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Jun 26 2008
Candlesticks in trading have two main purposes;
One is to tell the trader the open, low, high and closing price of that particular time period, and two, whether the close was higher (green bodied), or lower (red bodied) than the open.
However they can alert the trained eye to pending reversals offering the chance for a trader to get a head start on a possible new trend, or to alert the trader who is already in the markets that the trend is ending and to tighten stops or take profits now.
The two candlestick patterns we are demonstrating here is the hammer (& hangman), and the tweezers (also known as railway tracks).
When looking at either pattern, they look quite different, however when it comes to what is going on in the market place, the same thing is happening. So let’s see what that is.
After a significant run up in price, the market will exhaust itself or be overbought; however this is when the most action usually takes place. The reason is because towards the end of the trend, the misinformed public are still buying, not wanting to miss out on what is probably a well talked about market and trend. However at the same time, the professional traders are the ones selling to the misinformed public.
This activity creates a resistance to any higher prices because all the late buying is being absorbed by the professional selling. On a candlestick chart, this will often be shown by either a bearish pair of tweezers or a hangman. Essentially price moves up and then moves all the way back down again, in the space of one or two candles (see diagram below).
Likewise, after a significant move down the market will exhaust itself or be oversold; the misinformed public are the ones selling because they can’t handle their losses anymore, and the professionals are the ones buying from them.
Again, this activity creates support for price and the candlestick patterns will show price move down and then all the way back up again. This is shown by a bullish pair of tweezers or a hammer.
The bearish tweezers pattern and the hangman show the same activity, price moves up, and then moves back down roughly the equivalent amount. The bullish tweezers pattern and the hammer show the same, price moves down and then moves back up roughly the same distance.
If you look at the diagram below, you’ll see this in action. The main difference between the tweezers and the hangman or hammer is the time period. The tweezers are two candles, but the activity is the same. The other difference is that the colour of the hangman or hammers body is not relevant because the open and close are very close to each other.
Two things that make these candlestick patterns more powerful is when the range of the candles are longer than the average range, and there is higher than average volume to go with it.
Jun 16 2008
Oscillators are great tools when used wisely. They offer many ways in which they can be used, divergence, over bought/over sold, crossovers to name a few.
They can also be used to get a feel for the markets, whether trending or in a range.
If a trader wants to use oscillators to get a feel for the markets, what they need is some recent price action and a belief that the current trend or range will continue long enough to create some more opportunities.
For example, if you believe you are in an uptrend, and the trend has quite a way to go, you can then use an oscillator such as the ‘stochastics oscillator’ to tell you how deep the corrections are likely to go, based on how the oscillator behaved recently.
All you need to do is adjust the oscillators variable until the indicator produces a repetitive signal and one that you feel you can use.
Take a look at the chart below.
This is a daily chart and what has been added is a stochastics with a 25,5,5 setting. The most important variable was the first number, 25. Not because 25 works better than any other number, but because for this market, during this trend, 25 offered simple triggers as to when the corrections were likely to end and the trend continue, as shown by the arrows.
All you do as the trader is determine what number gives you the best signals or triggers for a possible trade.
When in an uptrend, look to use the oscillator as a signal that a correction is ending, and not when the trend itself is ending. Likewise, in a downtrend, use the oscillator as a signal that a bear market rally is ending, and not the downtrend itself.
However, when in a ranging or sideways market, you can use the oscillator as a way to signal when the top and the bottom of the range have been made.
Jun 16 2008
During trending markets you will always have corrections. They are an inevitable part of a trend, and as such provide excellent trading opportunities.
What’s more corrections can often appear as certain shapes and structures that can be seen quite easily to the trained eye, offering similar opportunities time and time again.
One of those familiar shapes or structures is an A-B-C pattern. The a-b-c pattern is quite common and as such has varying names depending on the theory or the analyst using it; however its characteristics are the same.
If you are in a trend, the a-b-c pattern will make 3 waves or swings, waves A and C will run counter to the trend, and wave B will run in the same direction as the trend. When the pattern is complete, the main trend will resume.
The a-b-c pattern is never picture perfect, even though traders would love it to be, but two common characteristics that make it easier to trade are the following:
1. Waves A and C will often appear similar in length.
2. The whole pattern will often run within a channel.
If you look at the chart below you can see a nice a-b-c pattern, following the characteristics just mentioned.
The trend is up, and then wave A swings down against the trend, wave B swings back up with the trend, finally wave C swings back down. Also, the lengths of waves A and C appear similar in length, and the whole pattern fits within a small channel.
You wont always see them appear in such a nice fashion, which can make them harder to trade, however when you do, they offer a great opportunity.
