Return following signals from short term double bottom/top formations on the Oslo Stock Exchange 1996-2014

Research results from Investtech, 30 June 2017
Published in Norwegian on 13 June 2017. Norwegian original here >>

About the author
Geir Linløkken is the Head of Analysis and Research at Investtech, and is responsible for portfolios and money management. He founded Investtech in 1997, to provide independent technical analyses based on science and investor psychology. Mr. Linløkken has an MSc. in Computer Science, specializing in Mathematical Modeling, at the University of Oslo. He is the author of the book "Technical Stock Analysis". His daily work includes analysing stocks and developing quantitative methods for stock market investments.

Keywords: double top formation, double bottom formation, buy signal, sell signal, Oslo stock exchange, technical analysis, statistics

Abstract:

Geometric price patterns, like double bottom and double top formations, are used in technical analysis to predict future price development. Many investors use such patterns as an important part of their decision making process when buying or selling stocks. We have studied the price movements that followed short term signals from these formations on the Oslo Stock Exchange in a period of 19 years, from 1996 to 2014. The results indicate that classical technical analysis theory should be revised. The sell signals have been followed by a price increase stronger than average benchmark development, while buy signals have been followed by weaker development than benchmark. This is surprising, as previous research has shown that long term double top/bottom formations are in agreement with technical analysis theory.

Research into technical price formations

This research report is part of a bigger research project conducted by Investtech into price development following technical formations in stock prices. This report is on short term double bottom and double top formations on the Oslo Stock Exchange in Norway.

Short term Medium term Long term
Rectangle Report Report Report
Inverse/ head and shoulders Report Report Report
Double top, double bottom Present Report Report

Double bottom and double top formations

Identification of geometric price patterns in stock prices is an important area of technical analysis. The idea is that these patterns describe the investors’ mental state, i.e. whether they will want to sell or buy stocks in the time ahead, and they thereby indicate the future direction of the stock price. Double top and double bottom formations are two kinds of such patterns.

In theory a double top formation is a top formation which marks the end of a rising period. The formation consists of two tops of approximately the same width and height, see figure 1. The formation of a double top mirrors increasing pessimism among investors and signals the beginning of a falling trend. Double top formations are especially useful in predicting long term market trend reversals, but are also used in the shorter term.

There is an opposite version of this formation; the double bottom formation, see figure 2. This is a bottom formation which marks the end of a falling period. A double bottom formation signals increasing optimism among investors and the start of a rising trend.

Double top formation - sell

Figure 1: Sell signal from double top formation.

Double bottom formation - buy

Figure 2: Buy signal from double bottom formation.

In technical analysis terminology, a break down from a double top formation triggers a sell signal. Similarly a break upwards from a double bottom formation triggers a buy signal. We have studied the price movements following short term buy and sell signals from such formations on the Oslo Stock Exchange in Norway.

Identification

It is no easy task to identify double top formations in stock prices. The illustrations above show that the price forms two even tops of approximately the same size, before it breaks downwards and triggers a signal. However, stock prices are rarely as regular as these illustrations. The price will often be quite uneven and the tops will be of differing width or height.

Many investors identify price patterns by looking at price charts and drawing lines by hand. This method has many weaknesses, most of all that it is subjective, allowing you to see the formations you want to see, and it is very time consuming. Therefore we need an automatic algorithm whereby computers identify the formations and the signals they trigger.

Investtech has studied technical and quantitative analysis since 1997. We have developed mathematical algorithms for automatic identification of double top and double bottom formations in stock prices. The formations are entered into the technical analysis charts, shows in signal lists and presented updated daily to Investtech’s subscribers.

In this report we have looked at the price movements that follow short term buy and sell signals from double bottom and double top formations on the Oslo Stock Exchange. The statistics are based on formations automatically recognized by Investtech’s computer programs. No parameter optimization or changes to algorithms have been made during this study. This is an analysis based on the existing historical material.

The Base Data

We have used stock prices from 1 January 1996 to 10 October 2014 as the basis for the statistics. In this period, the main index on the Oslo Exchange rose from 106.9 to 573.6 points, which is 437 % or approximately 9.3 % a year. Compared to the risk free interest rate in this period, this is approximately what can be expected for similar periods of time.

In eight of these 19 years, the exchange rose by over 30 %, while it fell by more than 10 % in five of the years, and varied between minus 10 % to plus 30 % in five of the years. We have had both good and bad periods, and several sideways periods as well, and consider this representative for a normal period of time on the exchange.

All stocks that have been listed in the period are included. Stocks that have been delisted due to for instance mergers, takeovers and bankruptcy are included. However, we only have data for these companies for as long as they were listed. A company which went bankrupt will then have a final trading price which is not zero, which is a weakness in this study. However, this is only the case for a small number of companies. Most companies also fall a lot before they are delisted, so the difference between the price fall from when they were listed and a price fall down to zero will be small.
It is also very rare that new buy signals are generated from double bottom formations when a company’s stock price is falling. Therefore it matters very little to the statistics for buy signals. Return from sell signals would however have been a little weaker had we corrected for bankruptcies. Combined it is our opinion that these conditions have minimal impact on the results of this study.

