If you have ever wondered how to read technical charts and draw those seemingly random support and resistance lines, then this primer is a good start. Even if you do not believe in technical analysis, it is still an interesting topic. This article is the 2nd of a series in a straightforward, easy to understand introduction to technical analysis.
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It’s time to put the raven dart board away for stock pickings.
Occasionally, articles will appear about blindfolded monkeys beating top hedge fund managers. And not just any monkey, but blindfolded ones no less. Yet no one trades in this manner.
Especially the monkeys.
Jim Simons netted $1.6B in fees from the management of his investment company, Renaissance Technologies. The firm is regarded as the most successful hedge fund company. Not bad for someone without a financial background. Messr Simons is a PhD mathematician by training with a code breaking background with the NSA. He founded Renaissance Technologies in 1982 on Long Island and is a pioneer on quantitative trading.
Some consider quantitative analysis, as a specialized area of technical analysis, and while there is some overlap, they are markedly different strategies. Some traders will combine the two methods, similar to those who blend technical and fundamental analysis into a super strategy but quants tend to stay in their own discipline. There is no evangelizing here — just a straight forward introduction to technical analysis. After this series, there will be a similar series on quantitative analysis.
The last article, Mastering Candelesticks, Part 1, introduced the basic building block of technical analysis, the candlestick, and this article is a continuation on the topic. If you are new to the subject, you may want to read or review part 1 first. Let’s get started!
Each candlestick is densely packed with information. If you recall, or need a quick review (see figure 1). a candlestick has a body, the height of which reflects the change in price from open to close. Green if it closed higher than the open and red for the vice-versa down day.
More Candle Stick Patterns
Its possible for candlesticks to be bodyless signifying that the close matched the open. If the crosshair is significantly higher up, that means the bottom fishers came out to save the day, the shorts covering, or a combination of the two. It will likely open stronger tomorrow.
A significantly lower crossbar on the other hand is indicative that it may have bumped up against a resistance, and the bulls are throwing in the towel, at least for the short-term. Expect weakness at the open.
If the cross bar is near the middle of the length, nothing can really extrapolated other then a sense of indecisiveness — an equilibrium balance between the bears and the bulls.
The Bodyless Doji
It is even possible that a candle stick has little to no body — just a single trade or few trades at ONE price for the day. This may happen for a thinly traded instrument and its mentioned just for the sake of completeness sake. They are also called doji’s.
There are variations of the doji, based on where the open/close are relative to the day’s trading range. The doji’s vary from neutral (plain), bullish (dragonfly), to bearish (gravestone).
At this time, one must consider the preceding days trend. Starting with the dragonfly, if the prior trend was downward, then this is indicative of a potential end to the downtrend. Likewise, if it was an uptrend, the dragonfly could indicate that the bulls are running out of steam.
The same can be said of its reverse the associated gravestone. If it was an uptrend, the wind was taken out of the sail. If it was preceded by a downtrend, it may mean it end to that.
If you take a step back, and read the above again on doji’s you will this summation: both the dragonfly and gravestone share the same indication that the trend is ending. However, keeping that in mind, the dragonfly is bullish while the gravestone is bearish.
Shaven Tops and Bottoms
Shaven top: If it opens at the top and closes lower, its a strong bearish indicator and there are no buyers remaining. If it closes higher, then that’s bullish
Shaven bottom: If it opens at the top and closes lower, it is bearish. Meanwhile if it closes higher, it is highly bullish.
So what’s the difference between whether the shave is at the top or the bottom? If it closes higher, then it’s bullish. And if it closes lower then it’s bearish irrespective of where the shave is? True. The difference is in the respective strength of the indicator. A lower close on a shaven top is more indicative of its strength, than its corresponding higher close on the bull side. Conversely, a higher close on a shaven bottom is stronger than its lower close.
The Hammer and the Hangman
Both the hammer and and the hangman are characterized by a short body with a only one wick — that being a long bottom wick.
Hammer: Lets start first with the hammer on upper half of figure 3 below. You have a trending of consecutive days with lower lows, as well a lower close than the open, hence the black bars. Then you have a day that closes higher than the open along with a long bottom shadow.
That is your hammer. After a few days of trending lower, a support has finally been reached which gives folks on the sideline that it is now safe to to buy, effectively ending the downtrend. Sure enough the next two days are positive.
Hangman: After a series of up days, again you see a short body with a long bottom shadow. Additionally the day closes lower than the open. It is then a high probability that the uptrend is due for a reversal and the hangman kicks off the next two days being lower.
Both the hammer and the hangman are relatively strong indicators.
Different styles of bars have been displayed so that you can be exposed although they all display the same information. Some sites will allow you to choose the style and most charting software are also configurable to your style of choice. But its always better to be intimately familiar before using software or drawing trend lines.
While the simple candlestick can disseminate a lot of information, it is only the basic element of the chart. In the next article, we will start putting the candlesticks together to start establishing trends. From there we can start drawing support, resistance, and trading range lines.
Before I wrap up, keep in mind that other data such as volume, momentum, moving averages, and other metrics are also important metrics and will be introduced in the future articles.