Line Your Own Pockets

Michael: 00:00

Hello, everyone. Welcome to another episode of Line Your Own Pockets. Today, we're gonna talk about candlesticks, and whether or not there's any is there any there there? It's funny that every trader in the world probably spends a large percentage of their day looking at candlesticks and candlestick charts. Funny enough, I didn't even tell you this before we got started, so I'm going just way off base.

Michael: 00:21

So I went to California and one of the presentations, I which have to read this book, which is really cool, this ex NASA scientist, he's a well, no, current engineer at NASA, found the old writings from I'm gonna butcher this, Minu Minuhisa Homa. He's the man credited with creating the Japanese candlestick, like

Dave: 00:47

Okay.

Michael: 00:48

Hundreds And of years he, with a combination of AI and actually getting a real translator, translated his whole trading system and his whole thing and put in this cool little book. But anyway, that's completely off topic. But just to talk about how long candlesticks have been around, it's this was yeah, I think it was the seventeen hundreds when this yeah, 1717 is when he was born, and this is the guy whose credit would create these things. So been around for some time, everyone uses them, so I guess we're gonna answer or we gotta ask the question, is there is there any value in them at all, or have we all been wasting our time for like three hundred years?

Dave: 01:29

Yeah. Great question. Yeah. I think it's a great way to look at a chart to use candles, obviously. I mean, that's what I use on mine.

Dave: 01:39

I'm assuming that's what you use on your charts. So this question comes from somebody that I coach, and he said, Dave, have you done much back testing on candlestick patterns? And alright. So here's where most traders that I see come from. And I I think it's I I think you go through a phase in your trading career where you're looking at this stuff a lot, the the patterns in in candles.

Dave: 02:14

Mhmm. I I think it's like a sort of a phase you go through. I remember I had a book, I think it was Steve Nyssen wrote a book on, like, all the candlestick patterns. Right? All the common ones that she know, all these fancy names for them.

Dave: 02:30

And I I mean, that was very early on in my yeah. I mean, it wouldn't even hardly trading then, but I was just, you know, researching. And I I think a lot of traders go through that phase and they think, oh, yeah. Candles are BS. Like, there's all these patterns are just useless.

Dave: 02:49

And I don't think that's quite true. But I'd but the way most people, traders, think about it, I understand what they're saying. So give me your take, Michael.

Michael: 03:01

Well, I think there's gonna be a little bit of an overlap when we said we had same thing about indicators. Right? Is a moving average is it is it valuable? And I think it at the core, you need to break down exactly what it is and exactly what you're looking at. Right?

Michael: 03:18

A candlestick is just a way to represent smaller time frame data. Right? If you're looking at a daily candlestick, it's giving you a kind of quick and dirty representation of what happened intraday. You know, for example, the just the classic hammer candle or something with a very lower body wick, and then it closes roughly where it opens. Well, you can look at that candle and you can very quickly have some indication of what happened intraday.

Michael: 03:49

There was at some point in the day, there it was down and then it kind of reversed and and closed higher. So the the question when you're when you're looking at it like that, you're asking yourself is, well, is lower time frame data, the high low open close of of whatever time frame beneath whatever you're looking at, does that have any value? Because at at the end of the day, whether it's a candlestick chart or a bar chart or whatever it is, it's just four data points that you're putting together and just shows you what's happening inside of the the thing that you're looking at.

Dave: 04:25

Yeah. I think so a lot of traders well, let me ask you this. What do you think is the most common candlestick pattern that traders look at? Like, what's the most popular one?

Michael: 04:39

That most people, like, use for trading or or attempt to use for trading?

Dave: 04:43

Yeah. I would like, for think of the the larger investing crowd more. There's a lot that comes to my mind that I that I always think of when when people say candlestick bounce.

Michael: 04:56

Interesting. Well, the the first thing that came to my mind is just is just the hammer. Right? The that's the one that I think most people look at because it's the maybe the easiest to identify and the most dramatic, I guess, in some way because, you know, it's it's very easy to paint the picture of what happened when you see a hammer candle takes place. Right?

