Pattern Recognition & Trading Decisions

Author's Notes

Markets are like life:  both are uncertain and complex but capable of being described in a number of simplified ways; which may not always be in agreement.  The community who trade the markets include those who look for "under-valued" stocks, those who believe that price alone gives them enough information for market decisions, and psychologists attempting to peer into the collective mind of the market to find a trade.  Human nature being what it is, proponents of these individual schools tend to imply that their school alone has a monopoly on market truth.

The question raised by this book is:  what knowledge is needed to exploit the markets effectively?  In answering this question I have turned to a little-known mathematical theory that proves that a portfolio of similarly effective models with uncorrelated errors provides a more accurate answer than that of any individual model.  The theory is not unlike one developed for investment portfolios and its underlying result can be articulated as:  do not invest all your credence in a result from a single school of market exploitation, but seek effective and uncorrelated views - i.e. don't put all your decision-making eggs in one basket.

Turning now to the original question of what knowledge is needed to exploit the markets effectively: one answer could be an effective knowledge of any school;   but portfolio ideas described above suggest a better answer lies in combining knowledge of every uncorrelated effective school .

The next question is:  how does a person obtain such a multi-perspective approach?  Market literature tends to be polarised by the different schools, which makes it hard for newcomers to sift through conflicting absolutes to make their own choices.  For the would-be trader or investor, reading specialised market literature can produce an "archipelago" effect in that the literature tends to offer islands of knowledge but not the connections between them.  This book represents an attempt to offer newcomers a working knowledge of a multi-perspective approach to market decisions.  My hope is that it will also offer the background needed for a better appreciation of specialised market literature. 

The book is organised in four parts: the first three providing background in the markets and the differing schools of thought for their exploitation, and the fourth attempting to bring these ideas together.  The first part consists of market instruments, psychology and decision theory;  the second an introduction to fundamental analysis;  the third, technical analysis;  and the fourth, trading decisions.  In attempting to offer this breadth of coverage the book is unusual;  but this coverage is needed if its principal objective of offering a multi-perspective approach to the markets is to be achieved.  Such a perspective also offers a basis for the selection and appreciation of other market literature.

The book's cover has supportive endorsements from the well-know author and technical analysis guru, Martin Pring, and Merrill Lynch's (NYC based) Technical Strategist Director, Don Kapetanakis.  I would like to thank both gentlemen for their support, and point out that in giving it, they offer an example of open-mindedness that both potential readers of the book and others who hold positions of respect in the markets might want to be aware of.

The book's accompanying CD-ROM contains PC software needed to implement some of the ideas and formulas described.  Subsequent articles featured here are intended to help readers get greater value from software and data.  Currently, this web page hosts specific articles to help users with the programs Indicators.exe and Portfolio.exe.  These are likely to be amended and complemented with companion articles as more feedback is received.

A major part of the CD-ROM consists of trading pattern material kindly contributed by Recognia Inc. Many examples of trading patterns in portable document format (.pdf) are found in the CD-ROM's directory "Patterns" and named according to the pattern of interest.  In one or two cases I use abbreviations;  e.g. the file HSTop.pdf has examples of head and shoulders' top patterns.  Also included is Recognia's educational material, which can be found in the "Education Center" sub-directory of "Patterns", by clicking on Index.html.

The CD-ROM also has a number of files on companies and associated commercial activities that are best viewed with spreadsheet software, such as Excel.

If the CD-ROM's installation program partially disappears off the screen, please note that the screen resolution needed is XGA (1024 x 768 pixels).  Some old computers may not have this screen resolution but the vast majority of computers currently in use do.  If needed, screen resolution can easily be reset.  Consult the "Windows" help facility if there is any difficulty.

Preparing Data Files to Use "Indicators.exe"

The .cmx data format required by Indicators.exe was originally developed to investigate the performance of futures trading systems. It contains futures–specific fields in respect of open interest and delivery month that are not required for stocks...

full article on preparing data

Preparation of Returns Data for Portfolio Program

The file Returns.txt in the CD-ROM that accompanies the book is derived from a trading system. For such systems, particularly with futures, capital to be allocated can be quite difficult to calculate and the return on that capital equally so...

full article on preparing returns data