Welcome to this introduction to Quality Indicators.
We initially developed our Quality Indicators for chart patterns, and the intention behind
it was to help people that were unfamiliar with chart patterns, to be able to distinguish
between better quality patterns and ones that were less well-formed.
In this video I will be discussing not only the Quality Indicators on chart patterns,
but also how we aimed to achieve a similar set of helping indicators with our other types
of analysis - Key Levels and Fibonacci Patterns.
But first, let’s start with the Chart Pattern Quality Indicators.
There are five different Quality Indicators on chart patterns, and four of the five are
measures of visual quality.
They are characteristics of the pattern that you can see yourself on the price graph.
As traders gain more experience in using chart patterns, it tends to become second nature
for them to immediately spot these visual queues, but for people new to chart patterns,
these indicators can be essential to their trading decisions.
Each indicator scores a value between zero and 10, and these are illustrated graphically
as a number of coloured squares in this area on the right of the pattern display.
For example, this pattern got a very high score for breakout, but not so high for initial
trend.
Let’s look at each in more detail.
The first indicator I would like to discuss is Initial Trend.
This is particularly important to patterns that form during trending market cycles, such
as triangles.
The theory of charting suggests that the move after the pattern breaks out is often in some
proportion to the size of the initial trend.
That makes this a very important indicator of pattern quality.
This is an example of a strong initial trend, where the price graph made a long rally towards
the first touching point of the pattern, in contrast with this example of a weak initial
trend that had hardly any initial rally, in fact it looks more like the initial trend
came from the wrong direction altogether - the initial trend was supposed to be bearish.
The second indicator (and I'm not discussing them in any particular order of importance
or anything), is Clarity.
This is a measure of the amount of noise and volatility that can be seen on the price graph.
If the price graph looks smooth like this one, then you can expect a good quality rating,
but if the graph is noisy or choppy like this one, the clarity rating decreases.
You may find that the clarity rating becomes more accurate with patterns of greater length.
The next indicator is breakout strength - this is a score for the momentum with which the
price punched through thesupport or resistance.
Remember, breakout is only achieved when the closing price of a bar is outside of the support
or resistance line - not the high or low.
So if the closing price is a significant distance beyond the boundary of the pattern, breakout
is strong.
Otherwise when it crossed the support or resistance only just by a mathematically insignificant
margin, we rate breakout low.
What it means in the theory, and more so in common sense actually, is that if the price
has strong momentum, it betters the chances of reaching the target level.
Then we have Uniformity.
This is also an indicator that tells us whether a pattern will look aesthetically pleasing.
If the points on a pattern where the price touches the support and resistance lines are
evenly or uniformly spaced, then it suggests that the psychology in the minds of traders
had time to have its effect on the market.
For patterns such as triangles where the support and resistance converge, the spacing will
naturally become closer - this is still ok, because it looks natural and normal.
But, when you find two or three touching points all scrunched together in one corner of the
pattern, even your instinct will tell you that this is not a very well-formed pattern,
and it is not good-looking.
So these first four quality indicators are really measures of how good-looking the patterns
are.
There is a fifth indicator, but it only applies to exchange traded instruments, where there
is a value for the volume of trade that was made on an instrument.
If it applies, like on most stocks, then this quality indicator is a measure for how the
volume traded has increased towards the end of the pattern formation.
Volume is a very important confirmation of the market's acceptance of changes in price.
If volume goes up it means that there are more people involved.
More people meanmore opinions and broader reach of the market psychology mechanism,
that these patterns are based on.
These five are Quality Indicators for chart patterns, and then we have a 6th measure,
"Overall Quality", that is a simple arithmetic average of the five scores together.
This average is also the quality score you would see here in the results grid.
Now let's look at the Fibonacci Quality Indicators.
There are three Quality Indicators for Fibonacci, and one of them is clarity, which is calculated
in exactly the same way as for chart patterns, and it means the same thing - if the price
graph is choppy and spikey and volatile, the clarity rating will be lower.
The other two quality measures for Fibonacci are Price Symmetry and Time Symmetry.
In the video called Fibonacci Patterns, where I have given an overview of them, I gave the
following explanation for price symmetry: Fibonacci patterns form where the price difference
between certain turning points on a graph are in proportion to one another that are
equal or related to the Fibonacci ratio.
Because prices are discrete, meaning we count it in units of cents or pips - not to an arbitrary
number of decimal points - it would rarely happen that we hit the Fibonacci ratio right
on the spot.
We would always be out by a small fraction.
So for this type of analysis to be practical, we use a small error margin, and we say that
if we are closer than that to the real ratio, then it is acceptable.
But obviously some patterns end up closer to the real ratios than others - and this
is what Price Symmetry measures - how close we came to the actual Fibonacci ratios within
the acceptable error parameter.
Let's take a look now at Time Symmetry.
When we look for Fibonacci ratios, we actually only pay attention to differences in price.
This could mean that we have Fibonacci patterns that look rather awkward, especially if there
were unexpected spikes or long slow price movements.
But if we were to look for the same Fibonacci ratios on the time axis, then the proportions
of the patterns would be much more natural.
So Time Symmetry is a simple measure of where the Fibonacci ratios on the price axis are
mirrored on the time axis.
This would automatically have a positive effect on the pattern's aesthetic appeal.
With Key levels we only have a single Quality Indicator, which we also covered in the video
on Key Levels, and that is the number of touching points that have confirmed the level.
There is also some small margin of error, so it is allowed for touching points to be
within a small price difference from one another in order to be considered "on the samelevel".
The more points we have on the level then, the more times it has been confirmed, and
the greater our expectation is that it will be upheld - or, if it is breached, then the
greater the move will be beyond it.
So in summary, remember the Quality Indicators are aides that most often help you determine
the visual quality of patterns, they are not so robust that you can base an algorithmic
trading system on them - you still need to be involved in the process, using your own
judgement and making up your own mind about what works for you and what doesn't.
I hope this has been a helpful video, and if you need any further help you can contact
us on support@autochartist.com - we would always do our best to help you with what you
need.
Thanks for watching this video