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1 2

1. Introduction ...................................................................................................................... 4

1.1 Introduction of previous works on HSBP ....................................................................... 4

1.2 Research Aim and Objectives ......................................................................................... 6

1.3 The contributions of this research ................................................................................... 7

1.4 The experiment of this project ........................................................................................ 7

2. Background ....................................................................................................................... 8

2.1 Early development of technical analysis ......................................................................... 8

2.2 Technical analysis with computer application .............................................................. 11

3. Literature Review ................................................................................................................ 15

3.1 Previous Work ............................................................................................................... 15

3.2 Chart .............................................................................................................................. 15

3.2.1 Line Charts ............................................................................................................. 16

3.2.2 Bar Charts ............................................................................................................... 17

3.2.3 Candlestick Chart ................................................................................................... 18

3.3 Trends and Price Movements ........................................................................................ 19

3.4 Chart Pattern.................................................................................................................. 20

3.5 Reversal Chart Patterns ................................................................................................. 20

3.6 Head and Shoulders Pattern .......................................................................................... 21

3.6.1 Head and Shoulders Bottom Pattern (HSBP) ......................................................... 21

3.7 Directional Change ........................................................................................................ 23

3.7.1 Directional Change (DC) events ............................................................................ 24

3.7.2 A more formal definition of DC ............................................................................. 25

3.7.3 The process of Directional Change ........................................................................ 26

4. Head and Shoulders Bottom Pattern (HSBP) Conditions with Directional Change ............ 28

4.1 The current issues for searching for Head and Shoulders Bottom Pattern .................... 28

4.2 The methodology for recognising Head and Shoulders Bottom Pattern(HSBP) .......... 29

4.3 DC Extreme Point with HSBP ...................................................................................... 29

4.4 Head and Shoulders Bottom Pattern Conditions ........................................................... 31

4.5 Head and Shoulders Trading Strategy ........................................................................... 35

5. Experiments: Trading Under HSBP ...................................................................................... 41

5.1 DCC: From raw data to Directional Changes ............................................................... 43

5.2: HSBP_Detector: From DCs to Potential HSBP ........................................................... 47

5.2.1 A review of HSBP Conditions with an example .................................................... 47

5.2.2 Scanning for potential HSBPs ................................................................................ 51

5.3 HSBP_Strategy: Evaluating HSBP trading strategy ..................................................... 54

5.3.1 An example of HSBP trading strategy Li-1, with the module of HSBP_Strategy . 56

5.4 An overview of SH-1 workflow .................................................................................... 63

5.5 Result ............................................................................................................................ 64

6. Discussion ............................................................................................................................ 67

6.1 The advantage of DC in the definition of HSBP ........................................................... 67

6.2 Different thresholds produce different number of potential HSBPs. ............................ 68

6.3 Uncommon HSBPs ....................................................................................................... 69

6.4 Comparison to previous work ....................................................................................... 71

7. Conclusion ........................................................................................................................... 73

7.1 The significance of this thesis ....................................................................................... 73

7.2 Future works.................................................................................................................. 74

REFERENCE .............................................................................................................................. 76

APPENDIX ................................................................................................................................ 78

4 1.

1.1 Introduction of previous works on HSBP

5 d 6

1.2 Research Aim and Objectives

This research aims to propose a rigorous definition of Head and Shoulders Bottom Patterns (HSBP) based on the method of Directional Change. Having a precise definition of HSBP will then allow us to evaluate the effectiveness of a HSBP based trading strategy. This thesis proposes the following steps to realise our objective of

HSBP definition.

1. 2. 3. 7 4.

1.3 The contributions of this research

1. 2.

1.4 The experiment of this project

8 2.

2.1 Early development of technical analysis

Richard W. Schabacker comprehensively

introduced Technical Analysis in Charts and Patterns in his trading class and books [20, 21]. He 10 Also, Schabacker thought the study of chart reading aimed to discover and summarise the standard chart patterns which frequently and unanimously appear. These standard chart patterns help analysts forecast future price movement. In addition, he made great contributions to the development of technical chart patterns. Some famous patterns such as Triangle and Head and Shoulders Patterns were created by him. One of the other important contributions in the history of technical analysis was Technical Analysis of Stock Trends which was published by Edwards and Magee in

1948 [6]. Edwards and Magee, based on the research of Richard W. Schabacker and

their extensive experience, discussed several significant chart patterns in particular, which not only introduced the basic concepts of these patterns but also illustrated the practical application of technical patterns with the trading strategies. They discussed how the reversal patterns like Head and Shoulders Patterns were formed, and why there needs to be time to form a standard pattern. Particularly, the authors illustrated the reasons through the points of view of trading behaviour and market psychology to present the trading processes between the buyers and sellers, and finally the result of the formation of a particular pattern in a time period. And many technical manuals have continued to introduce the theory of technical chart patterns based on the works of Richard W. Schabacker and Edwards and Magee [6, 20]. 11

