A recent failure of an island reversal pattern in the chart of the 10-Year Note yield adds to a long list of failed chart patterns in the last few years and reinforces claims that they are random formations. In the era of deep learning, trading with chart patterns is like taking a horse to a car race.
The chart below shows the failure of the island reversal pattern in 10-year Note yield chart:
It is common sense for most traders nowadays that no one can profit from such random formations.
The idea that chart patterns have some forecasting power has served well the purposes of market makers and locals in finding counter-parties to squeeze out and profit from. These market professionals had many reasons to finance the books and magazines where these patterns were presented.
Some brokerages still offer chart pattern scanners. In the 1990s, a book on chart patterns would receive multiple offers from publishers and a large advance would be paid to the author. Now it is understood by most that these patterns are random and manuscripts for related books are rejected while aspiring authors do not even get an email reply. Yet, these random chart pattern formations have found their natural place in social media and YouTube, where millions of messages that attribute to them some forecasting power are posted daily and hundreds of new videos are made every week to teach new traders things such as the head and shoulders, triangles, island reversals and wedges, among other random patterns.
As long as this continues, professional quant traders have a chance of making money from other traders who believe that these formations can say something about the future, even when combined with some form of naive confirmation and risk management.
In quant terminology, chart patterns were an attempt to use lossy compression, a method borrowed from information technology, to forecast market direction. The net effect was a massive wealth-redistribution from chart traders to specialists and locals over the years. More information can be found in this article:
Of course, some will claim they are successful trading with them. Obviously, given a large population of chart traders, some will be successful by chance or due to other factors, including but not limited to a talent in gauging price action. This is not the subject of this article.
A more detailed explanation about the random nature of chart patterns with several recent examples of failures can be found in my book, Fooled By Technical Analysis.
If you have any questions or comments, happy to connect on Twitter: @mikeharrisNY
Charting and backtesting program: Amibroker
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