Introductory Remarks: Challenging Community Perspective on Daytrading Patterns
Let me first address this example from Wikipedia's "Illusion of validity" that's been cited here:
Comparing the results of 25 wealth advisers over an eight-year period, Kahneman found that none of them stood out consistently as better or worse than the others. "The results," as he put it, "resembled what you would expect from a dice-rolling contest, not a game of skill." Yet at the firm for which all these advisers worked, no one seemed to be aware of this: "The advisers themselves felt they were competent professionals performing a task that was difficult but not impossible, and their superiors agreed." Kahneman informed the firm's directors that they were "rewarding luck as if it were skill." The directors believed this, yet "life in the firm went on just as before." The directors clung to the "illusion of skill," as did the advisers themselves.
This example only serves as a valid illustration that an entire industry is filled with clowns who would serve their company no better than monkeys if:
- Actual dice-rolling yields similar if not identical results (even a 0.1% gain on a 100mil portfolio buys me a house),
- The main point of the job is to be good at capital allocation. What about other skills that might be required and substantially complex? Think in terms of negotiating, consistent reporting, pitching, attracting new clients, etc., which are not represented by capital allocation decisions, and
- The strategists aren't actually purposefully trying to simulate rolling dice as maybe their intent is to diversify ad nauseam to simply hit their risk target. That way, they simply chase the market-based ROI as consistently as possible, which is entirely the point of many hedge funds.
TL;DR: Just because you're not getting superior returns to "rolling dice" doesn't mean you're a bad wealth manager. In fact, admitting you're no Warren Buffet and instead are going to diversify your funds in such a way that you hit market returns may be a very profitable strategy for a hedge fund or similar business models.
3-Bar Play: Sense and Nonsense
Now, let's actually discuss the main topic, which is the 3-bar play. The best descriptor of the 3-bar play is Jared from Live Traders. He did a 2-hour video on letting his viewers judge 3-bar set-ups and explained the dozens of reasons why this is not enough in its own right to base a trade off of. For him, it's a strong initial reason to take a deeper look into the stock. You need to consider volatility, trading volume, previously established support and resistance levels, and understand the strength of the set-up in its own right based on what the bars look like. And, any half-decent trader will ALWAYS tell you that you must backtest your strategies and hand-pick them (rather than testing hundreds algorithmically and being subject to obvious biases). So, if it doesn't work, it will never get past that stage.
Now, to give an example of scum who misinform the public and don't mention any of the above caveats: Wait, that's not a 3-bar set-up at all!
Just in the header this guy missed out on a couple of things:
1. 3-bar plays are not suitable for beginners, because of the sheer amount of additional inquiry that is required to understand when the set-up can be used for a trade, and when it can't.
2. The initial bar should be unusually long to indicate a very strong potential move in the direction of that bar. The bars after should serve as confirmation that we're likely headed in this direction.
The profitability of the strategy comes from the combination of being able to set relatively tight stop-losses and loose take-profits, resulting in a favorable risk-reward ratio, as well as being able to adjust the expected win rate by being stricter or looser when considering the criteria mentioned before.
The bad rep of the strategy, general short-term trading strategies, and trading educators comes from clowns such as the one in the picture who wouldn't think of doing a lecture on BAD set-ups and showing his audience they are not yet capable of trading the pattern he's explaining because they need to take into account additional factors.
As I've tried to demonstrate, the question is not if the pattern or educators are good or bad. It's about how you use it in conjunction with other indicators, understanding which educators are how knowledgeable and transparent on given subjects, and understanding the fundamentals on which the patterns and general daytrading are based. You're not going to build a house using just a hammer, and you're not going to have a fun time building one without it. We all need a toolbox, and 3-bar plays should be a sensible addition to that toolbox, not a hail-mary to take every trade that resembles it.
Closing Remarks: Challenging Community Perspective on Daytrading
Fundamentally, the reason that short-term trading is potentially profitable is because Warren Buffet won't - and can't - give a damn about any of this. Daytrading and similar strategies only work until the volume required to push 2% of your account size exceeds what you can put into stocks that are volatile enough to pass for daytrading. It becomes more profitable to identify good management, a good business model, a discounted price, which is what Berkshire does, has done, and always will do.
But, and that's my point, these two extremes of the investing spectrum can coexist, and clowns in either category do not prove anyone's point.