67% success for buy signals

A recent research report by Investtech.com shows that buy signals from rectangle formations for stock price charts are successful in 67% of cases.

In technical stock analysis one studies the investors' behaviour within the market, with the aid of charts. The aim is to predict future stock price development, in order to reduce the risk and increase the expected return for an investment. An important part of technical analysis is identifying particular geometrical patterns in stock price charts. The idea being that these describe the psychological state of the market, and therefore indicate the further direction of the stock price.

Investtech has since 1997 developed technical analysis systems, based on advanced mathematics and statistics. The company analyzes over 25,000 stocks on a daily basis. The analyses include specific recommendations based on charts with support and resistance, trend channels and formations, model portfolios and screening systems for stock selection. The company has developed automatic programs for identifying rectangle formations and the signals they trigger.

Investtech’s Head of Research, Mr Geir Linløkken, has in a recent research report analyzed the predictive value of buy signals triggered by rectangle formations. Mr Linløkken has based his research upon a dataset comprised of 629 identified buy signals, triggered by rectangle formations, during the period 1996 to 2004. These rectangles had an average length of 96 trading days, and an average height of 15 percent.

-We have seen some extremely interesting results, says Mr Linløkken, pointing out that as many as 67 percent of the signals triggered by rectangle formations have proved to be successful.

The research report from Investtech shows that only 7% of the signals met their targets during the day the signal was given and the following day, whilst 53% were successful during the course of half a formation length, and 76% over a period twice the length of the formation.
-The fact that there are as few as 7% after one day is positive, remarks Mr Linløkken, since this indicates that investors can receive large profits, even if they don’t buy in immediately. After half of the formation length, however, we see that over 50% of the signals have already met their targets, so neither should one wait too long before buying into such stocks.

Linløkken emphasises the fact that the dataset, which the report bases its conclusions upon, is seen as being representative for an average trading period, within an average market. The time period of 9 years is relatively long and there have been both rising and falling years, along with a number of periods with sideways development.
-Given the assumption that the investors' collective psychological behaviour in the stock market is constant over time, we believe that buy signals from rectangle formations will produce similar results in the future, concludes Mr Linløkken.

The complete research report can be found here.

Figure 1. A rectangle formation with a buy signal. The stock price has for some time moved between two almost parallel and horizontal lines. The lower line is called the support line and the upper line is the resistance line. When either the support or resistance lines are broken, then the theory of technical analysis says that the stock price will continue in the same direction for at least as long as the rectangle is high, which is illustrated here by the green arrow. This level is denoted as the formation's target and should ideally be reached within a time period which is the same length as the formation.