September 29, 2012- Sharpening the Mind – part 2 of 6 – Steve Nison’s Japanese Candlestick Charting Techniques (Second Edition)

This is a continuation of Steve Nison’s Japanese Candlestick Charting Techniques (2nd Edition).

The first part can be read here – August 27, 2012 – Sharpening the Mind – part 1 of 6 – Steve Nison’s Japanese Candlestick Charting Techniques (Second Edition) 

Exactly a month ago, I had time to read and summarize a technical textbook to Chartered Market Technicians (CMT) aspirants from chapters 1 to 4.  We continue further today, exactly a month ago.  Wow, it’s been that long!  I had been terribly busy, but I’ll use my early waking hours to brush up on some readings 🙂

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Chapter 4: Reversal Patterns (page 43)

The Engulfing Pattern

A.) Bullish and Bearish Engulfing Patterns

Criteria for Engulfing Patterns:

1.)  The market has to be in a clearly definable uptrend or downtrend, even if the trend is short term.

2.) Two candles comprise the engulfing pattern.  The second real body must engulf the prior real body (it need not engulf the shadows.)

(Personal comment – you can think about these concepts just like Pacman and Ghost.  The larger candle will “Eat” or ‘Engulf” like Pacman or Ghost will to another fellow.  This shows buying pressure has overwhelmed selling pressure or vice versa)

3.) The second real body of the engulfing pattern should be the opposite color of the first real body.  (Exception to the rule is if the first real body of the engulfing pattern is a doji.  Thus, after an extended fall, a doji engulfed by a very large white real body could be a bottom reversal.  In an uptrend, a doji enveloped by a very large black real body could be a bearish reversal pattern.

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Factors increasing the likelihood of engulfing patterns being an important turning signal:

1.) If the 1st day of engulfing pattern has a very small real body (i.e. a spinning top), and the second day has a very long real body, the small first real body candle reflects a dissipation of the prior trend’s force and the large second real body proves an increase in force behind the new move.

2.) If the engulfing pattern appears after a protracted or very fast move.  A fast or extended move creates an overextended market (either overbought or oversold) and makes it vulnerable to profit taking.

3.) If there’s heavy volume on the second real body of the engulfing pattern.

(A quick example of this theory in recent memory is BLOOM’s move.)

Usually after an extensive move, if you see huge spikes, especially on a very quick move with huge ranges, a consolidation might ensue.  While the trend is still clearly up, especially if a strong base of resistance has been “cleared/ engulfed” out easily with volume, a healthy correction nearing 10.50-11.00 areas is not difficult to foresee in the next few weeks as short term traders digest their 20% gains from the lows while finding for new buyers who can lift the stock to unchartered territories.  What can be said though, is that the stock will likely consolidate its gains.  A doji is a clue that the stock is trying to stabilize near a new potential support.  It might hesitate for a few sessions before continuing its ascent.  Long upper shadows show a strong visual clue that the market was rejecting the 11.50-11.74 levels, pulling back after a long body.  However, a completely bullish engulfing pattern can just nullify all our speculations.  Note how AGI defied gravity in the 13.60 to 14.00 level two days ago.  Please go to my next example:

(Note that this is a probability game and there is nothing that suggests that BLOOM will not continue breaking into new highs.  The stock can just consolidate above 11, perhaps 11.00 to 11.40 as well.  The volume of profit taking is quite small versus the buyers in previous days too suggesting it is clearly still in an uptrend.  Also, the markets often frustrate everyone in the room- notice that AGI still keeps on breaking new highs.  Look at that bullish engulfing pattern from 13.60 to 14.00!!! )

Angles of Ascent in AGI has become steeper and faster as it managed to overpower each resistance with force.   While there hasn’t been any markedly strong signal of exhaustion seen from the chart, this chart and the company’s fundamentals for that matter has strongly made a reversal of fortunes.  Note that AGI’s 1H2012 surprised analysts in all fronts with Emperador Distillery unit registering net incomes double of last year.  (Many Filipinos have been drinking brandy, tequila and vodka! hahaha!)  While a decent pullback is healthy, if there are not enough sellers to supply the frenzy of buyers, the stock will still stay at its lofty levels before it encounters a strong “resistance” or “wall of sellers”.  For now, the stock has not rested any bit.  Do not pick tops.  People who pick bottoms and tops are just supposed to go to the department stores.  There are many tops and bottoms to choose from there 🙂 hahahaha.

A picture of a Top and a Bottom.  

