Pattern Counter & Volatility
- : March 7, 2021
- : B. Krishnakumar
The week gone by has been pretty tough for positional traders due to the spike in volatility. If we could objectively identify a change in volatility regime, will it help in adjusting the strategy and / or deal with the new regime. It is possible. But the mechanics of the same is for you to sort out.
The purpose of this article is to identify or get a sense of trend and volatility regime using Point & Figure charts. Point & Figure is a wonderful charting method with unique features that helps in this regard. I would use the Pattern Counter feature to help us understand the volatility vs trend component.
If you are not aware of this Pattern Counter feature, then I request you to read my article on the feature. I explained about the logic behind calculation of the various scores.
Have a look at the Nifty 50 pattern counter scores across multiple box sizes.
The above table captures a wealth of information about the trend and volatility component of the market. Have a look at the trend ratio across multiple box sizes. The trend ratio is a small number suggesting lack of trend.
The scores in the Pattern Counter table are calculated by using the last four columns in the Point & Figure chart. The above chart visually captures the earlier assessment of trend & volatility. You can notice that lots of boxes of X & O are printed in the last four columns which is captured by the high range score of 132. But the number of boxes of X & O are almost equal in the last four columns suggesting lack of trend, which is captured by the low Trend Ratio score.
If you look at the column called “pattern” in the above table, it is clear that the pattern is not bullish in any time frame. We are in a bullish retracement in shorter time frames and in a consolidation in the bigger 1% box size. So, the data points are clearly suggesting lack of trend. There is no point in being bullish or taking bullish breakout trades until the pattern turns bullish and the trend ratio shows some improvement in the shorter time frames.
You can use a similar study in the smaller time frames too and get the similar information for any instrument. Let us take a quick look at the Nifty Futures data across multiple box sizes in 1-min time frame.
Again, it is apparent from the above table that there is no trending action in any box size. The pattern too is divergent across box sizes suggesting confusion. Remember, in a strong trending market, you would typically see the patterns to be in unison or may be there could be a retracement in the smaller box size.
In the above table, there is something interesting happening though. Have a look at the extreme short term time frame or the 0.05% box size. There scores in this box size indicates early signs of things turnaround for the bullish camp. The strength score has turned positive indicating more boxes of X are printed compared to O which is a bullish sign. The trend ratio is also healthy as of now.
Have a look at the range score across multiple box sizes. In the shorter time frame of 0.1% box size, the range score at 132, which is a high number suggesting lots of boxes of X & O are getting printed. But the trend ratio is not healthy at 13.64% suggesting that the X & O prints are evenly balanced.
In a strong trending market, the strength score and the trend ratio will be relatively high. Rule of thumb is that Trend ratio scores above 50% or below -50% can be considered as a sign of a strong trending market.
On the contrary, a high range score and a small trend ratio would be a sign of volatile market and indicates the absence of trend.
Armed with this basic information, let us take a look at the Nifty 50 0.1% box size Point & Figure chart. As observed earlier, the high range score along with a low trend ratio is a classic sign of volatile price action where lots of X & O are printed (which is reflected by high range score) without having a big influence on the price or trend.
Without even looking at the Point & Figure chart, I can easily gather so much information about the trend / volatility in the instrument, just by looking at the Pattern Counter scores. Here is the daily chart of Nifty 50 index in 0.1% box size.
If we get an improvement in the trend ratio, it would be an early sign of a turnaround in market sentiment in the short-term time frame. I would also pay attention to the strength and trend ratio in bigger box sizes to get an idea of how the term improvement in scores in the shorter time translates into bigger time frames.
The above chart is 0.05% box size Nifty Futures chart in 1-min time frame. The indicators plotted in the above chart are XO Count & XO Indicator. Choose the length as 4 and you will get the strength and range scores from the chart.
You can play around with this concept and design or tweak your strategy based on this concept.