Knuth - Trading between the lines: pattern recognition and visualization of markets

Contents

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Copyright 2011 by Elaine Knuth. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Knuth, Elaine.

Trading between the lines : pattern recognition and visualization of markets / Elaine Knuth.

p. cm.(Bloomberg financial series)

Includes bibliographical references and index.

ISBN 978-1-57660-373-4 (cloth); 978-1-118-04315-8 (ebk); 978-1-118-04316-5 (ebk); 978-0-470-87911-5 (ebk)

1. StocksCharts, diagrams, etc. 2. StocksPricesCharts, diagrams, etc. 3. Technical analysis (Investment analysis) I. Title.

HG4638.K58 2011

332.63'2042dc22

2010053522

To Alexander

To the memory of my Parents

Preface

This book is more than a mere how-to guide to trading strategies. It is about conceptualizing price behavior so we can more easily recognize price pattern structures with predictive character to build our own trading tactics. Rather than finding discussions of patterns that work, the reader will learn to recognize a pattern and build speculative trading tactics.

Before covering specific patterns, Chapters 1 and 2 challenge us to think about how we perceive our surroundings and what drives price and perception of price. Only with this can we then begin to think about what pattern recognition means, and how we can use the tools of pattern recognition.

Each pattern concept and constellation of a series of patterns throughout the book is first explained (framed) in a metaphor that fits the idea of the pattern. When reading about the lightning bolt pattern , for example, we first think about what conditions create lightning in the real world, and then within the context of this metaphor the pattern is described. Or when reading about the Icarus pattern , we first learn about what lead up to the mythological flight of Icarus. Beyond being simply a pattern name and description, the use of metaphor helps us better understand the concept behind a pattern. It is my hope that the reader will then adopt this method in visualizing and identifying additional predicative patterns for his or her own trading.

Readers will notice something else unusual to books on trading. There are few indicators on the charts throughout the book. This is deliberate. To keep a focus, charts are intentionally kept as simple and concentrated on price only as possible. Indicators are limited to occasional use of exponential moving averages, momentum, and an example of Wells Wilders Average True Range (modified from his 14-period to a 20-period range). Our foremost purpose is consideration of price and pattern for analysis over indicators that are derivatives of price.

A reader might also ask, Why does Don Quixote from Cervantess The Ingenious Hidalgo Don Quixote de la Mancha appear throughout a book on market visualizations and patterns? This literary work is episodic with a succession of events, much like the markets we are examining. Don Quixote was a sane madman who roamed the Spanish countryside as a knight errant. He was adorned from head to foot with ridiculous armor and weapons in search of new and random adventures, prepared to battle against giants and evil (mostly in his imagination). He did all this for the rewards of recognition, honor, and the embrace of the lady love of his thoughts, Aldonza Lorenzo, or the name he conferred to her, Dulcinea del Toboso (a figure we never encounter as she is become, the Holy Grail of his mind). I found it fitting that our sane madman along with his wise fool, Sancho Panza, accompany us as we look closely at the patterns of market episodes.

Acknowledgments

There are many whom I would like to thank and it is simply not possible to name everyone. Those I can include here are Guido Riolo, who first suggested that I might incorporate some of the ideas we had been discussing into a book, and Stephen Isaacs of Bloomberg Press, who found the project worthy. I thank Emilie Herman of John Wiley & Sons, who encouraged me to write with any approach I felt would work, unconventional as it may be; and Jennifer MacDonald and Stacey Fischkelta, whose energy, patience, and encouragement kept me on track throughout the project. I also wish to thank so many colleagues, from all over the globe, who, over the years and many discussions on the nature of open markets, pricing, and patterns, gave impulse to some of the ideas this bookincluding most recently ideas shared and debated with Irfan Polimac. Additionally, I must thank AQX Securities AG for tolerating late nights and weekends in their offices to see this project through. I am grateful for the technical help I received from Michael Krieger, who advised me on making sure that the charts and figures used throughout the book are of the highest quality possible; and to Lyle Andrews, as the 3-D visualization examples were generated from his fascinating product, Metaview.