TRADING Strategies

KEEPING IT simple
While software packages that provide the latest bells
and whistles are fine, they sometimes obscure the
benefits of a simple trading approach.

Short-term strategies based on price patterns are a

FIGURE 1 THE 3L-R SETUP
robust alternative to complex indicators and formulas. The 3L-R pattern consists of four
daily price bars.

BY MICHAEL HARRIS ware programs that allow you to design,

3
test and execute trading strategies. The
multitude of indicators, pre-packaged
trading systems and technical analysis
2
tools these software platforms offer are

P
of great benefit to the trading public, in
that they give individual traders the abil-
ity to perform research and analysis pre- 1
eople often underestimate viously in the domain of financial insti-
the effectiveness of simple tutions.
trading methods, focusing However, this access to technology has
more on advanced tech- a downside. In some ways, it has fooled
niques — in essence, equating complexi- many traders into believing the more
ty with profitability. complicated a trading strategy is, the bet-
Part of the problem is our fascination ter its chances of success. This is not nec-
with technology. There are many soft- essarily the case. We will show that sim-
ple trading rules have real value and can
TABLE 1 DAILY BAR LABELS result in profitable systematic trading
approaches that are easy for all traders to
Bar number Description implement and execute.

0 Today
1 Yesterday Figure 1 shows a price pattern formed by
four consecutive daily bars. The bars are We are not concerned with all price
2 Two days ago numbered from 0 (the most recent bar) to 3 points (open, high, low, close) for each
(the most distant bar). The most recent bar bar: For bar 0, only the value of the high
3 Three days ago
is also referred to as “today,“ bar 1 as “yes- is important; for bars 1 and 2, only the
terday“ and so on, as shown in Table 1). lows; for bar 3, both the high and low.

42 www.activetradermag.com • September 2001 • ACTIVE TRADER

 This is because the objective of this four-
FIGURE 2 3L-R: TRADING INTEL day pattern is to determine when three
The results of trading the 3L-R pattern on Intel using an 8-percent stop-loss consecutive lower lows are followed by a
and profit target. Results shown on a per-share basis. high above the high of the last bar. This
simple pattern is called the “3L-R“ (three
lows followed by a reversal).

Generic price
patterns —
patterns good for
trading everything
with a high
probability of
success —
Source: TradeStation by TradeStation Group
do not exist.
FIGURE 3 3L-R: TRADING DELL
The results of trading the 3L-R pattern on Dell using an 8-percent stop-loss The 3L-R pattern can be used to enter
and profit target. Results shown on a per-share basis. short-term trades. A new position is
placed at the open of the next trading
day following the confirmation of the
pattern. One of the advantages of this
type of pattern is that it can be described
in simple language. In this case:
Buy on the open if:
• yesterday’s low is lower than the
low of two days ago;
• the low of two days ago is less
than the low of three days ago;
• today’s high is greater than the
high of three days ago.

The rules above describe only the

logic of the pattern; they are not useful
trading rules by themselves. A more
complete trading rule must include the
market to be traded and risk-reward and
money management parameters. A sam-
ple trading rule based on 3L-R would be
to buy 100 shares of stock XYZ with a
Source: TradeStation by TradeStation Group
profit target of the entry price plus 7 per-

ACTIVE TRADER • September 2001 • www.activetradermag.com 43

 FIGURE 4 3L-R: BACK-TESTING INTEL
The 3L-R pattern produced several entries (up arrows) and exits (down arrows).

Intel (INTC), daily

50

45

40

35

30

25

20

October November December January 2001 February March April

Source: TradeStation by TradeStation Group

In some ways, technology has fooled

results that often fail in real trading. That
many traders into believing the more price patterns cannot be fitted is another
advantage they have over other popular
approaches such as moving average
complicated a trading strategy is, crossovers and indicators.
The results in Figure 2 show the pat-

