A dynamic trading rule based on filtered flag pattern recognition for stock market price forecasting

We propose an automatic and dynamic trading rule based on flag pattern recognition.The strategy does not depend on the ability of the trader to guess the best configuration of the trading rule.We include several filters for the trades, one of them considering the EMA indicator in short and medium timeframes.The trading rule is applied on a large intraday database for the DJIA index.We can conclude that our proposal is far superior to the previous flag pattern strategies as regards both profitability and risk. In this paper we propose and validate a trading rule based on flag pattern recognition, incorporating important innovations with respect to the previous research. Firstly, we propose a dynamic window scheme that allows the stop loss and take profit to be updated on a quarterly basis. In addition, since the flag pattern is a trend-following pattern, we have added the EMA indicator to filter trades. This technical analysis indicator is calculated both for 15-min and 1-day timeframes, which enables short and medium terms to be considered simultaneously. We also filter the flags according to the price range on which they are developed and have limited the maximum loss of each trade to 100 points. The proposed methodology was applied to 91,309 intraday observations of the DJIA index, considerably improving the results obtained in the previous proposals and those obtained by the buy & hold strategy, both for profitability and risk, and also after taking into account the transaction costs. These results seem to challenge market efficiency in line with other similar studies, in the specific analysis carried out on the DJIA index and is also limited to the setup considered.

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