Michael: 05:19

Big move one way, and then that move was completely kinda kinda reversed. So I think that's the one that I would say most people end up talking about or or looking at to some degree.

Dave: 05:30

Yeah. I'm curious to what listeners might say, but the one that comes to mind, maybe it's just the way I progress and the things I was doing before The I started first one that comes to my mind is the cup and handle.

Michael: 05:46

Oh, see, I would now okay. So now we gotta get we gotta go back to definition two. I would not consider that candlestick pattern. I would consider that a price when I'm thinking candlestick pattern, I'm thinking engulfing, hammer, doji, like just the pure, like, what is, like, morning star, evening star, like these Yeah. Different.

Michael: 06:09

When I'm thinking something like a head and shoulders or cup and handle, the reason I don't think those are candlestick patterns, and and maybe, you know, it's it's you could read more into the user question. The reason I think those are a little bit different is because you could do the same thing on a line chart with with those. Right? You could do a line chart for a bear flag or a bull flag or a so when I hear candlestick patterns, I'm thinking just the specific, you know, the the actual, like, weird there's one that's like a pregnant lady, and there's one that's like a weird bird. There's all of these, but there's specifically those candle pat stick patterns.

Dave: 06:48

But can't you also do those in a line chart, like you could do with the hammer in a line chart too?

Michael: 06:56

Well, a line chart, generally speaking, just represents the close. So all you're doing is you'd be looking at the subset. Right? So Yeah. To find a daily hammer pattern, you would need like a five minute line chart or or something like that.

Michael: 07:13

So Okay. So I don't know. May so maybe we just stumbled across two completely different episodes we wanna do. We could do one on Candle Stick Patterns, and then we could do one on, I don't know what you call those, geometric patterns or something

Dave: 07:27

like What would you call these if this is not a candlestick pattern, or like it's it's a pattern? It's a it's a chart pattern.

Michael: 07:33

I yeah. Well, I I think chart pattern's a better definition, because I could go, if I Google here we go. We'll let But Google if I Google candle candlestick patterns, I bet you there's gonna be a whole bunch of ones that that show up, but they're gonna be the the standard kind of run of the mill thing. Yeah. So there's just a picture that pops up, and it's just those, a dragonfly doji, and a gravestone doji, and a hammer, hanging man, spinning top, mar marzubo kickers, like, that's the kind of thing that I'm thinking about that take like one to two candlesticks and put them together and and build that as a pattern.

Michael: 08:16

To me, that is what I look at when I'm when I'm thinking about candlestick patterns. Those other ones, double tops and bottoms and flags and and all of this, I put more in like the chart or price pattern. But I I I do look at those as kind of two two separate things. And again, which might be two separate two separate episodes Yeah. That's interesting.

Michael: 08:37

That to the list with everything else, I guess.

Dave: 08:39

I say, I'm I'm curious what listeners think. Like, what do you think don't don't Google it. What do you assume that most traders think is like the most popular candlestick pattern? Maybe not what they think, but what they think is the most popular. So I'm I'm curious to see what people think.

Michael: 08:55

So now I'll agree with you that if we're talking about price patterns, I think like the cup and handle, what and like the bull flag have to be the most too common price patterns. I just don't define those as candlestick patterns. Right? I look at those other those other things. So I guess it's a good question to ask the person that asked you the question initially.

Michael: 09:19

And I would say, you know, the benefit is if you are if you are looking at testing candlestick patterns, the way I define them, that's gonna be way easier than testing price patterns. Because a hammer candle can be very easily mathematically defined. Yeah. You know, the low is a certain percentage or or distance from the high and the op like, very, very simple to build. Right?

Michael: 09:49

A doji, you're saying that, you know, the open and the close are roughly the same price, and and the high and the low are Yeah. Are are some distance above that. So those should be very easy to define. And if you watch our last episode, we were talking about signals as a whole, these could be very much used in that kind of same context as a signal to something else. Like, I have a couple systems that I use that use engulfing candles, but they're just not buying every bullish and bearish engulfing.

