Wednesday, December 9, 2009

Kamich, Chart Patterns

Chart Patterns by Bruce M. Kamich is the third volume in Bloomberg Press’s series Market Essentials: Technical Analysis. Kamich, a vice president at Morgan Stanley Smith Barney’s Technical Analysis Group, has written a very clear introduction to chart patterns for the uninitiated. He takes the reader on a journey from major tops and bottoms to such formations as triangles, flags, pennants, and wedges. For most of the patterns, he outlines targets as well as tactics and trading strategy.

Not surprisingly, Kamich begins his book by asking why we should study patterns. He suggests that “with so many traders and so much money going toward black-box systems and sophisticated math-driven programs to get their ‘edge,’ . . . the new edge in predicting and trading the markets should circle back to the early days of charting.” (p. 7) By way of analogy he points to the movement away from processed foods to the “old ways” of preparing food.

One of the problems with analyzing chart patterns today is that volume is elusive as it disappears from trading floors and exchanges into dark pools. So we don’t have the volume that is supposed to confirm a price pattern. “Oddly,” Kamich writes, “history may be coming full circle in that the chart books from the 1930s do not display the volume below the chart. In the 1930s, we did not have the data collection and spreadsheet capabilities of today to follow weekly and monthly volume stock by stock.” (p. 23) Kamich suggests that in the future the focus will be exclusively on price and that traders will have to adapt to the lack of volume data. For instance, they might replace the “strong volume” filter with a “percentage move” filter.

Another potentially more serious problem is that patterns may be changing since somewhere between half and three-quarters of trading volume in listed stocks is being executed by quantitative programs and algorithmic formula trading. And these programs tend to be similar. So “volume might expand when the programs perceive the same thing in the marketplace, as opposed to tape watchers and chartists watching a pattern develop and then anticipating or acting on the breakout at different points, depending on their time horizon and risk tolerance.” (p. 23)

Chart reading, Kamich maintains, “takes a bit of intuition.” (p. 8) As a result it has proven difficult to apply math and computer programming to chart reading. Although Kamich doesn’t close the door on such enterprises, he notes that humans can recognize a new pattern faster than a computer.

Kamich’s book is a perfect introduction to chart patterns, complete with some 115 Bloomberg charts. And here and there the book even provides nuggets for those who are familiar with the literature on charts. For instance, Kamich cites a rare study on the long-base pattern that found that when a stock breaks out from a base that lasts at least eleven calendar quarters the median price gain was 300%. This might be no more than a case of data mining, but then again it might turn out to have some merit.

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