An Introduction To Candlesticks – Part 2 (Another Free InvestEd Webinar)

Saul Seinberg Advisory Director

© 2011 Saul Seinberg

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Copyright and Permissions Notice

n  This is a copyrighted presentation by Saul Seinberg. Please do not copy or use this presentation, in whole or in part, without prior written consent from Saul. Thank you.

n  Use of this presentation, once granted, requires the following copyright notice:

n  “Copyright 2011 Saul Seinberg. All rights reserved. This material is presented with permission of the author.”

n  Stock charts are courtesy of StockCharts.com

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Disclaimer

n  This presentation is for educational purposes only. No recommendation to use the techniques described or to invest in the companies discussed is made or intended.

n  While the information included in this presentation has been checked against other sources, there may still be errors present.

n  It is your responsibility to perform your own due diligence with respect to use of information in this presentation.

n  Any use of the presentation material is at the sole risk of the user. Neither the presenter nor InvestEd Inc. is responsible for use of the presentation material.

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Quick Review of Part 1

n  Candlesticks are based on the open, close, high and low price for a given time period, usually a day, but other periods are used

n  Candlestick interpretation is derived from the emotional reactions of traders affecting price based on their perception of market conditions

n  The efficacy of a candlestick pattern is usually a function of trend context and confirmation

n  Candlesticks can and should be used with Western type technical analysis indicators, patterns and trend lines

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Quick Review of Part 1

n  In Part 1 of this webinar, we discussed the following candlesticks:

n  Doji n  Spinning tops n  Dragon Fly n  Gravestone

n  Hammer, Hanging Man n  Inverted Hammer, Shooting Star n  Engulfing patterns

n  Of these candlesticks, the Hammer, Hanging Man and Engulfing patterns are considered the most effective although stops should be used with all

Homework (AAPL Daily Chart)

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Support

Resistance

B2

B1

A2

A1

C3 C2

Volume

C1

C4

Reduce Chart Span For Focus

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1.  Reduce time span to see candles better

2.  For example, this is a one month chart

Placing Volume Bars

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2. Plotting volume in main chart window as an "Overlay" can cause confusion when volume overlaps candlesticks

1. Plotting volume as an "Overlay" is the default for the free

portion of StockCharts

Placing Volume Bars

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Separate Volume Plot 1.  Switch from "Overlay" to "Separate" 2.  Update

Cure when volume overlaps candlesticks

SBUX Red Outline & Volume

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Inverted Hammer?

Up volume on down candle

Down volume on up candle

Inverted Hammer?

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Volume Consideration

n  An "Up" day for a candlestick means the close was higher than the open

n  A "Down" day for a candlestick means the close was lower than the open

n  However, volume is treated as up (White) or down (Red) depending on where stock closed yesterday compared to where it closed today

n  Thus, you can have an "up" candlestick with red volume or a "down" candlestick with grey volume

n  Absolute period volume, whether up or down, remains an important consideration!

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An Introduction To

Candlesticks – Part 2

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Harami Patterns

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Harami Patterns

n  The Harami pattern is made up of two candles; the first is a long body candle adjacent to a shorter candle on its right, the shorter candle being within the body of the longer candle

n  The smaller candle in a Harami pattern is often a spinning top or a doji

n  A Harami resembles a reverse engulfing pattern; be careful not to confuse the two patterns

n  No matter the color of the first candle, the smaller the body of the second candle, the more likely it is that there will be a reversal, especially if the second candle is a Doji; strongest form of Harami

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Harami Patterns

n  If a small real body forms after an unusually long candlestick, that increases the possibility that there will be a trend reversal

n  Whether a Harami is bullish or bearish depends on the trend in which it appears, not on the color of the candlestick bodies that form the pattern

n  However, in most instances, the shorter candle is an opposite color of the longer candle

n  Harami patterns appear relatively frequently and although not as strong as engulfing patterns, they indicate a possible change in trend direction and signal caution; context is important

Bullish Harami Pattern

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Bearish Harami Pattern

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Gaps

n  Gaps are a common sight on all types of charts, especially daily charts

n  Gaps have been formally recognized and accounted for in candlestick based analysis and in Western technical analysis for many years

n  The candlestick term for gaps is "Windows," but that term has never stuck in the West

n  Simply stated, a gap is an opening in a chart where no trading is reported

n  Gaps are the emotionally driven response to news that may not even be related to a particular stock

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Gaps

n  On a candlestick chart, a gap is formed when neither the real bodies of two successive candles nor their shadows overlap

n  Both upside and downside gaps exist n  An upside gap is formed when the low of a current

period is above the high of the previous period n  A downside gap is formed when a current period

high is below the low of the immediate prior period n  The size of a gap is important, but even a fairly

narrow gap must still be understood n  Intra-day gaps are unusual, but a gap at the open,

called a Morning Gap, is encountered fairly often

Upside Gap

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Downside Gap

Upside Gap

Downside Gap

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Downside Gap

Downside Gap

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Downside Gap

What's going On Here?