Michael: 10:21

Looking for to happen and then engulfing. So if you're looking to test those, and, you know, and you look at all of these the same, you look at a bull flag the same as a, you know, say tweezer top or something, it's going to be much simpler to do the actual, like, raw candlestick patterns than it will be charting out these more kind of geometric patterns or these more kind of price based patterns for sure, like infinitely, infinitely easier.

Dave: 10:52

Yeah. So, yeah, why don't we don't we stick to just the candlestick patterns then? And as you, like, listed out the ones there, there were only a couple that I recognized or that I could think of.

Michael: 11:08

Oh, man. See, this is where the CMT comes in. I could you could describe anyone, and I could tell you probably not only what they are, but like the Japanese definition of them, because for some reason, we had to we had to know that.

Dave: 11:23

Okay. So how useful has that been in your trading, like knowing the definitions of those, or knowing they exist, or knowing like, hey, this something maybe I should test.

Michael: 11:33

The definition just completely meaningless and useless, because just like with any any pattern, it is the understanding of why it might work as opposed to anything. So, you know, say, now whether the patterns are useful or not, I think, especially for kind of what I do with with swing trading, and it probably is the same with day trading, I think they could be very useful. So, for example, if you're looking at a mean reversion strategy, you know, you're looking for a stock that's down a number of days or a number of weeks in a row, looking for, say, hammer candle or or bullish engulfing might be just the signal you need to not just buy stuff that's down a bunch. Because all you're doing is you're saying, well, I want a stock that is oversold in some way, but is showing some price action to the upside. So a hammer candle, you could say, is bears exhausting themselves because they tried to push the price down all day, and then bulls came in at the end of the day and and rallied it.

Michael: 12:38

And the bullish engulfing candle is kind of the same thing where it gaps down on the day, but then and rallies rallies high. So their exact, like, definitions and the know, the Japanese names that they came from, it's all that's for fun, but and and kinda useless. But understanding the the core mechanics, I guess, behind the price action, I think is something that is useful and interesting. Because like we talked about, all you're doing is you're looking at what happened using a daily candle to look at what happened intraday in in a in a rough way. You don't know the path that it took, but you know the low and the high and the open and the close, and that's kind of the the premise for everything, really.

Dave: 13:22

Yeah. So when I think back on my when I first started learning about Candlestick Jarts and bought that book, I think my assumption was, hey, I hear people talking about these patterns. People, you know, gurus saying, hey, this this is the right pattern. You know, this is the one you should look at. There's a lot of value here in this.

Dave: 13:46

And you first and when you first experience that, it's probably some guru that, like, it sounds like this cool nomenclature. Right? Like, all those patterns you just listed. Oh, wow. This is cool stuff.

Dave: 13:57

So you go and start looking at them. And as a beginning trader, you're like, okay. There's something there. But then as you start looking at that, you realize, okay. They're all BS.

Dave: 14:06

Like, you've you've that's the conclusion that, like, maybe a medium trader with a little bit of experience might conclude. And then as you get more advanced, I think you realize that there is power in some of these, and it's it is useful to think about it, but but when you think about it in the right way. Now if you look at like, the way beginning traders think about this is, like, oh, okay, there's a hammer on any time frame. Like, if there's some magic pattern on any time frame, you should do something, you know, there's a system there as a result of it. And that is true.

Dave: 14:43

Like, there's no way that's gonna work. If you combine that into other situations, there there's certainly some edge there in certain situations. So I think it go it kinda goes back to the last episode where we're talking about signal strength.

Michael: 15:00

Mhmm.

Dave: 15:00

Yeah. You can have you can look for all the hammers out there, and only some of them are gonna be strong. And figuring out which ones are strong and which ones aren't is gonna be the key. But if you just look for every one of them, there's not gonna be much there. There's gonna be so much noise.

Dave: 15:20

And, you know, it goes back to, like, any strategy you should think of, you know, buying new highs, buying new fifty two week highs, anything. The real edge is gonna come from figuring out when you should ignore that signal and when you should take it. I mean, that's the whole name of the game. Like, figuring out the events and then figuring out when you should skip it and when you should not skip it.

Michael: 15:53

So yeah. Two things. One, you literally just described that meme template where you've got, like, the idiot on one side and the genius on the other side, and then, like, the average person in the middle. And it's like, both the idiot and the genius are like, yeah, hammer candle, good. It's like but just under under what context?

