on a pattern, is the bar after it completes. So in the case of the "Day 1" probability, you are actually looking at the probability for a higher close on the entry bar (or same day bar).

With the help of Excel, we can take the forecasting a little further.

In the example below, I have used the rollover process to grab the % probability for a higher close for each match strength of pattern #JBFC, and given the results in the table below.  The "Trade" statistics use a 15% limit target with a 5% stop, the 'Return' is in effect the average return of all closed trades; winners and losers combined.

This analysis is based on historic occurrences of the pattern within a watchlist of stocks, in this case, 481 components of the S&P, over the past year of daily data. We recommend using your own watchlist of stocks, with at least 100 components to give you a robust enough match of patterns to analyse.

In the case of #JBFC, the first day probability is an effective coin-toss, but as the days progress, the probability of a higher close increases. Crossing above 60% chance of a higher close in the case of a Strong match by Day 4. This is best illustrated on a chart.

As a trader, you can use this information to enter trade with a certain level of confidence that it's going to progress in your favour; in this case, you would be looking to trade pattern, #JBFC, as a long position.

From there, you can use the % Target and % Stop parameters to tailor the risk:reward for the pattern. The 15% limit and 5% stop generated good returns per trade (again, only closed trades were considered).

The final step is to find stocks exhibiting this pattern, and apply the Target/Stop strategy.

We have a head start in the above example as this is the current pattern for $SPY, so we would be looking to buy today's open and apply the % Target and % Stop to the open price.

However, you can also switch to the Signal tab, and look for other equities from your watchlist, exhibiting this pattern.  Note, the pattern match may have been in the past, which means the stock will have moved on from the initial entry; either reducing (if it has moved higher), or increasing (if it has move lower), the profit potential of the trade.  Note, if the stock have moved lower it's probably going to hit its stop, so it may be better to focus on stocks which have already moved higher from the Entry.

Here are a list of stocks which matched to #JBFC

If you click the 'eye icon' you will load a chart with the pattern highlighted with a vertical coloured red or green bar.  You can then roll your mouse over the highlighted bar to get the limit and stop price used for the trade. It's these stop and limits which are used to determine the success of a pattern.

Happy Hunting...

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