What Is a Memory-of-Price Strategy?
A memory-of-price trading strategy is one based on the premise that future prices are influenced by double top and double bottom resistance points experienced in the past. According to such a theory, historical prices that fit these technical patterns exhibit a sort of "memory" that informs subsequent price action.
- A memory-of-price strategy is a technical trading technique that assumes current and future price action is predicated on past performance.
- In particular, some technical traders believe that double top and double bottom patterns instill such a memory of price.
- Some traders reject memory-of-price strategies because they believe that prices instead exhibit a random walk, where past performance cannot inform future prices.
Understanding Memory-of-Price Strategies
A memory-of-price strategy assumes that a great deal of buying and selling needs to take place before prices can exceed or decrease below their previous double top or double bottom amounts. A double top is also known as a resistance price and a double bottom is also known as a support price. Only once these support or resistance prices are broken, will prices move in either direction.
Double top and double bottom refer to technical chart patterns in which there are two consecutive peaks or two consecutive floor levels, respectively. These numbers are a greater indicator of a turning trend in price, believed to mean that growth has stalled and should soon fall, or that a price has bottomed out and may soon be expected to climb once more.
The memory-of-price strategy is utilized most often by traders who have stops in place, used as risk controls, that prevent them from further trading. This can cause them to miss out on potential earnings. The profit margin for this type of strategy is low, while the potential for extreme losses is significantly higher.
Example: The Double Top Pattern
While the double top pattern may sound like a positive indicator, it typically points towards a coming decline. A double top is a charting tool that shows prices have reached their highest points two cycles in a row, implying that the market is about to turn because the asset is no longer climbing in value. Although values are stabilized in this scenario, the expectation is that this is indicative of stagnation before prices begin to decline.
Take as an example the charting of stocks for Tree Group, LLC. Their stocks have been on a slow and steady climb for the past six months. As we enter the seventh month the stock is trading at $55 per share. The eighth month once again indicates trading occurred at $55 per share. This would be a double top, having maintained the same peak rate of trade two months in a row.
Some investors may see this as an indication that share prices in the ninth month will drop below $55 each, since they have leveled out at the resistance price, indicating that it’s time to sell them. While this may save the investor from losing a small amount in the short term, their long-term return on investment may be reduced due to not holding onto the shares until they once again rebounded.