Michael: 16:11

And it it was, you know, funny. I've been talking about what I've been reading or listening, doing a video series on this Market Wizard book, and one of the last guys, his stats was just ins his stat was insane. He it was eleven years without a losing month for his particular strategy, which is just wild. And one of his quotes that I just brought up here that I I loved from it was that, it's nothing works all the time, but something works but all but everything will work some of the time. So he's basically just saying that, you know, you like, there's literally every single trading style you come up with will have its moment and will have a time that it it works fantastically.

Michael: 16:54

But no trading strategy will work, like, consistently all the time, bar none. And how he was able to achieve these results is just a bunch of different systems and like we talked about, you know, eventually they all end up they were all like news driven type of things, but so different what we would have done. But yeah, came to the same kind of conclusion where there's you could pick anything, even if it was, you know, relatively kind of dumb system, and it's it's gonna work sometimes. So the the main question you're asking yourself is when does that work? So some of these candlestick patterns might seem silly and they might have, you know, silly names and and all that.

Michael: 17:37

But there's going to be some amount of time in which a evening star pattern has some sort of predictive value. Question you're asking yourself is, well, what is the candlestick describing? And do I think it has predictive value above and beyond what any other one would? So an evening star is a one candle push up, and then a little doji at the top, and then another candle push down. It's just another reversal pattern.

Michael: 18:07

And if you look at it, it's it's going to be roughly the same as a hammer, and roughly the same as a a bearish engulfing candle. So what you should be asking yourself is, you know, a, what what is the candlestick pattern describing under the hood? But at the same time, is in what scenario would that work? Because, you know, like you just mentioned, if you bought every hammer candle, you're gonna destroy yourself. Even if there was no such thing as fees or or commissions or anything like that, you're gonna destroy yourself.

Michael: 18:42

But in what scenario do you think that something like that would have value in which you're essentially seeing bulls take control early and then or bears get take control early and just get completely, you know, beaten up by bulls. There's gonna be some world in which that's gonna be a good scenario. Your job is just to answer in in what what world is it? Like, what in what area should I be looking at those things?

Dave: 19:07

Yeah. So going back to the original question here from this trader, he's coming from trade ideas, and he's starting to back test that I'm a broker. So Okay. Trade ideas, see, so that's important because trade ideas has alerts and filters. Some of the alerts are literally these patterns, and they're more than just like the I would say it bleeds into more chart patterns that you're what you would call chart patterns.

Dave: 19:43

So but there are the candlestick patterns also. So that's the context he was coming from. Now because he it's so easy to test and trade ideas, you have this three month window for backtesting, though. Now you're you're trading with or you're backtesting with Ambroker. You have a whole slew of bars you could enter into your database and you could backtest over a much larger window, and you can pretty easily come up with a backtest for all these patterns.

Dave: 20:17

So that's the context which she was coming from. And so it is tempting because you can you actually can recreate the those patterns in AFL and create big long backtests for these patterns. Mhmm. Now, how do I think about these? How do I use these in my systems?

Dave: 20:44

The the best way to do this, I think, or the easiest way is to add columns that describe some of these patterns and add them to your column library. So the way I think about this is, you know, I've got a, say, a strategy I've got a signal for. The more recent Candle data that's that's happened really close to the signal, like, before the signal, that's gonna have it's likely to have the most predictive values, the more recent ones. I mean, just imagine, you know, like a a five minute moving average versus a two hundred day moving average, which one's likely to have more predictive value in a short term strategy? It's gonna be the more recent one.

Dave: 21:36

Right? It's gonna be Yeah. What what action has happened recently. I mean, another way to think about that is, you know, have you ever accidentally added some future lead to a strategy you're testing? Like, even if it's very subtle?

Dave: 21:49

Yeah. How much of a difference that makes in the strategy? Like, it's it's huge. Even when you just peek forward accidentally just the end of the current one minute candle, it makes a huge difference in your results. So, obviously, recency So makes a huge so what I'll do is add columns for recent candles, and it often will be predictive in in my strategies.

