Candlestick Charts, Lecture notes of Financial Statement Analysis

Download Candlestick Charts and more Lecture notes Financial Statement Analysis in PDF only on Docsity! - 46 - Candlestick Charts Bullish Signals Morning Star This pattern is not a common one but probably the most dynamic. This is due to the fact that it is made up of 3 candles which shows, naturally, longer and clearly market sentiment. As you can see from the image shown, the classic setup for a Bullish Morning Star is, for the first candle, a strong move lower that maintains the underlying negative tone of the market. Prices then consolidate and the resulting candle shows little net movement – this can be minor gains, losses or, preferably, virtually no net movement. Often this hesitation is followed by a renewal of selling pressure and the overall tone of the market is intact, but when the 3rd candle shows powerful buying interest –and gains must reverse more than half of the net losses – then the Morning Star pattern is confirmed. This is likely, when taken in context, to prove the catalyst for a complete change in the market's attitude to value. - 47 - Bullish Engulfing Pattern Engulfing patterns (Bullish & Bearish) consist of 2 candles and also signals a complete change of direction. Here you can see a Bullish Engulfing pattern with the 1st candle showing upside rejection and modest net losses but the 2nd candle shows a renewal of demand that, open to close, totally engulfs the previous period’s ‘real body’. Obviously the larger the price action shown by the first candle, the more significant the reversal can be – there should however be an awareness that exceptionally large candles, first and second, probably denotes a non-technical event and - 50 - Rising Three This pattern could also be regarded as continuation. The bullish trend is continuing with a strong rise for the 1st candle. This is followed by a profit taking setback that lasts between 2-3 periods but this counter-move should ideally not break out of the real body parameters of the 1st candle. The pattern, and a renewal of the underlying trend, is completed by a 5th candle that completely regains the preceding 3 periods of decline. - 51 - Bearish Patterns Bearish Evening Star This is the mirror image of the Bullish Morning Star pattern.. As you can see the classic setup for a Bearish Evening Star is, for the first candle, a strong move lower that maintains the underlying bullish tone of the market. Prices then consolidate and the resulting candle shows little net movement. Often this hesitation is followed by a renewal of buying interest pressure and the overall tone of the market is intact, but when the 3rd candle shows powerful selling–and losses must reverse more than half of the net gains– then the Evening Star pattern is confirmed. - 52 - Bearish Engulfing Engulfing patterns (Bullish & Bearish) consist of 2 candles and also signals a complete change of direction. The image shown here is of the formation of a Bearish Engulfing pattern with the 1st candle showing fairly sizeable gains but the 2nd entirely overturning that upside. Obviously the larger the price action shown by the first candle, the more significant the reversal can be – there should however be an awareness that exceptionally large candles, first and second, probably denotes a non-technical event and therefore some awareness of the context may be needed to assess the impact. - 55 - Inverted Hammer/Shooting Star The Inverted Hammer pattern shows an aggressive rejection of the period’s high and it this upside failure, rather than whether the candle body shows small net gains or losses, that is important. As such it is a mirror image of the Bullish Hammer. A more extreme, and less common, variation of the Inverted Hammer is a Shooting Star. This is rarer as to form a perfect example the period that forms the upside failure has to open with a bullish gap higher and then the period following this candle opens with a gap lower. Due to the 24 hour FX markets the Shooting Star is almost never seen, but futures markets do produce such patterns. - 56 - Falling Three This pattern is the mirror image of the bullish Rising Three. In one sense it is bearish and the other continuation as for it to be valid it needs to be created within a negative trend. This trend is interrupted, after a sizeable down candle, by a profit taking rally that, ideally should be 3 up periods but weak enough to only reverse the preceding down candle or perhaps not even that. The formation is completed by a renewal of selling pressure that results in a strong fall – very often the 5th candle is a similar size to the 1st. - 57 - Continuation Patterns 3 White Soldiers The key element here is the context which this pattern is presented. An up trend must be present ahead of some consolidation, then renewal of demand signalled by the 3 white soldiers. - 60 - Long Legged It only takes one look to see the difference in this Doji pattern. Both the high and low have been rejected for an unchanged, or almost unchanged, open to close but this time the low was a deep one and unsurprisingly, although the lack of net movement highlights uncertainty, it is the bounce that is most likely to have the impact. Of course this greatly depends on the price action that preceding this period. - 61 - Gravestone Here we have the complete opposite of the Long Legged Doji with the gains being much greater than the losses and so it is the upside rejection that is likely to have the greater impact on prices going forward. Once again it is context that is the key thing before assessing the possible movement. - 62 - Marabuzo Lines What is a Marabuzo Line? Before we can see the relevance of the Line we have to look at what a Marabuzo actually is. The term is applied to the real body of a candlestick that is larger than the norm. That is a fairly nebulous concept and there is no hard and fast rule that can be applied here. An evaluation of the chart being studied and the time period being used will determine the relevant numbers. Even that result will have to be reappraised to reflect different market conditions. Sideways, trendless trading will create less sizeable movements, therefore a relevant Marabuzo will, naturally, be of a smaller size than in volatile markets where all candlesticks are larger. Let us be clear; this style of analysis, like all Technical Analysis, is not a science but a reasoned application of principle.