2.2 Technical analysis with computer application

12 13 14 15

3.1 Previous Work

3.2 Chart

3.2.1 Line Charts

3.2.2 Bar Charts

3.2.3 Candlestick Chart

3.3 Trends and Price Movements

3.4 Chart Pattern

3.5 Reversal Chart Patterns

3.6 Head and Shoulders Pattern

3.6.1 Head and Shoulders Bottom Pattern (HSBP)

3.6.1.1 Left Shoulder

3.6.1.2 Head

3.6.1.3 Right shoulder

3.6.1.4 Neckline

3.7 Directional Change

3.7.1 Directional Change (DC) events

3.7.2 A more formal definition of DC

3.7.3 The process of Directional Change

27
28

4.1 The current issues for searching for Head and Shoulders

Bottom Pattern

4.2 The methodology for recognising Head and Shoulders

Bottom Pattern(HSBP)

4.3 DC Extreme Point with HSBP

30
Figure 9. An example of DC summarises with the seven EPs. 31

4.4 Head and Shoulders Bottom Pattern Conditions

32
33
34

Figure 10. An example of a valid HSBP.

35
Figure 11. Example of a non-HSBP; Condition 5 is not met Įȕ too big Įȕgap between AveEP35 and EP4).

Figure 12. Example of a non-Įȕ

Į ȕgap between AveEP35 and EP4).

4.5 Head and Shoulders Trading Strategy

36
Figure 13. An example that the EP7 is confirmed by a certain threshold, while the event of penetrating the neckline has determined before determining the EP7. 37

Richard W. Schabacker and Edwards

and Magee that a long position is opened following the event of penetrating the neckline. Hence, 38
39
40
41
42
43

5.1 DCC: From raw data to Directional Changes

44
45

Figure 15. An example for DCC process.

Figure 16. An example for the workflow of DCC.

46
1. 2. 3. 4. 5. 6. 7. 47

5.2: HSBP_Detector: From DCs to Potential HSBP

5.2.1 A review of HSBP Conditions with an example

48
49
50

Figure 17. An example to explain Condition 1 4.1

Figure 18. An example to explain Condition 5 and 6.

1 Figure 17, 18, 22 and 23 have uploaded on Dropbox:

5.2.2 Scanning for potential HSBPs

52
Figure 19. The Mechanism of scanning for potential HSBPs. Figure 20. The mechanism of determining a potential HSBP by 6 conditions, an example. 53
54

5.3 HSBP_Strategy: Evaluating HSBP trading strategy

55
56

Workflow of HSBP_Strategy

Step 2Step 1

Step 3

Phase

Raw Data

Open long

position Yes

OP_Rule

Close long

position

SL_Rule

SP_Rule

No Break

HSBP_Detector

HSBP_Strategy

Potential

HSPBs

Figure 21. A workflow of HSBP_Strategy.

5.3.1 An example of HSBP trading strategy Li-1, with the module of HSBP_Strategy

57
58
59
Figure 22. An example to illustrate OP_Rule and SP_Rule. 60
61
62
Figure 23. An example that HSBP_Strategy closed the long position for stop loss. 2

2 NSSC is the symbol of NAPCO Security Technologies, Inc.

5.4 An overview of SH-1 workflow

TALTmaxTmin (See Section 4.4)

Raw data

Directional

Change

Computing

(DCC)

Extreme

Points

(EPs)

HSBP_Detector

Potential

HSBPs

HSBP_Strategy

Trading

Actions

SH-1

Workflow of SH-1

InputOutput

Figure 24. SH-1 flow diagram.

5.5 Result

3 The periods of the selected 100 stocks from 01/2004 to 11/2015.

65
66
67

6.1 The advantage of DC in the definition of HSBP

6.2 Different thresholds produce different number of

potential HSBPs. 69
Figure 25. A summary of the trading actions results.