Michael: 22:19

Yeah. Because, you know, the only thing that is more recent than the the candlestick pattern of the thing that the time frame you're looking at, it would actually be like time and sales data. Right? Because you're just literally looking at the the high low open close, which is why if anyone ever tells me that candlestick patterns are just nonsense and useless, I'm like, well, how how can the high low open close value of the most recent candle be useless. Right?

Michael: 22:50

And it's so it's that, by definition, just doesn't make sense to me. But at the same time, I I I see where they're coming from for the same reasons we talked about with the gurus saying, oh, look, just look at this hammer candle, and then you just buy it, you make so I think and I think we had the same take when we talked about just basic indicator values. Right? How can someone say an RSI is useless when it's just you look at the math equation, it's just like, you know, the average up move versus the average down move over the the the last period of time, or how can people say that, you know, the slope of a moving average is useless? Well, if the move average average it's just a proxy for price.

Michael: 23:30

If the the move average is sloping higher, then prices on average moving higher, if it's sloping lower, on average moving forward. So none of these are, I think, kind of useful or useless in and of themselves. They are just different ways to express what the stock has done recently. And, you know, what you're asking yourself is what is the best way to express that? I don't know how and I'm sure you've seen the same thing.

Michael: 23:55

How many times you go, man, this stock is really oversold, and they'll bring up a chart that has like a Bollinger Band, and an RSI, and a stochastic, and they'll have like seven indicators that all essentially say the exact same thing, which is slightly different kind of mathematics to express that same thing. Like in that case, I I get why some of this stuff gets a bad rap because you just see a bunch of people use it in an incredibly stupid way. And it's not that it's a bad thing, it's just that a lot of people are just using it in a way that makes no sense.

Dave: 24:27

Yeah. And a lot of gurus, you know, like to talk in absolutes and, you know, say things that sound smart, so they like to use these, you know, fancy names. So let me tell you how I responded to this guy because I've I got the Slack message here, And then I'll go into some more details about it. So he said, have you done much backtesting on candlestick patterns? And like I said, I knew the context where she was coming from.

Dave: 24:56

I said, yes, but the existence of the pattern alone isn't enough, usually. I think of it more as an entry tactic than a fully formed idea. So Yeah. All these could be entry tactics when applied to a certain universe, and that could form a strategy. I do for like I said, I I also like to add columns for into my column library, and this this is the one that comes to make it.

Dave: 25:29

I'm gonna list a couple that come there that I think are very useful. One is called dodginess. This is something I came up with to describe okay. Because, you know, you mentioned earlier, it's something that I almost brought up, it's not quite right. You said it's easy to define what these are.

Dave: 25:50

Like, what is a hammer? And that's not quite true because you get differing opinions. It's easy to define it for yourself, but it's hard to get agreement on exactly what the definition should be.

Michael: 26:04

So Yeah. It is a bit of a what the guy said, what what, pornography? It's like, know it when I see it, and it is a bit of like a Loki's wager type situation. Like, if anyone I won't describe Loki's wager, but look it up if you're if you didn't take philosophy, it's interesting. But it's like, is it a doji if it's, you know, the high and the low?

Michael: 26:25

Technically, you're supposed to be the exact same price. Well, what if they're 2 pennies off? What if they're 3 pennies off? What if they're 4 pennies off? So, yeah, it it the devil in the details for sure.

Michael: 26:38

But I think my point there was just that, you know, give me a head and shoulders pattern to try to program in versus a hammer pattern, and I'm gonna have a way easier time kinda being in that that hammer pick pattern area than I'm gonna be in in a head and shoulders or even some of the more obscure ones that I bet you probably haven't even heard of. Like, there's bat patterns and like all kinds of weird. Yeah. I love the they call it the Bart Simpson pattern where it's just got the spiky on top of his head, like weird stuff you can get into. But you're definitely gonna have a better time looking at these these candlestick patterns than some of them more, which, you know, mentioning that now that I know the person is coming from trade ideas, you're right.

