Do classic chart formations such as the head-and-shoulders or the double-bottom/double-top hold up to close scrutiny? Here's a look.
A few years ago, I read a Federal
Reserve Bank report entitled
just a flaky pattern.” The authors
of the piece had rigorously
tested the profitability
of a trading strategy based on
the head-and-shoulders pattern
in the foreign exchange
market. The results indicated
the head-and-shoulders had
some predictive power for the German mark and the yen.
I was taken by the study’s objective approach to what has
always been looked upon as a subjective pattern. I wondered
if tests of the head-and-shoulders as well as of the
double top/bottom would yield similar results in the Trea-sury bond futures market.
I started with the head-and-shoulders pattern. My definitions
and approach are somewhat similar to those used in the Fed’s
study. My definitions are:
• Reactionary high: A reactionary high is a local maximum
price, which is more than 1 point or 32 ticks above
the previous reactionary low.
• Reactionary low: A reactionary low is a local minimum
price, which is more than 32 ticks below the previous