Thursday, May 29, 2008

Are patterns becoming too popular?

Tonight I received an e-mail from Ameritrade informing me that they now have pattern recognition software for retail traders. As soon as I saw this I got to wondering if trading patterns has become too popular.

Almost every night on Fast Money they have a chartist on the show. When they started the show the only one using charts to any extent was Eric Bolling. The other traders would basically roll their eyes when he pulled up charts during the show. Not so anymore. Almost every blog I visit is loaded with charts full of patterns, trend lines, support and resistance, etc. etc. Mine included.

While I was reluctant to come around to trading patterns I have to admit that they often worked probably more than 50% of the time. More than 50% defines an edge. If you have an edge you can probably make money in the market.

Now one thing I can tell you is that when something works for very long the market will eventually discount it and your edge will disappear. The three charts are examples of widely recognised patterns that did not "work" as expected.

Somebody once said that speculating in the market comes down to anticipating the anticipators.

When I received tonights update it started to dawn on me that the smart money is probably starting to anticipate the pattern traders. I expect the more obvious patterns are going to work out less and less frequently.