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Predicting Stock Market Trends

Why is it so difficult to predict stock market trends? Just look at two of the ‘indicators’ some investors use for predicting stock market trends.

Some people put their faith in the “January Barometer”. A theory that the movement of the S&P 500 during the month of January sets the stock market trends for the year. If the S&P 500 is up at the end of January compared to the beginning of the month, expect the stock market to rise during the rest of the year.

Another prediction of stock market trends is based upon the Super Bowl indicator. An ‘urban legend”; claiming that if the winning team is from the AFC there will be a down market and if the winning team is from the NFC expect an up market.

Now if this isn’t proof that stock market trends are based upon human behavior, I don’t know what is. Stock market trends are nothing more than the shifting of investor optimism. Since investor optimism is an expression of human emotion, it makes sense that we find clues in stock market trends by observing candlestick patterns.

Japanese Candlesticks is the best technical indicator for predicting stock market trends. The Candlestick Forum helps investors recognize stock market trends by explaining how human weakness creates conditions resulting in predictable patterns. Candlestick signals visually illustrate investor sentiment, as the Homing Pigeon reversal pattern below.


HOMING PIGEON

Description

The Homing Pigeon is the same as the Harami, except for the color of the second day's body. The pattern is composed of a two-candle formation in a down trending market. Both candles are the same color as the current trend. The first body of the pattern is a long body, the second body is smaller. The open and the close of the second day occurs inside the open and the close of the previous day. Its presence indicates that the trend is over.

Criteria

  1. The body of the first candle is black; the body of the second candle is black.
  2. The downtrend has been evident for a good period. A long black candle occurs at the end of the trend.
  3. The second day opens higher than the close of the previous day and closes lower than the open but above the closing price of the prior day.
  4. Unlike the Western Inside Day, just the body needs to remain in the previous day's body; where as the Inside Day requires both the body and the shadows to remain inside the previous day's body.
  5. For a reversal signal, further confirmation is required to indicate that the trend is moving up.

Signal Enhancements

The higher the second candle closes up on the first black candle, the more convincing that a reversal has occurred.

Pattern Psychology

After a strong downtrend has been in effect and after a long black candle, the bulls open the price higher than the previous close. The shorts get concerned and start covering. The price finishes lower for the day but not as low as the previous day. This is enough support to have the short sellers take notice that the trend has been violated. A strong day after that would convince everybody that the trend was reversing. Usually the volume is above the recent norm due to the unwinding of short positions. 

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