Developing Expertise Through Pattern Recognition

The second major answer to the question of trading expertise is that of pattern recognition. The markets display patterns that repeat over time, across various time-scales. Traders gain expertise by acquiring information about these patterns and then learning to recognize the patterns for themselves. An analogy would be a medical student learning to diagnose a disease, such as pneumonia. Each disease is defined by a discrete set of signs and symptoms. By running appropriate tests and making proper observations of the patient, the medical student can gather the information needed to recognize pneumonia. Becoming an expert doctor requires seeing many patients and gaining practice in putting the pieces of information together rapidly and accurately.

The clearest example of gaining trading expertise through pattern recognition is the large literature on technical analysis. Most technical analysis books are like the books carried by medical students. They attempt to group market “signs” and “symptoms” into identifiable patterns that help the trader “diagnose” the market. Some of the patterns may be chart patterns; others may be based upon the identification of cycles, configurations of oscillators, etc. Like the doctor, the technical analyst cultivates expertise by seeing many markets and learning to identify the patterns in real time.

Note how the pattern recognition and research answers to the question of expertise lead to very different approaches to the training of traders. In the research perspective, traders learn to improve their trading by conducting better research. This means learning to use more sophisticated tools, gather more data, uncover better predictors, etc. From a pattern recognition vantage point, however, trading success will not come from performing more research. Rather, direct instruction from experts and massed practice leads to the development of competence (again like medical school, where the dictum is “See one, do one, teach one”).

Another way of stating this is that the research viewpoint treats trading as a science. We gain knowledge by uncovering new observations and patterns. The pattern recognition perspective treats trading as a performance activity. We gain proficiency through mentoring and constant practice. This is the way of the athlete, the musician, and the craftsperson.
Can expertise be acquired by learning patterns from others and then gaining experience identifying them on one’s own? It would seem so: this is traditionally how chess champions and Olympic athletes develop.My conversations with traders who have enrolled in this service leave me with little doubt that they have acquired profitable skills, eventually moving on to becoming successful independent traders. Richard Dennis’ experiment with the “Turtles” is perhaps the most famous example of how expertise (in this case, a pattern-based trading system) can be successfully modeled for people with little market background.

And yet there are nagging doubts about the actual value of the patterns typically described in market books and tapes. A comprehensive investigation of technical analysis strategies by Bauer and Dahlquist found very little evidence for their effectiveness. An attempt to quantify technical analysis patterns by Andrew Lo at MIT found that they did, indeed, contain information about future market moves, but hardly as much as isportrayed in the popular literature. Because pattern recognition entails a healthy measure of judgment, it is very difficult to demonstrate its efficacy outside of the expert’s hands. In other words, the expert trader may be utilizing more information in trading than he or she can verbalize. This is certainly the case for chess experts and athletes. While they can describe what they are doing, it is clear that their proficiency extends well beyond the application of a limited set of rules or patterns.

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