Patterns are a part of life. They are the everyday recognizable groups or familiar combinations. Our whole universe is pattern based from DNA to different electron groupings to galactic structures. Patterns of letters and words can also create an infinite amount of written thoughts. They can be even be found on any price chart, but using them as a predictive tool might be as difficult as judging a book by it's cover.
41,000 3-Bar Patterns
Our focus is on the markets, any market, any time-frame. Chart Patterns shouldn't be difficult to identify. We've spent our whole life practicing variations of this life/art form. Are they really important or just a man-made convenience? Which part of the cause and effect equation do they represent? Obviously, to use them to our advantage, some should be more important than others. Any analysis should be application oriented and our goal is to improve our financial bottom-line. Will patterns hit the mark or be just another myth.
Learning how to read a chart should start at the Bar-to-Bar level. The 2 basics are their relative position to each other and how they were formed. Dissecting the bars to look at the top and bottom halves can also be quite informative. We will start by creating one matrix for the Bar to Bar relationships and another for the Bar Construction, that is how a bar was created. With just these 2 elements, over 41,000 distinctive 3-Bar Patterns can be identified.
First, The Bar-to-Bar matrix starts with a reference bar. Any type Hi-Lo bar will do. (the any-type-bar is next to the any-key on the keyboard). From bar 1 to bar 2 the 2nd Hi is either obviously higher or lower. If not clear, people will say its about the same, so we'll call it "even". The same thing is now applied for bar 2 to bar 3. The illustration below shows just the top half of the bars. The same should be done for the bottom bar halves.
The symbols used are H = higher L = lower and E = even. Starting with the reference bar #1, the next 2 bars HI's are either: (see figure 1 below)
Figure1
The lows are done the same way. There are 9 different ways the Hi's come in and also 9 for the Lo's. So here is a 9 X 9 matrix or 81 combinations.
The next part shows how each bar was created. Either the Hi came first or the Lo did. The smaller time frame bars, which ours are made from, can actually be double, triple tops and bottoms, with all kinds of intra-bar retracements etc. Therefore for simplicity, we will consider only 1 Hi and 1 Lo per bar.
To see in general how a bar was created, take any daily chart for example. Draw a box around each consecutive 5 bars and note the Hi, Lo, Open and Close. This is what that weekly bar would look like. In some, the Hi's are made first and some the Lo's. Of course in some you got your doubles and triples and so on, but this is a simplified version.
A bar will be identified by which extreme it hits first. One
that makes a Hi first will then have to make its Lo. This is
called a Top bar (T). A Bottom (B) bar makes the Lo then its Hi.
So each group of 3 bars will be
called by which extreme each bar hit first. They 8 possibilities
are:
TTT, TTB, TBB, TBT, BTT, BTB, BBB, BBT.
In the real world, the brain does more "best-fitting than we
realize. So, if a bar doesn't Open or Close at the Hi part or Lo
part of the overall bar, we make a judgement that it was
"sorta at the middle". Breaking a bar into thirds
accomplishes the same type of divisions. This "sorta in the
middle" guy will be called a Middle (M) bar. If a bar opens
around the middle, it will then hit the Hi or the Lo next
followed by the other bar extreme. Therefore the possibilities of
each of the bars are:
TB, BT, MTB, MBT - just for the Open Hi and Lo
TB = opens at Top, went to Bottom
BT = opens at Bottom, went to Top
MTB = opens in Middle, made Top, went to Bottom
MBT = opens in Middle, made Bottom, went to Top
TB BT TBM BTM - just for the Hi, Lo and the Close
TB = made a Top, closed at Bottom
BT = made a Bottom, closed at Top
TBM = made a Top, went to Bottom, closed in Middle
BTM = made a Bottom, went to Top, closed in Middle
Putting it all together, ONE bar can do (at least) 1 of 8 ways
as follows:
TB, BT, BTM, TBM, MTB, MBT, MBTM, MTBM - for Open, Hi, Lo and
Close.
After 3 bars, you have 8 * 8 * 8 or 512 possibilities of how
3-Bars can be created. Multiplying that times the 81 Bar
Relationships will equal 41,472 3-Bar Patterns. (4-Bars =
3,000,000 5-Bars = about 1/4 billion).
THE 8 WAYS OF BAR FORMATION - Showing the Open, Hi, Lo and
Close (See figure 2)
Figure 2
The above variations are only of a simple type. Other influences for this exercise could also include Bar Size or True Ranges.
OPPOSING VIEWS
Patterns are conveniently attractive and have inspired Pattern Finding software, studies on bar ranges, breakouts and different time frames. All of which can be easily found.
You must Believe what you see as it is, and not because of the myriad of chart forms and shapes try to justify your convictions. One person can't wait to buy what someone else is glad to sell. Isn't that what makes the markets merry-go-round. The "pattern anticipator" traders play with an open hand and are always leaving their markers all over the charts.
If the markets (and life) are different types and levels of patterns on and on, why go hunting historically to find more, when the obvious ones are not understood yet. From a probabilistic view, the predictive value of what "might happen" must be more than pre-historic in every sense. It must first answer the question of WHY should it work, but if analyzed out of context from the larger pattern, the value greatly diminishes. Are the other patterns,which do not conveniently combine into common shapes, really less important or just more difficult to simplistically categorize.
Going with the trend is accomplished by identifying a different set of patterns. The same goes for non-directional trends and "discontinuances of direction". We gotta "go with the flow" and deal with Whatever the markets throw at us all the time. If we make the effort and look a little closer, maybe we'll find something basic to ALL patterns. Possibly The REAL clues on the bar charts are not the obvious finds but what causes them.
Ken T. /\/\/\ + \/\/\/ = -----------
MARKETREE - c1994