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Gaps

n  There are several types of gaps, particularly in Western style technical analysis

n  Common or Area Gap n  Breakaway Gap n  Continuation or Runaway Gap n  Exhaustion Gap n  Morning or Opening Gap

n  As you might expect, a number of trading strategies have been based on chart gaps

n  Gaps can act as resistance or support n  Gaps are usually filled, sometimes partially, over

time, sometimes quickly, sometimes slowly

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Interpreting Gaps

n  Each price gap should be analyzed on an individual basis taking its trend into consideration, plus

n  Size of gap n  Price action prior to gap n  Nearby support or resistance? n  Trade horizon (short or long term) n  Current volatility n  State of broader market

n  In addition, the investor's or trader's risk tolerance and money management rules need to be applied when ascertaining how to respond to the gap

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An Introduction To

Candlesticks – Part 2

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Kicker Signal

n  The Kicker or Kicking Signal is deemed by its practitioners to be the most potent candlestick signal of all although it is not one of the most popular candlestick patterns

n  The importance and likely success of the Kicker Signal is magnified when it occurs in an overbought or oversold situation

n  Many advocates of the Kicker Signal take the position that confirmation isn't needed because of the strength and efficacy of this signal

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Kicker Signal

n  There are two variations of the Kicker Signal which is formed by two candles

n  In variation A, the first candle opens and moves in the direction of the current trend

n  The second candle opens at a different price than that of the previous day and heads in the opposite direction of the previous day’s candle; a gap forms between opens

n  The bodies of the candles are opposite colors n  This formation is indicative of a dramatic change in

investor sentiment with the candlestick bodies visually depicting the magnitude of the change.

Kicker Signal – Variation A

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Bearish Kicker Bullish Kicker

Price Gap

Kicker Signal – Variation A

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Bullish Kicker

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Kicker Signal

n  In variation B of the Kicker signal, the opening prices of the two candles in the pattern are equal and a gap between the opening price of the two candles is present

n  In variation B, the first candle opens and moves in the direction of the current trend, but the second candle opens at the previous day's open and moves in the opposite direction of the prior candle (Bigalow)

n  The bodies of the candles are opposite colors n  Variation B also indicates a strong change in investor

sentiment with the candlestick bodies visually depicting the magnitude of the change.

Kicker Signal – Variation B

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Bearish Kicker Bullish Kicker

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Island Reversal Signal

n  The island reversal signal is a gap pattern thought to be predictive of a trend reversal

n  This signal is formed by a first gap followed by a flattish period of one or more candles and then completed by a second gap in the opposite direction of the first gap

n  The island reversal signal is generally taken as a strong change where the flattish period becomes either the bottom or top of a trend

n  The duration of the trend and the size and thrust of the gaps are usually predictive of the size of the reversal

Bullish Island Reversal

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What's this pattern?

Bullish Island Reversal

Bullish Island Reversal

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Island Reversal; this one is bullish

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Bearish Island Reversal

Island Reversals; these are bearish

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Predefined Scans

n  Predefined scans are useful for learning candlesticks because you can concentrate on a specific candlestick pattern

n  Predefined scans are very helpful if you use a particular type of candlestick pattern as a part of a short or long term trading strategy

n  Comparing mirrored candlestick patterns, bullish and bearish, is a quick way of gauging the sentiment of the overall market

n  For example, are there many more bullish engulfing patterns than bearish engulfing patters or is the reverse true?

Candlestick Scans

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Almost 4 times as many Bearish Engulfing signals on this day as there are Bullish Engulfing signals; market

is definitely tilted to bearish side

33 Bullish Engulfing signals

119 Bearish Engulfing signals

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An Introduction To

Candlesticks – Part 2

Case Study #1 - GOOG

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Case Study #2 - GMCR

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Candlestick Strengths

n  Candlestick charts are superior to bar charts because they provide impactful visual insights into the psychology of a trading session

n  Messages from a candlestick chart are immediate and vibrant while those from a bar chart are definitely more muted

n  Since both types of charts include the same information, you can use candlesticks with popular Western TA tools such as moving averages, trendlines, MACD and RSI

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Candlestick Strengths

n  Candlesticks, over time, make analysis quicker and more efficient

n  Although not perfect in this respect, candlesticks are particularly useful in signaling trend changes especially since these signals are often earlier than those generated by conventional indicators and patterns

n  Candlesticks are an excellent swing-trading tool and are helpful in option trading

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Candlestick Weaknesses

n  Candlesticks are time limited and not useful for growth investors except when a buy, hold or sell decision needs technical support

n  Candlesticks are difficult to evaluate when a chart gets crowded

n  Candlesticks patterns and charts do not provide price targets that are available in other forms of charting

n  Candlesticks don't indicate when price movement took place during a session

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Using StockCharts

n  StockCharts is a terrific site, even the free portion is worthwhile, both for the charts and the Chart School

n  The default chart at StockCharts is called a SmartChart n  The default chart type for the SmartChart is

Candlesticks although this can be changed n  Instructions for using a SmartChart can be found at

http://support.stockcharts.com/forums/30077/entries/31220 or click on http://tinyurl.com/6odablb

n  You cannot save charts in the free portion of StockCharts, but there is a “work-around”

n  From any SmartChart, click on “Linkable Version” below the chart, bookmark the resulting URL as a template, then change to your stock symbol when you go to URL

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References

n  StockCharts, ChartSchool, http://stockcharts.com/help/doku.php?id=chart_school:chart_analysis:introduction_to_candlesticks or click on http://tinyurl.com/82laqp4

n  Getting Started in Candlestick Charting by Tina Logan, Wiley Publishing, 2008

n  Candlestick Charting Explained by Gregory Morris, Irwin Publishing, 1995

n  The Candlestick Course, Steve Nison, Wiley Publishing, 2003

n  Profitable Candlestick Trading: Pinpointing Market Opportunities to Maximize Profits, Stephen Bigalow, Wiley Trading, 2002 (later edition available)

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An Introduction To

Candlesticks – Part 2

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