All prices are adjusted for splits, dividend payments, reverse splits, and other corporate capital changes, in order to reflect the actual value development of the stocks.

715 time series are included, of which 597 are stocks with at least 66 days of trading. At the end of the period, approximately 220 stocks were listed on the exchange.

The stock’s daily closing price is used. We have only used prices and turnover figures from the stock’s primary market place. Alternative markets like Chi-X, Bats and Burgundy are excluded.

The Data Set

We have used Investtech’s algorithms for automatic identification of price formations. The algorithms were run on short term charts made up of 96 price days, approximately 5 calendar months. We consider the algorithms good at identifying actual double top and double bottom formations, and they do not classify indistinct patterns as actual formations.

At identification of signals, only data up to the date the signal was triggered were used. The later data were hidden from the algorithm.

All signals identified from double top and double bottom formations are used. Normally each formation only triggers one signal. However, in rare cases they may trigger several signals. This happens if the price following the break reacts back into the formation, creates a modified formation and then breaks out again.
Sometimes one stock can also trigger several signals on the same day. This happens if the algorithms have recognized several formations of different length and height which are broken out from at the same time.

In order to have the data set as representative for the Oslo Stock Exchange as possible, we remove certain signals from the data set:

  • Duplicate signals are removed. This will be the case when there have been mergers and ticker changes, where Investtech has two editions of the same historical time series. For instance, we remove a buy signal from DNB if we already have it for DNBNOR.
  • Signals that are very close in time to a previous signal are removed. It is a requirement that there have been at least seven calendar days since the previous signal from the same stock in order for a new signal to be counted.
  • Formations that are less than 2 % in height are discarded. These are small and considered to have low signal value.
  • Signals from stocks with poor liquidity are discarded. This is because it is difficult for investors to make actual trades in such stocks, and also because the price is often uneven and with big leaps, making pricing uncertain and subject to noise.
    We discard signals where daily average turnover on the Oslo Exchange in the past ten days including the signal day was lower than half a million Norwegian krone (NOK) or where the stock was traded on less than half the days. This also removed all signals from the exchange indices, leaving us with signals from stocks and equity certificates only, and a few traded funds. The actual turnover of stocks that gave signals may have been above this limit, as trade in other markets than the Oslo Exchange, like Chi-X, Bats and Burgundy, are not included.
  • Signals with less than 66 days' price history following the signals are removed. This gives complete price history for the first 66 days following the signals.

Our data set now consists of 796 identified buy signals from short term double bottom formations and 908 sell signals from short term double top formations in stocks and equity certificates on the Oslo Stock Exchange in the period 1996 to 2014.

Results

The chart below shows average price development following short term buy and sell signals from double bottom and double top formations. The signals are triggered on day 0. Only days when the exchange is open are included, so 66 days equal approximately three months. Buy signals are the blue line and sell signals are the red one. The shaded areas are the standard deviation of the calculations. Benchmark index is the black line.


Figure 3: Price development after buy and sell signals from double bottom and double top formations on the Oslo Stock Exchange identified by Investtech’s automatic algorithms in short term price charts. Click the image for bigger version.

Buy signals

Buy signal Day 1 10 22 66
Absolute 0.48 % -0.1 % -0.86 % 0.18 %
Benchmark 0.05 % 0.48 % 1.06 % 3.31 %
Relative, percentage points 0.43 -0.49 -1.92 -3.14
Statistical t-value 1.91 -1.26 -3.16 -2.97

The blue line in figure 3 shows average price development following buy signals from short term double bottom formations. After a rise on the first day, the price actually falls following such formations. This is the exact opposite of what technical analysis theory says should happen.

The price falls the most early on and after one month it is down by 0.9 per cent, which is 1.9 percentage points weaker than average benchmark. After three months, the price has reocvered a little, to a rise of 0.2 per cent, but this 3.1 percentage points weaker than benchmark.

Statistical t-values in one and three months are t=-3.2 og t=-3.0. Even though assumptions of normal distribution and independent samples are likely not fulfilled, this indicates a relatively good statistical connection between signals and the following negative excess return.

Note that these are signals from short term double bottom formations. We have results for long term double bottom formations that clearly support established technical analysis theory. Long term they do predict future price increase, see the research report here.

It now seems that the time perspective of the charts and formations can be considered to be an important factor for their predictive power.

Sell signals

Sell signal Day 1 10 22 66
Absolute 0.27% 0.93 % 1.55 % 4.77 %
Benchmark 0.05 % 0.48 % 1.06 % 3.31 %
Relative, percentage points 0.23 0.45 0.49 1.45
Statistical t-value 1.64 1.42 1.03 1.56

Figure 3 shows that sell signals from short term double top formations have been followed by increasing prices. The increase is an average of 1.6 per cent the first month after signal and 4.8 per cent the first three months. This is 0.5 and 1.5 percentage points excess return compared to average benchmark development.

