The higher highs and higher lows pattern signals an uptrend. Is this likely to continue or reverse?
In almost all markets, the higher high and higher low pattern signals weak future short-term gains. Unfortunately, it doesn’t work as a short strategy.
The higher highs and higher lows pattern
The pattern is pretty self-explanatory, but let’s show it on a chart:
We can see that the three days marked in the chart all have both higher highs and higher lows. As a matter of fact, we have four consecutive days like this if we include the one prior to those three.
Is higher high and higher low a reversal or trending pattern?
There is only one way to find out: let’s backtest.
We backtest three different asset classes: the S&P 500 (SPY), the gold price (GLD), and long-term Treasuries (TLT).
Trading strategy 1: two consecutive days of higher highs and higher lows
If we have two consecutive daily bars with higher highs and higher lows, we enter at the close and we exit after 1-10 bars. We use the optimization function in Amibroker.
This is the result in S&P 500 (SPY):
The first column shows which day we exit. The first row shows that the one-day average gain is a tiny 0.01 (we are holding from the close until the next day’s close). A holding period of two weeks (ten trading days) has an average of 0.23%. That tiny gain is just half the random gains over a two-week period.
Clearly, the longer the holding period, the better the result. This is expected because of the long-term tailwind by owning stocks.
The number of trades declines the longer the holding periods. This is due to the clustering of trades because many trades happen in a short period of days.
This is the result in the gold price (GLD):
There seem to be a quite similar pattern in the gold price as in the S&P 500: poor returns after higher highs and higher lows.
The two-week average gain is significantly lower than the random two-week period (0.37%).
This is the result in long-term Treasuries (TLT):
The test period has been influenced by falling interest rates and thus higher bond prices. Despite this, we see that the short-term return is negative. The two-week holding period corresponds to the same return as any random two-week period.
Can we improve the higher highs and higher lows pattern?
Unfortunately, it doesn’t help to increase to three or fours days of consecutive days of higher highs and higher lows. Neither long nor short works.
Conclusion about the higher highs and higher lows pattern
Our tests reveal that the higher highs and higher lows pattern is a typical short-term reversal pattern. However, it’s not powerful enough on its own to use as a trading signal.
We suspect there are other patterns and indicators that offer better rewards for such a short holding period. Please have a look at our free trading strategies or monthly Trading Edges.