Michael: 27:22

I think you can trust some of these candle patterns way better than double tops and bottoms and head and shoulders that were built into that program. Because part of the problem is gonna be there, hey, a only three months for the data, but also your definition the difference in definition of a a hammer candle, I think you're gonna be way smaller than the difference in definition of like a head and shoulders pattern. Because the the room for interpretation in these geometric patterns, I think, are much larger than the room for the interpretation of of the candlestick patterns, if that makes any sense.

Dave: 28:01

Yeah. And that's why I created this doziness thing in my column library because it makes what seems like should be a binary variable. Is this a dozier or is it not a dozier? It makes it it assigns basically a range to it. Like, how much of a dozier is it?

Dave: 28:21

So the way it works is it varies between one and negative one, where zero is a quote, unquote perfect doji. The open is exact same as the close. So and there's a whole range that of values it can have, which allow you to use the cruncher to, like, really figure out what level is the important one or the optimal one to use. It's much easier to do when you're looking at a continuous variable like doziness versus, you know, is this dozy zero or one? It's much easier to do.

Michael: 29:03

Yeah. And I was trying to think how do you do with the rest of them, but I guess you could. You could be, like, a bullish engulfing could be the amount of, you know, the the range of that candle. You can do a lot of a lot of different ones. And I think it all, again, comes back to the it's like the whole spirit of the law versus the letter of the law.

Michael: 29:25

Like, what you what you're doing is you're defining how much essentially, how much chop has taken place or or could call it range consolidation or whatever it is in that last candle, and you're just using that as a spectrum. Right? If if the candle closed right at the high and and or opened right at the high and closed right at the low or vice versa, that's very much not a Doji. Where if they closed perfectly, they are, and you're just saying there's a spectrum there. And that's the same way you could do a lot of a lot of these other ones to say, you know, yes, it needs to meet the the technical definition of x, but by how much, and does that affect the actual price action as well, which goes to that more of the the spirit of the law versus the letter of the law.

Dave: 30:11

Yeah. So another one I use, and and sure you would call this an actual pattern, but it's a value that I could use with doziness to to actually describe some of these candles. So the other one is close the position the the closed position for the previous There are some strategies I trade where that is important. How where it closes in the very previous candle to the signal candle. That I can just tell you that.

Dave: 30:44

And so if it's closer to the high for a long, this tends to be better. Like, that that has some predictive value there. You know, it's not perfect predictive value, but there's enough there. There's enough EV there where that's worth adding a rule to for this particular pattern that I trade. But thinking about and getting good at figuring out how to describe the market action, whether it's using a candle as a shortcut or figuring out the the the way to describe recent action and adding a column for it so that it becomes valuable, not only for this backtest you're running on, but every strategy backtest from now on, is a very good skill to learn, and it's one that you'll get better and better at.

Dave: 31:40

There's lots of patterns, like so I think of columns in two different at least two different ways. One is my column library that I'll go into every backtest that I run. The other one is I'll have strategy specific columns that describe everything about, like, maybe there's a certain pattern that I'm looking for in the candles, and I have columns that are describing that, that might not make sense exactly to all the other strategies I trade, but they're very strategy specific. So I'll have columns that go in to that specific strategy, in addition to all the ones in my library that get added to the backtest. So I think it's a really good skill to be thinking about and and and to to learn over time.

Dave: 32:33

It's like always figuring out, okay, I see this market action. How could I first of all, is it described somehow? Am I capturing that in my column library somehow? Can I add something that would really nail down exactly what I'm looking looking at in a better way? That's like, how can I create a column that will describe that action very succinctly in a way that I can figure out if it's predictive for this strategy and and any going forward?

Michael: 33:01

One, I like how and I've got some some strategies to do the same how you mentioned the the position in the range of that things opened and closed, and that from trade ideas, those were my favorite, I guess, filter sets and columns was, you know, positioned in in range for the close or the open of of different different candlestick patterns because you'll be shocked how much you can recreate with those if you're kind of really creative about it. So that's one thing that I think is probably the easiest thing to add to a column library or add to your thinking is that, you know, just to go to the hammer because everyone knows it, right, really, you know, what's what's happening there is the the close is above the open, even though it was down a lot first. Right? And at the end of the day, that's that's basically what it's saying. So you to go back to what you're trying to do, you can do both of those things with a position in range really easily, where you can say, okay, I I want the bear or the bears to have their day, and then the bulls come back to take control.

