Analyzing Reversals With Candlestick Signals
Stock markets all over the world have the same basic characteristic. They are moved by human emotion. The trends in stock markets are not affected by fundamental reasoning. Stock markets move based on investor sentiment. Candlestick signals provide a graphic depiction of that sentiment. There are very little fundamental changes in the individual stocks that are traded in the stock markets from one week to the next. What moves prices is the perception of those fundamental changes.
Candlestick signals quickly identify the reversals of investor sentiments. The US stock markets, which were being heavily sold off for the last three weeks, now appear to have new investor confidence coming into them. What changed in the fundamentals of most US stocks over the past three weeks? Probably nothing at all! However, as often seen in any trading entity, investor sentiment is based on prospects for the future. Stock markets move as that sentiment ebbs and flows.
Stock markets move up and down in waves. These waves are the perception of investors that prices are too high or prices are too low. Candlestick analysis is a simple graphic evaluation of when those perceptions are reversing. The Candlestick signals represent high profit, high potential depictions of the change in human emotions. Human emotion, when applied to investment psychology, has not changed for centuries and probably will not change for the next few centuries.
Being able to evaluate the changes in human emotions provides the Candlestick investor with a huge advantage. This is not a difficult concept. The oscillations of human emotions have been projected for many years with numerous indicators. These indicators, such as stochastics, Fibonacci numbers, Elliott waves, etc. would not be in existence if they were observed over and over. Applying Candlestick signals to these indicators that indicate overbought or oversold conditions greatly enhances an investor's ability to extract profits from the stock markets with great consistency.
Market Direction - As seen in the Dow chart, the downtrend in the markets were clearly identified by the Evening Star signal in early March. The stochastics indicated that the market was overbought. The Shooting Star signal at the very top acted as the indecision day in the Evening Star signal. The 200 day moving average acted as support in late March and early in April. However, when that level was breached, the panic selling started entering the market. This is illustrated by three large black candles in the Dow.
Where do most investors sell? They usually panic sell at the bottom. That is clearly illustrated by the three strong down days this past week. When do you grab for the falling knife? The Candlestick signals help answer that question. As seen on Monday, the Dow formed a Hammer/Doji formation. The stochastics indicated that prices were oversold. The following Tuesday showed signs of new buying. This starts to confirm the Candlestick signal at the bottom.
The NASDAQ provided an alert that the bottom was near on Friday. It gapped down when stochastics were in the oversold area. That now becomes an indication that the sellers are getting panicky. Where to most investors sell? They panic sell at the bottom. A gap-down in an oversold condition indicates that the selling is getting overheated. Monday's trading created an Inverted Hammer-type signal, although not a pure Inverted Hammer. However, the gap-up trading on Tuesday was a bullish sign.
Is this the absolute bottom? Maybe not, because the reversal signals have not yet been very convincing. This would create the analysis that a bottom is forming. A few days to the upside might be expected on a bounce. After that, another pullback that tests the recent low might be possible. What should the investment strategy be at this point? Take profits on the short positions and start adding long positions. However, if the current potential rally shows weakness in the next few days, close out the long positions and wait for another buy signal to appear.