Automating Chart Patterns: A Deep Dive into Three Essential Algorithms | by Nilay Parikh | February 2024

PIPs stand out by focusing on the visual impact of price movements, selecting points based on their perceptual prominence within a portion of price data.

Mechanics

The algorithm starts with the first and last data points and iteratively selects additional points that exhibit the maximum distance from a line connecting other significant points.

Implementation

The Python function recursively finds new PIPs by calculating the distance (vertical, Euclidean, or perpendicular) from each point to the line and selecting the one with the maximum distance. This process continues until the desired number of PIPs is reached.

import yfinance as yfimport numpy as np

def detect_pips ( data , threshold ): pips = []for i in range(1, len(data) – 1):# Check if the current data point is above the threshold and higher than its neighbors’ data[i] > threshold and data[i] > data[i – 1] and data[i] > data[i + 1]:pips.append((i, data[i])) # Add the index and value of the PIP# Check if the current data point is below the negative threshold and lower than its neighbor self data[i] < -threshold and data[i] < data[i - 1] and data[i] < data[i + 1]:pips.append((i, data[i])) # Add the index and value of the PIPreturn kernels

# Download S&P ETF data from Yahoo Financesp_etf = yf.download(‘^GSPC’, start=’2020-01-01′, end=’2024-01-01′)[‘Close’]

# Calculate daily returns daily_return = sp_etf.pct_change().dropna().values

# Set the threshold for detecting PIPsthreshold = 0.02 # Adjust as needed

# Detect PIPs in the S&P ETF daily returns = detect_pips(daily_return, threshold)

# Print the detected PIPsprint(“Detected PIPs:”) for pips in pips:print(“Index:”, pip[0]”Value:”, pip[1])

Algorithmic Trading Strategies:

Perceptually important points (PIPs) can be valuable in various advanced algorithms and trading strategies across different domains, especially in financial markets. Here are some strategies and algorithms that PIPs can use and why they are important:

Pattern Recognition:

Chart Patterns: PIPs are often used to identify key chart patterns such as double tops, double bottoms, heads and shoulders, and triangles. These patterns often involve significant price movements that are considered PIPs, and they can indicate potential trend reversals or continuations.

Volatility Based Strategies:

Volatility Breakout: PIPs can indicate periods of increased volatility in the market. Volatility breakout strategies aim to capitalize on sharp price movements following periods of low volatility. By identifying PIPs, traders can enter positions in anticipation of significant price breakouts.

Trend Following Strategies:

Moving Average Crossovers: PIPs can confirm trend changes identified by moving average crossovers. When a shorter-term moving average crosses above a longer-term moving average, it can signal the start of an uptrend, especially if accompanied by PIPs that confirm the move.

Support and Resistance Identification:

Support and Resistance Levels: PIPs often occur at support and resistance levels, which are areas where the price tends to find buying or selling pressure. Traders use PIPs to identify these levels and make trading decisions based on how the price reacts to them.

Risk management:

Stop Loss Placement: PIPs can be used to set stop loss orders to limit potential losses in trades. By placing stop-loss orders just outside significant PIPs, traders can help protect their capital and effectively manage risk.

Algorithmic Trading:

Automated Trading Systems: PIPs can be incorporated into automated trading systems to generate buy or sell signals based on predetermined criteria. Algorithms can be programmed to detect PIPs and automatically execute trades when certain conditions are met.

Quantitative analysis:

Statistical Arbitrage: PIPs can be used in statistical arbitrage strategies to identify mispriced securities and take advantage of temporary price differences. Quantitative models can incorporate PIPs as part of the trading signals to determine entry and exit points.

In summary, PIPs are important because they represent significant price movements that can indicate potential trading opportunities, trend reversals, or areas of support and resistance. By incorporating PIPs into advanced algorithms and strategies, traders and investors can improve their decision-making process and improve the performance of their trading systems.

Strengths and limitations

PIPs offer a balance between time and price focus, making them versatile for various applications, including data mining for new patterns. However, the choice of distance metrics and the number of PIPs can significantly affect the algorithm’s output.

Each algorithm – Rolling Window, Directional Change, and PIPs – brings a unique perspective to the identification of local tops and bottoms. The Rolling Window method is a testament to the power of simplicity, Directional Change underscores the importance of price movements, and PIPs provide a harmonious blend of time, price and visual meaning.