Trade Ideas Blog

Baader-Meinhof Phenomenon & Patterns

Nov 28, 2012

You know when you stumble upon some obscure piece of information (like you learn a new word) and then afterwards you encounter it over and over?  Apparently there’s a name for these seemingly amazing coincidences: The Baader-Meinhof Phenomenon.  It turns out our brains are hardwired for pattern recognition.  In fact, we often place too much importance on repeating patterns.  With so much data flying around, it would be surprising if we didn’t find “patterns” that on the surface look significant.  Humans are full of biases (for example, a ridiculously large percentage of people think they’re above average drivers), so here’s another one to add to the list.

So what does this mean for us as traders?

It means we should be skeptical of chart patterns we think we see or the “sure fire” trading strategies that some guru is promoting.

Cup & Handle?

This is what makes backtesting so powerful.  Instead of relying only on what we think we see or the dozen or so charts we’ve reviewed for “patterns”, we can backtest our theories and see what the data actually says.  Traders who are new to backtesting are often disappointed that their theories don’t immediately pan out, but backtesting lets you delve deep into your ideas and with some practice you’ll end up with more reliable and robust trading strategies.

The OddsMaker backtest results

Visit the Strategy Development section of our website to learn more about our backtesting tool, The OddsMaker, and our unique Execution Consulting services.