Michael: 34:15

That is much easier to do with a kind of position in range type of thing, because you're saying, they, you know, they're able to get it back, and and they're able to to go as well. And I think, you know, another reason another way to look at it is there's a myriad of strategies out there that use a stock going from red to green in some way, either through the open or through the prior close. And that in and of itself is is just kind of building the same kind of candle pattern style. So you can use them like a filter set, like like Dave was talking about, and then also as the trigger as well. So when it comes to how useful these things are, it turns out, you know, pretty darn useful, just not in the way that you'll you'll see on TikTok.

Michael: 35:01

Yeah. On on a a way that, you know, when you strip them back to to kind of first principles, you're just looking at what is this actually. Well, it's just a way to describe the high, low, open close of the the most recent candle.

Dave: 35:13

Right. I mean, one way to think about it is it's not they're not magical. Like, there's nothing magic about the pattern. Just describing something, and and there's situations where that could be valuable. I think that's where people kinda get stuck.

Dave: 35:23

You know, they're looking for early in their career, they're looking for the magic pattern. They're looking for this thing that that always works or, you know and that's not there, but but that doesn't mean that you can't use these for to, you know, really contribute to some p and l to your strategies.

Michael: 35:41

Well, and it's it's funny that it's it's not there, but it's I don't even wanna say close, but I wanna say, you know, you're kind of on the you know, go back to the the meme template, right, of the of the guy. You you were you were actually going in the right direction, and then I think the people who kind of abandoned it halfway and say these things are just completely nonsense and useless and, right, everyone's an asshole and and they get super cynical about it. Yeah. They've they've gone the other way as opposed to, okay, every hammer candle doesn't work, but some hammer candles seem to work. Now, me investigate the difference.

Michael: 36:17

Seems to be a much better, kind of outlet for all of this than the than the other guy, right, who just kind of completely abandons it and completely moves away from it. It's like they were, you know, they're getting very very close to kind of understanding the idea behind it. They just had to accept a couple things that not all hammer candles are gonna work, and they also need to accept that regardless of what you do, it's not always gonna work. And as soon as traders get there, then they they they see the value of the thing that they were looking at, as opposed to the traders who abandon everything because it wasn't perfect, when they should have just, you know, continued with the same thing. And it's like, yeah, you were you were you were close, you were on the right road, just don't get too cynical that you you get off entirely, just kinda redirect yourself a little bit.

Dave: 37:07

Yeah. Alright. So there's two things I wanna touch on here. One is the reason that a continuous variable is so much more powerful than a binary variable. And I I remember sort of thinking about this when I was trying to describe as in a column what a hammer was.

Dave: 37:29

And my conclusion was it's actually a combination of doziness and closed position. So Mhmm. But, you know, when I looked for the definition of what a hammer is, you're gonna find different things, like how much, like, yeah, how how big is the body of the candle? That's what you're gonna that's what the question is. But if you have continuous variables, you can, you know, decide what's important.

Dave: 38:00

Doesn't really matter what it you end up, you know, choosing what the definition of a hammer is. You can actually just put it through the crunch, and it's gonna tell you what's what's predictive for your strategy. So that's the important thing. And that's what makes these continuous Any time you can reduce something to a continuous variable, it's gonna be more powerful powerful just because of that. The other thing I wanna point out is the reason that it's not only is the most recent candle likely to be predictive, it's also easier to quantify.

Dave: 38:38

Like like, when you were talking about double tops and how much difficult, you know, how difficult they are to like, you're gonna have a whole bunch of different opinions on what one is.

Michael: 38:46

Mhmm.

Dave: 38:47

You're also gonna have more difficulty defining that pattern. But also, the more constraints you put on the pattern for it to appear, then there's just gonna be fewer instances of it. And that's really another reason why I like like, what does that previous candle look like? That there's gonna be you'll be able to there's a column there that's gonna have data for any candle. Whatever the candle looks like, there's gonna have it's gonna have data.