You can just go to any shop (Uniqlo, Cotton On, Bayo, Forever 21, H&M, Mango, Top Shop etc) and pick your tops and bottoms there.  Don’t go to the stock market looking for tops and bottoms.  It’s a fools game! 🙂  Healthy tip I’ve learned OVER the years.  Why oh why did I let you go My lovable AGI!!! WAAAHH!!!

Enjoy the ride, when you have a winner, hold on to your seats and pants!!!  If you’re agressive, ADD more – on suitable entry points of course.

Here’s a simple “financial infographic reminder” for my online and offline friends 🙂

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Next Reversal Pattern: Dark Cloud Covers

– a dual candle pattern that is a top reversal after an uptrend or at times at the top of a congestion band.

– the greater the degree of penetration into the white real body, the more likely this is a top.

– Most Japanese wait for more bearish confirmation following the dark cloud cover.

The rationale is readily explained.  The market is ascending with a strong white candle.  This is followed by a gap higher on the next session’s opening.  Thus far, the bulls are in complete control.  However, on the second day, the market closes not only beneath the prior close, but well within the prior day’s real body offsetting much of the gain of the first session.  In such scenarios, the longs will have second thoughts about their positions and may signal a short term top.

 (Picture courtesy of istockanalyst.com)

—> If on the opening of the second day, there is very heavy volume, then a buying blow off could have occurred.  For example, heavy volume at a new opening high could mean that many new buyers have decided to jump aboard ship.  Then the market sells off.  It probably won’t be too long before this multitude of new longs (and old longs who have ridden the uptrend) realize that the ship they jumped onto is the Titanic!

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Piercing Patterns

– composed of two candles in a falling market.  First candle is a black real body day and the second is a white real body.  This white candle opens lower, ideally under the low of the prior black day, then prices rebound to push well into the black candle’s real body.

– almost similar to bullish engulfing patterns

– In the piercing pattern, the white real body pierces, but doesn’t wrap around the prior black body.  The greater the degree of penetration in the black real body, the more likely it will become a bottom reversal.

The psychology is as follows:

a.) Market is in a downtrend

b.) Bearish black real body reinforces this view

c.) The next session, market still opens lower via a gap

d.) Bears watch the market with contentment

e.) Then market surges on the close, not only closing unchanged from prior day’s close but sharply ABOVE that close.

f.) Bears second guess their position and those looking to buy would say new lows will not hold, and view it as opportunity to buy.

(Tip- wait for such confirmations such as bullish piercing patterns, before bottom fishing – wait for significant white candle, to make your risk reward better, or just simply stay out of buying stocks in downtrends.  It’s harder anyway.)

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The Importance of Protective Stops

One of the most powerful aspects of technical analysis is that it can be used as a mechanism for risk and money management approaches to trading.  Defining risk means using protective stops to help protect against unanticipated adverse price movements.

You may think – Why bother with a stop?  It’s just a short term move against me.

Remember two facts:

1.) All long term trends begin as short term moves

2.) There is no room for hope in the market.  The market goes its own way without regard to you or your positions.

3.) The one thing worse than being wrong is STAYING wrong.  Lose your opinion, not your money.

Good traders do not hold views too firmly.  Getting stopped out concedes a mistake.

Warren Buffet has two rules:

1.) Capital Preservation

2.) Don’t forget rule #1

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Each trade you make is a battle, and you will ultimately have to do what even the greatest generals have to do:

Make temporary tactical retreats.  A general’s goal is to preserve troops and munitions.  Yours is to save capital and equanimity.  Sometimes, you must lose a few battles to win the war.

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We will continue with our Sharpening the Mind series next week.  🙂  One chapter perhaps every single day. Enjoy your weekends 🙂

I’ll try to come up with more educational and informative posts to help you be more profitable in your trading and investing soon. 🙂

– Faceless Trader

Please visit http://www.brainlesstales.com – chock full of fun and witty comics 🙂

http://www.brainlesstales.com/2011-04-21/the-bratwurst

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6 Responses to September 29, 2012- Sharpening the Mind – part 2 of 6 – Steve Nison’s Japanese Candlestick Charting Techniques (Second Edition)

  1. imbangklase says:

    Very entertaining post 😀

    Like

  2. AL says:

    thanks ft…

    Like

  3. Jan says:

    The humor you added makes the subject less boring , hope you add more chart example,so we can refresh our memory of the patterns.

    Like

  4. carl says:

    thanks for using PSE charts as examples, and coming from a lazy reader…. thanks for inserting pics! hehe

    Like

  5. Chris says:

    Idol talga kita nix! =D

    Like

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