Back-testing

Back-testing

January 16, 2019 Off By Chuck

A book on classical charting would use the chart below of Carvana, CVNA, as an almost perfect example of a head and shoulders topping pattern. Not only does it show almost perfect symmetry but also what can happen immediately after the pattern confirms, a back test.

When I speak of confirmation, I am just referring to price actually breaking and holding below support (red horizontal line). What happens quite frequently once a pattern confirms is a back-test to the (red) support (now resistance) line. Ideally, if you missed the opportunity to short the pattern on the break down, a back-test provides a wonderful opportunity to enter. Additionally, the risk is very small as a break back above the support line (now resistance) would invalidate the pattern and signal its time to cover the short. Typically, with a back-test entry all you are risking is 3-4%.

What makes this “opportunity” a higher probability to occur, is that price is below both the 50 and 200-day moving averages which are bearishly aligned (the 50 is below the 200). This pattern has an associated target all the way back down to $2 (no, not a typo) which is unrealistic. so taking the higher probability alternative, the first target is instead down at last May’s lows near $24, an almost 35% decline from the back-test level. With this opportunity providing more than an 8:1 reward to risk ratio, this is an outstanding setup for those with both able and capable of shorting stocks.