the better the chances of success. tern had a historical profitability of 74.14
percent for the period between January
1990 and April 2001. A total of 58 trades
However, simple trading rules can were executed; the pattern never pro-
duced more than three consecutive losing
trades and, at one point, had 13 straight
produce profitable systematic trading winners. Figure 3 shows the test results
for another stock, Dell Computer (DELL),
approaches that are easy to understand with the same 8-percent profit-target and
stop-loss levels. The profitability in this
case was nearly 69 percent.
and execute. Skeptics often question the robustness
of simple, pattern-based trading tech-
cent, and a stop-loss of the entry price the profitability of the basic pattern. niques during extended declining mar-
minus 7 percent. Note that other than risk-r eward kets. Figure 4 shows the 3L-R trades for
Figure 2 shows the historical test parameters, this kind of pattern has no the period between October 2000 and
results for the 3L-R pattern on Intel other elements that can be varied. This April 2001, when INTC declined more
(INTC), using profit target and stop-loss avoids “curve-fitting“ a system, a com- than 50 percent. The up arrows indicate
levels of 8 percent. The number of shares mon practice of tailoring trading rules to long entries; the down arrows indicate
traded, 100, is the same for all trades produce excellent results on past price exits.
because the object of the test is to study data. However, fitting leads to optimized Of the five trades made during this

44 www.activetradermag.com • September 2001 • ACTIVE TRADER

 Using trading worksheets
to monitor price patterns

T
period, three were winners and two los-
ers. Therefore, although market condi-
here are several ways to monitor price patterns that generate trad-
tions were highly adverse, the 3L-R pat-
ing signals for the open of the next trading day. For example, you
tern strategy made a net profit, proving
can use charting software and visually monitor the pattern forma-
this simple price pattern remained
tion, or use more sophisticated software to track daily prices and generate
viable in a down market. Table 2 shows
alerts when a trading model issues a signal for a new position.
the EasyLanguage code used to gener-
A simple method traders of all skill levels can use is a trading worksheet
ate the back-testing results for the trad-
on which each of the conditions in the pattern logic are listed and evaluat-
ing model based on the 3L-R pattern.
ed on a daily basis. An example of the worksheet for pattern 3L-R is shown
below.
On the top of the worksheet, the name of the pattern, the trade input
Figure 5 shows another simple price pat-
type and the last trading day are listed. The trading rules for the pattern are
tern. Again, the bars are labeled 0 for
included, with the conditions listed separately. On the right, the stock trad-
ed is listed along with the applicable profit target and stop-loss. The values
FIGURE 5 THE GAP-2H SETUP
required to evaluate each of the conditions in the pattern logic are also list-
ed. These values are used to test the validity of the conditions and the result
The GAP-2H pattern consists of
noted next to each condition — “yes” for valid and “no” for not valid.
three daily price bars.
In the example shown here, two of the conditions are not valid and one
is. Because all conditions must be valid for the pattern to generate a trade
0 signal, no trade is taken, which is noted at the bottom of the worksheet.
A separate worksheet must be used for each pattern and stock traded,
and it must be evaluated on a daily basis. Although this is a manual method
requiring extra effort, it has the advantage of helping you maintain contact
with the markets while imposing a daily routine that enforces trading disci-
1 pline.

MONITORING PRICE PATTERNS

Using a worksheet to track and evaluate price patterns can aid your trading.

Pattern: 3L-R
Trade input: Open of tomorrow Date: 4/12/2001
Trading rule: Stock: INTC
If low of yesterday is less than low of Target: 8%
2 days ago and low of 2 days ago is Stop: 8%
less than low of 3 days ago and high
of today is greater than high of 3 days
ago then buy tomorrow on the open. Values:
Condition Valid?
2 Low of yesterday: 27.17
Low of yesterday less No Low of 2 days ago: 23.35
than low of 2 days ago
Low of 3 days ago: 22.25
Low of 2 days ago less No High of today: 28.51
than low of 3 days ago
High of 3 days ago: 24.20
High of today greater Yes
than high of 3 days ago