Dave: 39:19

Where if you're looking for, okay, did a double top occur before this? You may look in your strategy, and there may only be, like, 5% or less where that particular magical pattern happened to appear. So I think this goes back to kind of the art of coming up with columns that describe the action in in a in a way that can be very predictive. It's it's hard to do, but it's it's worth practicing and getting good at.

Michael: 39:49

Well, yeah, and even for your your binary thing, you know, excluding the price patterns, If you define the hammer in a very specific way, there could only be 10 of them. If you're with hammers and things that are are close enough to, then then there might be a 100 things, instances. And now you're able to go through and and narrow them in.

Dave: 40:14

And also, you realize you realize when you watch these play out in real time, and you have this definition of what you think a hammer is, and you watch, you know, you watch this play out in real time, and, hey, it looks like a hammer, but then the last second, it like, it closes such that it doesn't qualify for your definition, you realize just how arbitrary the definition is when you watch it play out like that. So

Michael: 40:38

Well, yeah, because it's the difference if that candle closed two seconds ago, it would have been a hammer. Or if the last print was on the ask versus the bid, that would have changed the definition as well. Right? And, you know, it's why I bring up the the Loki's wager thing. I guess I guess I if I bring it up twice an episode, I have to define it, but just very simply, it's a it's a parable from philosophy.

Michael: 41:04

The idea was Loki was out drinking and annoying everyone, he lost a bunch of bets, and to settle his bets, he said, okay, you can cut off my head, but you can't cut off you can't cut any of my neck. So then it became a whole thing where these dwarves were trying to cut off his head, but they it's like, where does the next head start and the the head begin and all this. That's why when anyone just says the Loki's wager, it just means that there is a cut off, but where is the cut off is is really just arbitrary. You can never find the exact point a head turns into a neck and a neck neck turns into the head. And it's the same thing, like, with the bid or the ask.

Michael: 41:39

Like, it would be very unfortunate if you're trading this thing and you look at it and you say, okay, well, that's a hammer, and then the last price goes off at the bid, and all of a sudden it's got like a, you know, a 5¢ upper wick and it's no longer a hammer. So by defining these things, you're gonna have to pick a cutoff at some point, right, which is the whole whole analogy there. But finding out where that cutoff's gonna happen is way easier to do when you've defined these things on some sort of a spectrum as opposed to a hard number, and you just know that, okay, if I'm a little bit more lax, I let in a 100 more trades, And then there's gonna be a point where you get to the the point and it kind of all falls apart because now you're just letting in any random trade in the world. So it it it is always gonna have to be a cut off at some point, but you're gonna have you're gonna have more data in which to decide what that is, as opposed to what it said in the textbook is supposed to be the the hammer candle.

Michael: 42:39

It's like really at the end of the day, who gives a shit what it said in that textbook? It's what is it that it's actually it's it's telling you at the end of the day.

Dave: 42:49

Yeah. Well, yeah, I I love this episode. I would like to hear comments from listeners, like, what you believe is the most popular pattern.

Michael: 43:02

Mhmm.

Dave: 43:03

But also, I'd like to hear, like, the craziest name of a pattern, like your your favorite craziest name for the for a pattern that you know of. There's so many. Yeah.

Michael: 43:14

There's so many, especially if you go on Wall Street Bets for any length of time, because these people just again, I I it's like you've got some of these, I guess, people that you would never wanna be a friend with, but you'd always wanna go drink with. Like, it's like just for the fun of it, I that's that's me and Wall Street bets. Like, would never want to trade with any of these people, but I just find them infinitely hilarious. And the the amount of patterns they come up with is a riot to me, because it's kind of like making a mockery of of the whole system as they go. But I'll be interested to hear that as well, and also the the kind of debate between when is it a candlestick pattern and when is it a price pattern.

Michael: 43:54

Yeah. And maybe, you know, especially if the person who asked the question didn't have my definition of candlestick pattern. If they had more Dave's definition, then may we do a whole another episode where we talk about those those specific patterns and what we do with those on top of candlestick. But very interesting, as always. And I, as always, I'm Michael Nauss.

Dave: 44:17

And I'm Dave Mabe. Talk to you next week on Line Your Own Pockets.