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TASC 2013-05 | Detecting Head & Shoulders Automatically (Siligardos)

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Traders' Tip text

Despite that Mr. Siligardos has presented a pretty complex routine for spotting H&S Tops, this month we’ve got no single code line to share. How come? Fortunately, Wealth-Lab is shipped with preinstalled “Head & Shoulders Top” Strategy that does the detection and more. The built-in Strategy’s algorithm applies Peaks and Troughs as a convenient way of detecting H&S chart patterns.

Basically, a Head & Shoulders Top is comprised of three peaks, with the second being higher than the outer two. Detecting peaks and troughs is performed by looking for a percentage reversal in the price series (usually High and Low) greater than or equal than a specified reversal amount. For example, a reversal value of 10% detects a peak when price falls to $90 after having set a new high at $100.

From our standpoint, this algorithm solves the problem of catching H&S Tops as efficiently as the one by Mr. Siligardos, but is programmed in a more intuitive manner and without the added complexity. While having great flexibility and precision in spotting H&S chart patterns is good, “over-shaping” it with extra conditions may decrease the amount of signals. Also, each extra variable and constant inevitably adds a degree of freedom into the resulting trading system.

Our mechanical trading strategy has a set of rules dictating it to enter when an imaginary neckline (a line that connects the bottom of the two shoulders and extends it to the right) is broken, and to exit either for a profit on reaching an objective or for a loss when prices do a head fake. Motivated traders are welcome to try it out.

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Figure 1. A Wealth-Lab 6 chart showing the Head & Shoulders Top trading system in action on a chart of Monsanto - for comparison purposes with the article author’s Figure 8.

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