Where's Waldo? An example of technical pattern recognition

Keywords: trading, pattern recognition, technical analysis, back-test, performance, systematic, figures, close, reversal, reaction, fx.

Disclaimer: The study reflects only my views and is not of my employer. All back-tests are not assumed to reflect the reality due to many factors that may distort the values. Back-tests should only be taken as a proxy and not an accurate measure.

Tom Demark, the renowned famous technical analyst has created many successful indicators and patterns. Among his many discoveries, he came up with 7 different price patterns that he dubbed as "Waldo patterns". Inspired by the cartoon Where’s Waldo? Tom has developed these patterns to find short-term tops and bottoms. Any trader or even a receiver of such information would be excited knowing about this, but with hindsight and confirmation bias, the person seeing this, will test the patterns on the chart and focus on the ones that work while disregarding the ones that do not. The only way to remedy this problem is by developing a systematic trading strategy based on these patterns, and that is precisely what we are going to do. In this study we will limit our test to two of the 7 patterns, Waldo #5 and Waldo #8. (The numbering of the patterns starts at 2 which is why Waldo #8 is the seventh pattern).

The time frames used will be hourly and spanning from 2010 until around November 2019. The below definitions and conditions are taken almost word for word from a great book written by Jason Perl: DeMark Indicators (Bloomberg Market Essentials: Technical Analysis)

Back-test conditions:

• Test assets: EURUSD, GBPUSD, and USDCAD.
• Transaction cost: 0.5 pips per trade.
• Position sizing: $10,000 (1 mini lot).
• Starting balance: $1,000.
• Risk management: 35 pips stop-loss and 120 pips target.*
• Holding period: 4 bars (In case neither stop or target has been reached in 4 bars).
• The buying or selling occurs on the open of the next price bar after the pattern has been validated.

TD WALDO #5

To find a potential short-term top:

• The current bar's close should be equal to the close of the previous price bar.
• The close of the previous bar should be higher than the close of the bar before it.

To find a potential short-term bottom:

• The current bar's close should be equal to the close of the previous price bar.
• The close of the previous bar should be lower than the close of the bar before it.

Test asset 1: EURUSD 2010-2019

The below chart shows the equity curve of the strategy, i.e. Your account evolution.

The below chart shows the signal and the open price of the asset (which is why sometimes, the condition may seem not satisfied for a trigger).

Test asset 2: GBPUSD 2010-2019

The below chart shows the equity curve of the strategy, i.e. Your account evolution.

The below chart shows the signal and the open price of the asset (which is why sometimes, the condition may seem not satisfied for a trigger).

Test asset 3: USDCAD 2010-2019

The below chart shows the equity curve of the strategy, i.e. Your account evolution.

The below chart shows the signal and the open price of the asset (which is why sometimes, the condition may seem not satisfied for a trigger).

TD WALDO #8

To find a potential short-term top:

• The close of the current bar must be higher than all seven prior highs.
• The close of the current bar must be lower than the close of five bars earlier.

To find a potential short-term bottom:

• The close of the current bar must be lower than all seven prior lows.
• The close of the current bar must be higher than the close of five bars earlier.

Test asset 1: EURUSD 2010-2019

The below chart shows the equity curve of the strategy, i.e. Your account evolution.

The below chart shows the signal and the open price of the asset (which is why sometimes, the condition may seem not satisfied for a trigger).

Test asset 2: GBPUSD 2010-2019

The below chart shows the equity curve of the strategy, i.e. Your account evolution.

he below chart shows the signal and the open price of the asset (which is why sometimes, the condition may seem not satisfied for a trigger).

Test asset 3: USDCAD 2010-2019

The below chart shows the equity curve of the strategy, i.e. Your account evolution.

The below chart shows the signal and the open price of the asset (which is why sometimes, the condition may seem not satisfied for a trigger).

*The average risk-reward ratio refers to the realized ratio, as in live trading, you will not always get the expected risk-reward ratio, which in our case is 3.42.

Conclusion

The results show no added value whatsoever from Waldo #5 and Waldo #8 on the tested pairs with the given conditions above. Other conditions have been tested but the results were as disappointing as the above. The key point from this study is that theoretical patterns are not holy grail and should not be used without personally making sure they add value. One might wonder how these patterns were ever included in a textbook. Other Waldo patterns have been tested and showed no big difference from the above, making the Waldo group not great for any trading algorithm. Nevertheless, other external patterns do add value (some come from the great DeMark himself). I guess the best answer to this study is by wondering whether we should be asking:

Where's alpha rather than where's Waldo?

Sofien KAABAR.