Book: Kane Trading on: Advanced Fibonacci Trading Concepts
Kane Trading on:
A Key Chart Analysis Pitfall

I've had this article written for some time, but I never got around to 'cleaning it up' and posting it. I have quite a few other articles in addition to this one, and someday, perhaps, I'll get them posted. I discovered a very interesting thing some time ago when analyzing my own approach to 'reading' and studying charts, and I had planned some day to show this. It is quite a pitfall, and like many of the old carnival games, it is one that I think is exploited quite a bit, likely knowingly, by the many who try to sell 'weekend' courses on how to become a super-trader with little or no effort.
It all goes back to an idea familiar to anyone with a mathematics background, such as myself. There is a concept, which I will just briefly introduce here, called 'necessary and sufficient condition'. This, in short, means the condition one is discussing is both necessary for the desired or studied outcome to occur, and it is also sufficient for it to occur. This is not a very difficult concept to grasp, but until you 'see' it, it can be a bit tricky to get a handle on. An example should clear this right up.
Let's look at birds for our example. A necessary condition for an animal to be a bird is that it has to have wings. Let's not get caught up in details here, like an argument that penguins don't have wings (they do, they are just highly modified), and such. Now, is having wings a sufficient condition such that we can be sure we have a bird in our hands? No, what about insects, bats, and so on. They clearly aren't birds. So, we must have wings, they are necessary, but they aren't sufficient to show that we have a bird.
Now, how about feathers? Are they necessary? I'd say so. Again, let's avoid any arguments that penguins don't have feathers, because they do, they are just modified a bit. Are feathers also sufficient? Well, I can't think of any living animals that have feathers that aren't birds (again, let's not argue about the idea that some extinct dinosaurs may have been feathered, especially since they may also have been what evolved into birds), so this is also a sufficient condition to verify we have a bird.
In the first case, the wings, we had a necessary but not sufficient condition, and in the second case we had a necessary and sufficient condition. Although it is very subtle, it is also very mathematically important, as any mathematician will tell you. So, Jim, what has this to do with trading? As I hope to show now, just about everything, at least as far as my chart analysis goes. Let's move on to the process I was going through, the conclusions I was drawing, and how thinking in these mathematical terms 'saved' me.
In 'the old days' I'd take a starting approach to my study that basically hasn't changed much. I'd look at literally thousands and thousands of charts, scanning for anything noteworthy. Anything I thought might be able to give me another 'edge' to add to my collection. My approach was to look for patterns or conditions that were present when the desired outcome occurred, which was, for the most part, a strong, trending run. So far, so good.
I would start by looking at charts for the move I was trying to capture, as I explained in Kane Trading on: Trailing Stops. I would see a nice run, and I would make notes on the things I could observe on the chart right in the area where the move began. I would then look for another run, on the same issue or another, and make more of the same notes. I would do this for a large sample size, and study the notes for patterns and such.
Now, what I found was amazing. Not only did I find patterns and 'setups', I found them in profusion. I was totally blown away by what I had found. I was sure that I was not only some kind of a genius, I was also sure I'd be a trillionaire by the end of the week. Since I am not, to this day, a trillionaire, something must have 'went wrong' with my assessment. Let's see how it went up to this point.
I started to notice that many times I could identify a very specific set of conditions that happened in most, and many times, in every single case of the runs I was studying. I could see this very clear set of conditions line up, and a big run started right from that spot. I looked at the runs, and over and over it was happening in 100% of the cases. I started to think how I could spend a trillion dollars. I tried it out in real trading and it simply didn't work. In the vernacular 'I got my head handed to me'.
How could this be, it was 100%? So, I studied more charts, found different setups, again at or near 100%, and tried again. Ever see those wrestling matches where the one guy holds the other guy overhead and pile drives him into the canvas? That was the result when I tried the technique out. I was dumfounded, and baffled. Ever had this happen to you? No matter how many times I tried, the same thing happened. You mathematicians already see the punch line, I am sure.
Keep in mind, this was my 'early days', and I had a lot to learn. I couldn't see something obvious, and it took a lot of work until I figured this one out. It's one I feel many traders trying to make it never do figure out, and one the 'professional vendors' don't want you to figure out. It would ruin the carnival game, and have you working hard to develop skills instead of buying weekend promises, again.
What I had was a necessary condition, but not a sufficient one. I have the wings, but not the feathers. What does that mean in real trading terms? Easy. I didn't notice, because of how I was doing my studying, that perhaps this condition was happening a hundred times and it was not 'taking off', and then it was taking off once, and then another hundred that weren't.
I simply didn't see all those other ones, since I started with the desired results, and looked for what they all had in common. The condition may have been necessary for these runs, but it was far from sufficient. So, when I tried to trade it, I didn't realize it might set up and not give me the desired results most of the time. It's a simple idea, but from working with many traders over a long period of time I have seen this over and over, and it is how I started myself.
Nowadays, I do my analysis in much the same way. I still study the moves I want to capture, but instead of jumping up and down doing a money dance, literally, when I see something occurring just about every single time a run happens, I just get interested. I then start to look for that condition across the charts, without linking it to anything such as a run. I just look for it. Most of the time I find it all over the place, and it provides no useful edge for me.
I don't discard it from here even if it happens all over the place, as I still think it may have some use at some point. I write up detailed notes, and keep my eye on it as I do further chart studies. I've had things 'cooking' in the back of my mind for years and years, only to one day find a way to make use of them. I am trying, though, to find those setups that are both necessary and sufficient for a run. To do that, I simply put in the hours, and make sure I'm not in a necessary but not sufficient scenario.
This has kept me from doing a lot of foolish money dances singing the tune of 'I'm going to be a trillionaire' and saying to myself 'I think I'm going to buy a little island. Maybe Hawaii.', and other such nonsense. It's got me seeing things as they are, and that has helped me immensely in working my 'Trading Plan', putting in the time doing solid work, and not chasing unrealistic dreams that I heard about on an infomercial. I can focus on trying to succeed as a professional, just like other professionals do, from doctors to commercial airline pilots to attorneys.
I hope that this new perspective will help you avoid a common and easy to fall into trap in your chart analysis. This one is particularly malevolent because it is a 'wheel spinner'. It can have one doing the same thing, over and over and over, with little ability to see that they are trapped. Each new necessary but not sufficient find is soooo promising and so seemingly fantastic that you keep coming back into the trap, voluntarily. If I have helped you break free with this article, I'll have succeeded in my goal.
  NOTE: Reading this page or any page on the Kane Trading website, or utilizing this website and any material
  contained herein in any way, shall constitute an acknowledgment that you have read, understood and agreed
  to all the disclaimers, terms & conditions, and policies of this site
This website is best viewed with MSIE 6.0, text size set to medium, and screen resolution set to 1024 by 768.
Copyright © 2006 Kane Trading. All rights reserved.