Cybernetic Trading Strategies: Developing a Profitable Trading System with State-of-the-Art Technologies

14

Mechanically Identifying and Testing Candlestick Patterns

Candlestick chart analysis is a subjective form of analysis. The analyst must first identify the patterns and then judge their significance. For example, a white hammer pattern is more bullish after a major downtrend. Several software vendors have developed software to automatically identify candlestick patterns. Some of these products also generate mechanical trading signals. Generally, these packages do well at identifying the patterns, but they have mixed results in using their mechanical trading signals.

In this chapter, we will use fuzzy logic to identify several candlestick patterns using TradeStation. We will also show you how to integrate other forms of technical analysis with candlesticks to develop mechanical trading signals.

HOW FUZZY LOGIC JUMPS OVER THE CANDLESTICK

Let's now see how fuzzy logic can be used to analyze candlestick charts. In our height example, we saw that the first step in developing a fuzzy logic application is to list the variables involved and then develop a list of attributes for each variable. For a single candlestick, the attributes are as shown in Table 14.1.

TABLE 14.1 A CANDLE'S ATTRIBUTES.

Color White or black Shape Long, small, or about equal Upper Shadow Size Long, small, or about none Lower Shadow Size Long, small, or about none

Not all variables require fuzzy logic. In our ...