This is also the exact opposite of what is predicted by technical analysis theory. Statistically the difference from a null hypothesis (i.e. that the sell signals have no predictive power) is t-values of 1.0 and 1.6. This is not enough to disprove any significance of the sell signals and predict a price increase. However, it is enough to disprove that stocks with sell signals on average give negative excess return.

The results thus indicate that established technical analysis theory, which says that stocks with sell signals from double top formations will see falling prices, is not in agreement with reality.

Note that these are signals from short term double top formations. We have research results for long term double top formations that clearly support established technical analysis theory.

It now seems that the time perspective of the charts and formations can be considered to be an important factor for their predictive power.

The Stockholm Stock Exchange in Sweden

Figure 4. Price development following short term buy and sell signals from double bottom/top formations on the Stockholm Stock Exchange.

We have conducted the same study on the Stockholm Stock Exchange in Sweden for the period 2003 to 2014. Investtech's computers identified 1,003 buy signals and 1,361 sell signals in this period.

The results from Stockholm are very similar to the results from Oslo. Compared to benchmark, prices increase following sell signals from short term double top formations and fall following buy signals from short term double bottom formations.

Summary

We have studied return from stocks on the Oslo Stock Exchange with breaks through double top and double bottom formations in Investtech's short term technical charts over a period of 19 years, from 1996 to 2014. Investtech’s automatic algorithms identified a total of 796 buy signals and 908 sell signals from such formations.

Stocks with buy signals from short term double bottom formations on average developed weaker than average benchmark following the signals. After one month they had a negative excess return of 1.9 percentage points, which increased to 3.1 percentage points after three months. Statistical t-values for one and three months were t=-3.2 and t=-3.0.

Stocks with sell signals from short term double top formations on average developed stronger than average benchmark following the signals. After one month they had an excess return of 0.5 percentage points, which increased to 1.5 percentage points after three months. Statistical t-values for one and three months were t=1.0 and t=1.6.

The results from Sweden show the same trend, but the figures are statistically slightly less significant than those for Norway.

The results are the opposite of what is predicted by established technical analysis theory. Sell signals have given a good price increase and excess return compared to benchmark. Buy signals have given negative exess return. Statistical ratios indicate good enough significance to disprove the theory.

We emphasise that these results are valid for short term formations identified in Investtech's short term price charts. For long term formations, we have research results that confirm the established theory.

These results indicate that the time perspective of the formations is an important factor when it comes to their predictive power. Looking into this may be an interesting topic for future research.

Literature

  • Investtech, Insight & Skills. Price formations. Link
  • Investtech, Insight & Skills. Buy signal from double bottom formation. Link
  • Investtech, Insight & Skills. Sell signal from double top formation. Link
  • Geir Linløkken. Return following signals from double bottom and double top formations - the Stockholm Stock Exchange 2003-2014 . Investtech.com, 2014. Link (in Swedish)
  • Geir Linløkken. Return following signals from rectangle formations - the Oslo Stock Exchange 1996-2014. Investtech.com, 2014. Link
  • Geir Linløkken. Return following signals from rectangle formations - the Stockholm Stock Exchange 2003-2014. Investtech.com, 2014. Link
  • Geir Linløkken. Return following signals from head and shoulders formations - the Oslo Stock Exchange 1996-2014. Investtech.com, 2014. Link
  • Geir Linløkken. Return following signals from head and shoulders formations - the Stockholm Stock Exchange 2003-2014. Investtech.com, 2014. Link (in Swedish)
  • Geir Linløkken og Steffen Frölich. Technical Stock Analysis - for reduced risk and increased returns. Investtech.com, 2001.
  • John J. Murphy. Technical Analysis of the Financial Markets. New York Institute of Finance, 1999.

 

Geschreven door

Geir Linløkken
Hoofd research en analyse
in Investtech

"Investtech analyseert de psychologie in de markt en geeft u iedere dag concrete trading-voorstellen."

Espen Grønstad
Partner & Senior Advisor - Investtech
 


Investeringsaanbevelingen worden gedaan door Investtech.com AS ("Investtech"). Investtech garandeert geen volledigheid of juistheid van de analyses. Eventuele fouten in de aanbevelingen, koop- en verkoopsignalen en mogelijke negatieve gevolgen hiervan zijn geheel het risico van de belegger. Investtech neemt geen enkele verantwoordelijkheid voor verlies, direct of indirect, als gevolg van het gebruik van Investtechs analyses. Meer informatie omtrent Investtechs analyses kunt u vinden op disclaimer.


Investeringsaanbevelingen worden gedaan door Investtech.com AS ("Investtech"). Investtech garandeert geen volledigheid of juistheid van de analyses. Eventuele fouten in de aanbevelingen, koop- en verkoopsignalen en mogelijke negatieve gevolgen hiervan zijn geheel het risico van de belegger. Investtech neemt geen enkele verantwoordelijkheid voor verlies, direct of indirect, als gevolg van het gebruik van Investtechs analyses. Meer informatie omtrent Investtechs analyses kunt u vinden op disclaimer.

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