Automated Trading Strategy #69: Ancient Price Patterns
This portfolio strategy has a profit factor of 2.37 and made ~$500K in a 1yr backtest using 5 contracts on 10 instruments (micro and mini).
Important: There is no guarantee that these strategies will have the same performance in the future. I use backtests to compare historical strategy performance. Backtests are based on historical data, not real-time data so the results shared are hypothetical, not real. There are no guarantees that this performance will continue in the future. Trading futures is extremely risky. If you trade futures live, be prepared to lose your entire account. I recommend using these strategies in simulated trading until you/we find the holy grail of trade strategy.
As a quick reminder, our goal is to find the holy grail of automated trade strategy. We haven’t found the holy grail yet, but we get closer with every strategy. Click here for the most recent performance chart. The Q2 Update will be published shortly.
There are 8 billion people on the planet. Among the many things we have in common is a shared moment in time. Through all the wars, pandemics and holocausts, somehow we all made it to this moment in time together.
If we go back a thousand years, our ancestors were not that different from us. They too liked to trade and developed central markets to do so. The top “commodities” on the Silk Road, which flourished between the Chinese Han Empire (206 B.C. to 220 A.D.) and Rome, were horses, paper, spices, jade, glass, and fur.
So if trading existed all these years ago, trading “systems” must have emerged as well, especially in places that created a secondary market like the one found for rice in Japan. While undocumented, I believe many of the earlier systems found their way to the technical analysis boom that emerged in the late 19th and early 20th century. Perhaps we can look to the trading systems of the past for clues about how to create the holy grail of automated trade strategy today.
For example, there’s the Dow Theory, which was developed by Charles H. Dow. People like to think of Dow as a fundamental trader, but many of his strategies were based in technical analysis. In particular, Dow Theory emphasizes the use of moving averages and market indices to find trends as well as support and resistance levels.
The Dow Theory of Transitions is an extension of the original Dow Theory. Developed by Robert Rhea in the early 20th century, the Dow Theory of Transitions focused on identifying phases of accumulation, distribution, and panic in the market cycle. Traders use this system to analyze various market indicators and patterns to anticipate reversals.
The Dow Theory of Transition is remarkably similar to the Wyckoff Method. Developed by Richard D. Wyckoff, aka the father of price action, the methodology focuses on identifying areas of accumulation and distribution in the anticipation of future price movements. This is one of the most studied price patterns on Wall Street.
Point and figure charting dates back to the late 19th century. Made popular by Wyckoff, it was used to track price movements without the consideration of time. I’ve been researching the use of this chart as well. While it is very helpful in live trading, I have reservations about the simulation’s ability to calculate it accurately for backtest purposes.
Then you’ve got Gann Theory, which was developed by trader and analyst W.D. Gann in the early 20th century. Traders using Gann Theory look for patterns such as Gann angles, time cycles, geometric shapes and ancient mathematics to identify potential support and resistance levels.
There’s also the Elliott Wave Theory, which was developed by Ralph Nelson Elliott in the 1930s. Traders use Elliott Wave Theory to analyze fractal wave patterns and Fibonacci ratios to predict price movements.
Then you have the lesser known Gartley Patterns. Gartley Patterns were introduced by H.M. Gartley in the early 20th century as well. They are based on “harmonic” price patterns like Fibonacci ratios to identify patterns such as the Butterfly and the Crab.
There’s one system I haven’t talked about yet: Homma Munehisa’s candlesticks.
Homma Munehisa, Father of Candlesticks; God of Markets
Do you ever ask yourself what you would be willing to do in order to find the holy grail of automated trade strategy? Would you hire a small army to stand ~6 km apart (the distance between Sakata and Osaka is 600 km) to communicate market prices? Even if you had the resources to pull it off, would the scheme even come to mind? Sokyu (Munehisa) Homma (1716-1803) did what was inconceivable to most. He then used the prices obtained from his human-chain squawk box to develop a trading system that is still in use today: candlesticks.
I have a short list of material obsessions: one is an original publication of the book San-en Kinsen Hiroku, The Fountain of Gold - The Three Monkey Record of Money. It is said to be the first recorded book on market psychology.
If the price patterns used hundreds of years ago are still in use today, it speaks to a fundamental truth: the human response to changes in demand and supply haven’t changed much.
What most don’t realize about Homma is that he was also a contrarian, which you’ll pick up quickly if you read the book.
One of my favorite sections in the book is ”2.1: The Rule of Three”:
What is Homma telling us here?
He’s telling us that just like an orchestra getting ready to play, within each market, there is an underlying order in what may appear to be random. If you want to be successful at trading, your approach is key. It must be planned and taken seriously. The beginning is critical. Without it, due to the nature of the market and human psychology, it will be very difficult to compose yourself for the next trade. Restraint is a requirement. A keen awareness of the ceiling, bottom and exit prices are also crucial elements to consider before execution.
He goes on to use the Yin and Yang symbol as an illustration for how to think about the market, with each type of market (bull or bear) holding within it an instance of the other. What a perfect description of the market, and perhaps the main reason why it’s so hard to develop a static strategy that doesn’t have large drawdowns.
You’ll notice that one thing Dow, Gann, Elliot, Gartley, Wyckoff and Homma all did was focus on historical price levels, volume and the current trend. From rice to bitcoin, one thing is certain: prices are not random. They do not occur by “chance” — they are influenced by the same things that influenced trade thousands of years ago: supply and demand.
So, today I want to show you four of my favorite ancient price patterns. These patterns overlap and can be found in several of the trading systems listed above, which helps to reinforce the strength of the signal. I’m also hoping that the use of price patterns that have been around since the 18th century will result in less alpha decay. If this proves to be the case, it will give additional value to the use of price patterns in the future.
Strategy 69 uses an unlimited stop loss and take profit (though you can use both if you like) to achieve 1450 trades from a portfolio of 10 micro and mini futures contracts. See below for the performance chart.
As you can see, the profit factor is 2.37 and total net income is $94K, which is fairly low, but so is the average drawdown. The drawdown also allows for a nice scale opportunity. Here’s a backtest model when we scale up to 5 contracts instead of 1.
The use of 5 contracts creates a net income (not including commissions) of `just under $500K.
Now let’s get into how to recreate this strategy for yourself. I’ll show you the price patterns and a little trick I used to boost performance even higher.
Strategy 69 Description, Command Structure & Download (C#)
Not all price patterns are the same. Some are better/stronger than others. Strategy 69 is inspired by a few of my favorite price patterns. In particular, I looked for candlestick patterns that mimicked certain patterns found in the