6.3 Uncommon HSBPs

1. 2. 70
4

4 NHC is the symbol of National Healthcare Corp.

6.4 Comparison to previous work

72
73

7.1 The significance of this thesis

7.2 Future works

Richard W. Schabacker and Edwards and Magee both indicated that the factor of the 75
volume is decisive in consideration of HSBP trading strategy[6][20]. However, 76
[1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] - [12] [13] [14] [15] [16] [17] - [18] - [19] [20] 77
[21] [22] [23] [24] [25] [26] - [27] 78

Table 4

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

22.312/6/2013211.976/8/2010

32.4412/9/2013313.766/18/2010

42.212/17/2013410.887/19/2010

52.412/19/2013513.768/4/2010

62.2712/20/2013611.898/31/2010

BP.PBP.DSP.PSP.DBP.PBP.DSP.PSP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

22.312/6/2013268.52/6/2008

32.4412/9/2013377.72/13/2008

42.212/17/2013462.43/3/2008

52.512/24/2013575.93/24/2008

62.2912/30/2013669.83/28/2008

BP.PBP.DSLP.PSLP.DBP.PBP.DSP.PSP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

22.155/2/2005268.52/6/2008

33.125/17/2005377.72/13/2008

41.696/7/2005462.43/3/2008

52.827/14/20055824/28/2008

62.217/19/2005672.45/9/2008

BP.PBP.DSP.PSP.DBP.PBP.DSLP.PSLP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

213.518/8/2011248.710/15/2008

314.948/9/2011358.511/4/2008

411.6210/3/201143511/20/2008

515.6911/18/2011557.41/6/2009

613.9311/25/2011648.41/27/2009

BP.PBP.DSP.PSP.DBP.PBP.DSP.PSP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

29.1675/22/2006227.53/24/2005

310.1476/2/2006329.324/7/2005

48.326/13/2006426.314/15/2005

510.157/7/2006529.015/9/2005

69.457/14/2006627.325/13/2005

BP.PBP.DSLP.PSLP.DBP.PBP.DSP.PSP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

22.894/11/2012229.166/12/2007

33.115/11/2012331.916/19/2007

42.675/18/2012425.527/24/2007

53.066/7/2012532.178/8/2007

62.826/22/2012629.18/14/2007

BP.PBP.DSP.PSP.DBP.PBP.DSP.PSP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

22.48/11/2011213.435/1/2009

32.789/13/2011314.435/6/2009

41.9711/17/2011411.855/13/2009

52.91/31/2012514.225/29/2009

62.442/15/2012613.246/3/2009

BP.PBP.DSP.PSP.DBP.PBP.DSLP.PSLP.D

79
ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

29.752/5/201526.494/20/2004

310.472/19/201537.0144/22/2004

48.583/18/201545.2675/13/2004

510.716/26/201556.8136/16/2004

69.917/13/201566.3326/22/2004

BP.PBP.DSP.PSP.DBP.PBP.DSP.PSP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

29.3284/17/2014212.989/6/2011

311.145/27/2014315.379/16/2011

48.3511/25/2014411.710/3/2011

510.751/14/2015514.8210/28/2011

69.191/26/2015613.0911/29/2011

BP.PBP.DSLP.PSLP.DBP.PBP.DSP.PSP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

226.9212/20/2011218.7511/29/2010

338.041/27/2012321.21/3/2011

412.9811/21/2012417.962/22/2011

534.933/31/2014520.683/3/2011

624.581/30/2015619.313/16/2011

BP.PBP.DSP.PSP.DBP.PBP.DSP.PSP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

226.7910/13/2014235.69/22/2011

331.0210/29/2014339.419/27/2011

424.0712/11/2014431.4910/4/2011

531.3412/26/2014540.8510/14/2011

626.891/30/2015637.2710/19/2011

BP.PBP.DSP.PSP.DBP.PBP.DSP.PSP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

24.2325/24/2010226.1811/19/2004

34.7565/27/2010328.3112/22/2004

43.9196/8/2010423.454/6/2005

54.6366/18/2010528.436/1/2005

64.2826/24/2010626.66/27/2005

BP.PBP.DSLP.PSLP.DBP.PBP.DSLP.PSLP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

230.0312/24/2008235.036/10/2011

333.681/5/2009338.27/8/2011

427.491/14/2009428.778/8/2011

532.431/15/2009537.288/31/2011

629.731/26/2009634.949/9/2011

BP.PBP.DSLP.PSLP.DBP.PBP.DSLP.PSLP.D

ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

227.491/14/2009235.036/10/2011

332.822/6/2009338.27/8/2011

423.413/20/2009428.778/8/2011

532.515/8/2009537.559/20/2011

627.896/22/2009633.8310/3/2011

BP.PBP.DSP.PSP.DBP.PBP.DSP.PSP.D

32.487/23/200935.251/14/201037.9721/10/2011 00:00:0040.1910/28/2011

80
ThresholdName of ShareEPPriceDateThresholdName of ShareEPPriceDate

239.0510/4/2013219.855/17/2012

343.0510/25/2013321.586/6/2012

435.6612/12/2013418.168/1/2012

543.739/5/2014522.038/7/2012

639.479/24/2014620.538/23/2012

quotesdbs_dbs12.pdfusesText_18

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