Result: No position

ACTIVE TRADER • September 2001 • www.activetradermag.com 45

TABLE 2 PROGRAMMING CODE FOR 3L-R PATTERN

{*****************************************************
Description : 3L-R Pattern Entry Signal
Developed By : Michael Harris, Tradingpatterns.com today’s bar, 1 for yesterday’s bar and 2
*****************************************************} for the bar two days ago. The pattern
contains a price gap from the high of bar
if l[1] < l[2] and l[2] < l[3] and h[0] > h[3] then 2 to the low of bar 1. In addition, the low
buy (“3L-R”) next bar on the open; and high of bar 0 are greater than the low
and high of bar 1, respectively.
{***************************************************** This price pattern is named “GAP-
Description : 3L-R Pattern Long Exit Signal 2H,“ indicating a price gap followed by
Developed By : Michael Harris, Tradingpatterns.com two higher highs. It can be used to take
Comments: ptarget and stopl are in percentage terms long positions in select stocks.
*****************************************************} Buy on the open if:
variables: profitprice(0), stopprice(0); • the high of two days ago is higher
input: ptarget(8), stopl(8); than the low of two days ago;
• yesterday’s low is higher than
profitprice = entryprice*(1+ptarget/100); the high of two days ago;
stopprice = entryprice*(1-stopl/100); • today’s low is greater than
yesterday’s low;
if marketposition =1 then begin • yesterday’s high is greater than
exitlong (“3L-R Exit”) at profitprice limit; today’s low;
exitlong (“3L-R Stop”) at stopprice stop; • today’s high is greater than
end; yesterday’s high.

Again, we will buy 100 shares and use

a 7-percent target for the profitable exit
TABLE 3 PROGRAMMING CODE FOR GAP-2H PATTERN or stop-loss.
Figure 6 shows the back-testing
results for Intel from January 1990 to
{*********************************************** April 2001. The profitability is around 67
Description : GAP-2H Pattern Entry Signal percent with a maximum of two consec-
Developed By : Michael Harris, Tradingpatterns.com utive losers. Figure 7 shows the results
***********************************************} for a more recent stock issue,
if h[0] > h[1] and h[2] > l[2] and l[0] > l[1] and l[1] > h[2] and Amazon.com (AMZN), using profit tar-
h[1] > l[0] then get and stop-loss levels of 5 percent.
buy (“GPA-2H”) next bar on the open; Although only 13 trades were generated
— not enough for a sufficient statistical
{*********************************************** sample — the results suggest this pat-
Description : GAP-2H Pattern Long Exit Signal tern is profitable even in highly volatile
Developed By : Michael Harris, Tradingpatterns.com stocks. Table 3 shows the EasyLanguage
Comments: ptarget and stopl are in percentage terms code used to generate the back-testing
***********************************************} results for the GAP-2H pattern.
variables: profitprice(0), stopprice(0);
input: ptarget(7), stopl(7);

profitprice = entryprice*(1+ptarget/100);
stopprice = entryprice*(1-stopl/100);

if marketposition =1 then begin

exitlong (“GAP-2H Exit”) at profitprice limit;
exitlong (“GAP-2H Stop”) at stopprice stop;
end;

This code can be downloaded at www.activetradermag.com/code.htm.

46 www.activetradermag.com • September 2001 • ACTIVE TRADER

 FIGURE 6 GAP-2H: TRADING INTEL
The results of trading the GAP-2H pattern on Intel using a 7-percent stop-loss
and profit target. Results shown on a per-share basis.

The price patterns shown here illustrate

the value of simple trading methods.
However, careful analysis should
always precede the actual application of
any trading approach. Also, as with
most trading methods, price patterns
are also more effective when applied to
liquid markets.
Generic price patterns — those good
for trading everything with a high prob-
ability of success — do not exist.
However, some price patterns seem to
generate good results for a group of
stocks. Identifying profitable price pat-
terns is difficult and time-consuming,
but that is where most of the benefit
comes from. For a pattern trader to be
profitable, a pattern must be thoroughly Source: TradeStation by TradeStation Group Inc.
tested for a variety of stocks or futures
contracts. Ý
FIGURE 7 GAP-2H: TRADING AMAZON
The results of trading the GAP-2H pattern on Amazon using a 5-percent stop-
loss and profit target. Results shown on a per-share basis.

Additional research
▼ Stock Trading Techniques
Based on Price Patterns
by Michael Harris,
Traders Press Inc., 2001.

▼ Short-term Trading
with Price Patterns
by Michael Harris,
Traders Press Inc., 2000.

Source: TradeStation by TradeStation Group Inc.

NOTE: What you have just read has been presented solely for informational or educational purposes. No
investment or trading advice or strategy of any kind is being offered, recommended or endorsed by the author or
by TradeStation Technologies or any of its affiliates, agents or employees.

ACTIVE TRADER • September 2001 • www.activetradermag.com 47