In the last three days there is indecision in stock market price action with the S&P 500 forming an interesting pattern of inside/outside days. Although this particular pattern indicates a small bullish bias, careful analysis shows that it is actually what it is, a random formation that reflect indecision.
Below is the S&P 500 chart with the inside/outside pattern formation marked:
The pattern is formed by three bars, the second bar is inside the first and the third is outside the second but also inside the first.
We identified this particular pattern with the scan function of DLPAL (for details contact us).
P is the win rate, P1 is the 1-Bar win rate, Trades is the number of historical trades, CL is the maximum number of consecutive losers and Target and Stop the values of the profit target and stop-loss. C indicates the type of target and stop-loss, in this case it is a percentage added to entry price that is shown under Trade On as the open of next bar.
As shown above, this pattern has occurred 43 times since 1960 and for 2% profit target and stop loss it has been profitable 55.81% of the time.
Further analysis will show that in the case of exit at the close of the next bar, the win rate drops to 52.27%.
Below we use the portfolio backtest tool of DLPAL to test this pattern on a portfolio of all S&P 100 stocks since inception (current composition.)
The Last and First Date columns in the original results are replaced by the portfolio expectation and success rate (the fraction of profitable stocks) and the P1 column is replaced by the portfolio profit factor, i.e., the ratio of the sum of winners to the sum of losers.
It may be seen that the win rate of the portfolio drops to 51% and the pattern is profitable in 53% of the stocks. These results show that although there is a long directional bias it is small to cover transaction cost and it is there probably due to the longer-term upward bias of the stock market.
More importantly, the bias is very small for discretionary trading anyway. Even if it was much larger, it would make sense only in the context of longer-term averages.
The conclusion is that this indecision pattern in the last three days is what it is, a price action formation that reflects indecision and nothing else. Anyone who sees some potential in this pattern is fooled by randomness.
If you have any questions or comments, happy to connect on Twitter: @mikeharrisNY
Charting program: Amibroker
Pattern analysis software: DLPAL
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