Testing the Engulfing Candle Pattern - Daily

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dasenbrj

I am working on a little project here. The basic issue is: how useful are these patterns?

Overview: I am defining a bearish engulfing reversal as the current open being greater than the previous close, and the current close less than the previous open. I am only considering these in markets where current prices are in a trend higher, and the previous day was an up day. I am posting this in hopes that someone will check my process in coming to my conclusions.

What I have so far:

The bearish engulfing reversal:


  • Filter for bullish trend condition: the current closing price is greater than the trailing 15SMA of closing price

  • The previous day was an up day

  • Current open greater than previous close

  • Current close less than previous open
Definition of a winning engulfing reversal:

  • If the lowest price over the next ten trading days is lower than the close of the engulfing reversal day by one standard deviation (trailing ten day.)
  • A non winning engulfing reversal is one which does not meet this condition
Preliminary results:

  • According to these metrics, the pattern wins 63% of the time
    This is over 515 instances of the pattern in a handful of different stocks.
    Therefore about 324 of these instances were profitable.
Result:

  • The logic defined above for a winning position gives similar results over all of the data points... implying that the engulfing reversal is not any different from any other random trading day.

I am not sure what I am doing wrong... or if I am doing anything wrong.

It seems possible that the pattern would win 63% of the time, but is it really possible that on any random trading day, there is a 63% chance of the market trading lower by one standard deviation? This would mean that the pattern is totally, 100% useless, and that other comparable patterns are also 100%, totally useless. Futher more, it may be a reasonable strategy to short sell any random stock on any random day with a limit to exit the trade after the market trades lower by one standard deviation...

In a standard normal distribution, 68.3% of the observations will be within one standard deviation of the mean.... is the short term stock market just a standard normal distribution?

Attached is the Excel Logic for my tests, right click and "Save As" to download.

Thanks for your time...
 
Along with the H&S pattern in which you were interested, you are learning some important truths at an early stage in your development. You are also relying on your own investigations rather than follow somebody or other without verifying their claims.

All good. Stay the course.
 
dbphoenix said:
Along with the H&S pattern in which you were interested, you are learning some important truths at an early stage in your development. You are also relying on your own investigations rather than follow somebody or other without verifying their claims.

All good. Stay the course.
More...

Thank you very much.

In a standard normal distribution, 68.3% of the observations will be within one standard deviation of the mean.... is the short term stock market just a standard normal distribution?
 
athlonmank8 said:
Something can work 30% of the time and still be profitable. Expected Win vs Expected loss
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Agreed. If the stock market in the short run is just a standard normal distribution why not just enter random trades, cut losses quickly and let profits run?
 
dasenbrj said:
Thank you very much.

In a standard normal distribution, 68.3% of the observations will be within one standard deviation of the mean.... is the short term stock market just a standard normal distribution?
More...

Now here I am showering you with praise for your efforts at independent verification and you ask me a question like this. :)

Members could argue for several dozen/hundred posts about whether your question deserves a yes or a no, and probably will, but a more interesting question might be why you want to know. You've been at this for four months. Are you gathering data for a trading plan? Do you want to take a mechanical/mathematic approach? Why are you interested in the market at all?

Which isn't what you expected, but your question is much like Can I get rich trading stocks? And the answer would be yes. The answer would also be yes to Can I lose everything I have trading stocks.
 
dbphoenix said:
Now here I am showering you with praise for your efforts at independent verification and you ask me a question like this. :)

Members could argue for several dozen/hundred posts about whether your question deserves a yes or a no, and probably will, but a more interesting question might be why you want to know. You've been at this for four months. Are you gathering data for a trading plan? Do you want to take a mechanical/mathematic approach? Why are you interested in the market at all?

Which isn't what you expected, but your question is much like Can I get rich trading stocks? And the answer would be yes. The answer would also be yes to Can I lose everything I have trading stocks.
More...

I am doing basic research. I do trade my own account, global macro analysis with a simple trend following overlay. Fundamental factors drive the prices, and technical analysis can aid in making short term trading decisions (at least that is the hypothesis I am testing.) I am very much a developing trader, and I think the best way to progress is to trade and learn continually. My goal is to eventually have the skillset to profitably trade my account in this manner and make an excellent living.

To your point "why would I want to know," if I knew with a high degree of certainty that in the short run the markets are just a standard normal, and that Technical Analysis is useless, I would just make short term trading decisions based on that concept, throw all forms of TA out the window, and focus my time on global macro fundamental analysis. I'm trying to sort out what is useful and what is people seeing "bunnies in clouds."
 
dasenbrj said:
I am doing basic research. I do trade my own account, global macro analysis with a simple trend following overlay. Fundamental factors drive the prices, and technical analysis can aid in making short term trading decisions (at least that is the hypothesis I am testing.) I am very much a developing trader, and I think the best way to progress is to trade and learn continually. My goal is to eventually have the skillset to profitably trade my account in this manner and make an excellent living.

To your point "why would I want to know," if I knew with a high degree of certainty that in the short run the markets are just a standard normal, and that Technical Analysis is useless, I would just make short term trading decisions based on that concept, throw all forms of TA out the window, and focus my time on global macro fundamental analysis. I'm trying to sort out what is useful and what is people seeing "bunnies in clouds."
More...

Given your reference to bunnies, you probably know that I've pointed out that TA is primarily the study of price behavior and that the pattern and indicator stuff came much later. Therefore, is TA useless? No. Is throwing all forms of it out the window productive? Some forms, yes. Others, no.

As to the random entry thing, there are tons of threads about that and nothing is preventing you from reading them. But, no, the markets are not random and, no, a random entry plan won't get you very far (and by "plan" I mean a thoroughly-tested and consistently-profitable plan, not just making random entries all day long and hoping for the best).

Mixing fundamentals and technicals is a formidable task, particularly for the short term since fundamentals have so little to do with short-term movements. You may want to borrow a page from Wm O'Neil's playbook and select your universe from stocks that meet your fundamental requirements and use technicals to determine when to buy them.
 
dasenbrj said:
I am doing basic research. I do trade my own account, global macro analysis with a simple trend following overlay. Fundamental factors drive the prices, and technical analysis can aid in making short term trading decisions (at least that is the hypothesis I am testing.) "
More...

Have you read 'Soros on Soros'? You may find value there, considering how he stresses incorporating 'Price Action' into validating a fundamentals based thesis.
 
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