Higher Highs and Higher Lows Pattern Trading Strategy & Insights – Rules, Setup, Backtest

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.

Key takeaways

• We examine the effectiveness of the “higher highs and higher lows” pattern, traditionally viewed as an indicator of an uptrend in financial markets.
• Through backtesting across various asset classes, including the S&P 500 (SPY), gold (GLD), and long-term Treasuries (TLT), our study found that this pattern often leads to weak short-term gains, suggesting it’s more indicative of a short-term reversal rather than a continuation of the uptrend.
• Additionally, the pattern did not prove effective as a short strategy, and extending the pattern to three or four consecutive days did not yield better results.
• The conclusion is that relying solely on the higher highs and higher lows pattern may not be sufficient for successful trading strategies.
• The pattern is the opposite of the lower highs and lower lows pattern.

The higher highs and higher lows pattern

The pattern is pretty self-explanatory, but let’s show it on a chart:

The three days marked in the chart all have higher highs and lower lows. If we include the one before those three, we have four consecutive days like this.

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 successive daily bars with higher highs and higher lows, we enter at the close and exit after 1-10 bars. We use the trading strategy 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 longer the holding periods, the fewer trades there are. This is due to the clustering of trades, which occurs when many trades occur in a short period of time.

This is the result in the gold price (GLD):

The gold price seems to follow a quite similar pattern to 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, increasing to three or four consecutive days of higher highs and lower lows doesn’t help. 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 other patterns and indicators offer better rewards for such a short holding period. Please have a look at our free trading strategies.

FAQ:

Can the higher highs and higher lows pattern be used as a short strategy in trading?

According to the content, the pattern is not effective as a short strategy, and the backtesting results do not support its reliability for generating significant returns.

What was the trading strategy used in the backtesting of the higher highs and higher lows pattern?

The backtesting strategy involved entering trades after two consecutive daily bars with higher highs and higher lows and exiting after 1-10 bars, with variations in holding periods.

How did the higher highs and higher lows pattern perform in the backtesting of long-term Treasuries (TLT)?

Despite the influence of falling interest rates, the backtesting results for long-term Treasuries (TLT) showed a negative short-term return after the higher highs and higher lows pattern.