Trade Ideas Blog

Don’t be Fooled by Pattern Recognition

May 11, 2012

The Lure of Pattern Recognition (Be Very Careful)

Everyone who is in the market is looking to do the same thing, make money.  Institutions and hedge funds call this “alpha”.  The game of Making Money is a very competitive environment.  When you place a trade you are competing with highly funded well staffed opponents.  The efficient market hypothesis says that you can’t beat the market because all available information is already available and in the market (http://en.wikipedia.org/wiki/Efficient-market_hypothesis).

Individual investors typically have zero access to advanced computer models so they rely on the one thing that is available to them for free, intuition.  They they look at charts, draw trend lines, and infer patterns to make investment decisions.  The problem is that there is a large amount of scientific evidence that suggests our brains are wired poorly for this type of visual analysis. Consider the case of eye witness testimony.

False Misidentification http://snitkof.com/cg156/eyewitness.php

Alarming statistics state that in 2000, of 62 cases that involved the conviction and imprisonment of individuals for felonies, 52 of them-including 8 of them that had death sentences-involved mistaken eyewitness identifications. These individuals were later acquitted of these charges with the use ofDNA testing.


Double Bottoms, Triangle Tops, Head and Shoulders, Support, Resistance, Waves, all of these terms are used to describe price action of a stock.  The problem is that when you see it, you are looking at an instance and then extrapolating a pattern.  You have no idea how many other stocks are doing the same thing and what is the actual post observational result of the price pattern.  If you had the data you would see that most likely you are not seeing any kind of pattern at all, but rather your eyes are just attracted to creating recognizable shapes.  It makes you feel comfortable and says, “Hey I know what is going on right now.”  versus the actual which is you have no statistical proof of any kind of pattern whatsoever.
Much like the DNA evidence that is used to exonerate wrongly convicted felons, Trade Ideas servers watch every trade of every stock and baseline activity to identify if any pattern exists.  So here is the high level truth about patterns.  Most of the things you see when you look at a chart have no value at all.  Patterns exist as windows of opportunity that open and close.  You have to know when one is present to take advantage of it.

Trade Ideas users don’t have to read the tea leaves and guess patterns.

Trade Ideas technology is by far the best piece of technology to help you identify when this window of opportunity is present. This post is the first in a series from Trade Ideas highlighting the importance of leveraging technology in the right way to truly capture alpha and not getting misled or distracted by the noise of a chart or your gut.

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