Jun 16 2008
If you are a chart pattern seeker, you may or may not have heard of the termination pattern called the ‘butterfly’. The butterfly pattern is so named because it displays what appears to be a left and a right wing.
The pattern is a termination pattern, either signaling the end of an uptrend (bearish butterfly), or the end of a down trend (bullish butterfly).
There is one important characteristic of the butterfly pattern which is to do with the right wing. The right wing will always put in a higher low and a higher high than the left wing if the trend has been up, and a lower high and a lower low if the trend has been down.
In the chart below, you’ll see a bullish butterfly which appeared on the SPY at the beginning of 2008.
The high of the right wing is lower than the high of the left wing. The low of the right wing is lower than the low of the left wing. It can be thought that the extreme of the right wing sucks late comers into the last of the trend before turning around.
There is no right or wrong way to trade a butterfly; however the head of the butterfly is a good place to enter the trade, which can be seen on this chart with the red dashed line.
One last note. There are some guidelines according to some users of the butterfly that the wings need to be a certain Fibonacci proportion to each other. I have not found this to be the case; however this is a personal choice and you may want to seek further historical evidence.
Jun 11 2008
Do you use the MACD or even moving average crossovers as a way to determine the overall trend in your analysis? One thing you may have come across in the past is that although these are great methods, they always produce drawdown periods for you when the market is correcting or consolidating, and sometimes these periods can last for months.
One way to eliminate or reduce the effects of these consolidation periods is to ‘clip the trend’, and here we’ll demonstrate how to do this using the MACD indicator.
If you are in an uptrend, when the leading MACD line crosses below the trigger line, the uptrend is now clipped, leaving you with a decision to either not trade this market, or to look for shorts. Once the leading line crosses back above the trigger line, you can once again trade this market or now look for longs.
Likewise; if you are in a downtrend, when the leading MACD line crosses above the trigger line, the downtrend is now clipped, leaving you with the decision to either stay out of this market or look for longs. Once the leading line crosses back below the trigger line, you can once again trade this market or now look for shorts.
On the chart below, we have an up trending market which is being shown by both the MACD being above zero (one method for determining a trend), and a moving average crossover, where the short mav is above the long mav (the red line above the green line on the upper part of the chart).
The black arrows are showing you where the trend is being ‘clipped’ by the action of the MACD crossover (leading red line crosses below green trigger line), and as you can see on all occasions, a consolidation period forms, which is not ideal for a trader wanting to trade the trend.
The red circles are demonstrating when the leading MACD line crosses back above the trigger line and where the trend once again resumes.
Jun 05 2008
There are quite a few uses for Bollinger Bands in trading and today we’ll look at one of them: Divergence.
Divergence is a common element of oscillating indicators such as stochastics, MACD and RSI to name a few, but the Bollinger Bands can display divergence too.
When divergence takes place several things will happen. In this example, we’ll discuss price making a top and the bollinger bands alerting us to this.
1. First, price will make a high and break above the upper band, and usually quite significantly.
2. Second, price will then head back into the bands, retreating from the high.
3. Third, price will then make a new high but will NOT break out of the upper band.
When you see this series of events, you have bollinger band divergence.
The picture below will give you a visual example of the three events that I have just described. Whether you already use bollinger bands or not, this can be a very useful tool to add to your tool box.
Jun 05 2008
Using trend lines is a great way to determine a trend, but if a trend line is broken, you can still use the trend line to give you a possible price projection area.
On occassions the trend line will reflect a symmetry with price where the greatest distance price has travelled from the trend line one way, will be similar to the distance price will travel from the trend line the other way.
In order to get an idea of the price projection you must first have a trend line in place, and then a break of that trend line. Once you have these two, take the greatest distance from the trend line price travelled ‘before’ breaking the trend line, and project that distance from the point of the trend line break.
The following picture will demonstrate how this is done. If you use trend lines in your trading try it out to see how often it works for you in your market and time frame. It may just add another edge to your trading.
Jun 01 2008
The MACD Histogram is a great tool that can alert you to possible tops or bottoms.
On occasions the MACD itself may be following the price nicely but the Histogram can be diverging, telling the trained eye to look out for a turn in price.
The MACD Histogram is the difference between both MACD lines, and as such if it is weakening (diverging) even though price is still advancing (making higher highs) or falling (making lower lows), it can suggest the move is running out of steam.
Taking a look at the chart posted below, we can see two examples when the MACD has not diverged with price but the Histogram has, and on both occasions, price has turned the other way.
If you use or are planning on using MACD in your technical analysis, then do look out for what the Histogram is doing too, and add it to your trading tool box.
Chart courtesy of OptionsXpress
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