Your questions – answered – part 2! As noted in the “Part 1” part of the Answers blog series, I will try to bunch some of the questions with similar themes into one reply. Today, I focus on Technical Analysis techniques & strategies. This blog should be of interest to readers interested in becoming more proficient in TA.
Note: I offer a popular course on Technical Analysis which covers the entire spectrum of portfolio structure, buy and sell rules, candlestick signals, macro factors like cycles, EWT, sector rotation, and many other topics. Its all done in a logical step-by-step manner that teaches you the systematic approach I’ve used for 3 decades as a professional Portfolio Manager. Nothing was held back. Investors who’ve taken the course have told me it saved them thousands of dollars by avoiding bad trades – not to mention the profits made by learning a logical portfolio management structure. If you have not taken the course, I strongly suggest you do! Here is the link: Using The Power Of Technical Analysis in Any Market (thinkific.com)
Anyhow, on with the show:
Candlesticks: does “size matter”?
Ah, the age old question! Andrew asks if the wick length (bottom or top) such as a hanging man or hammer matters. Yes, Andrew, size matters. A long wick – on a reversal candle like hanging man, hammer, etc. means the action was more violent outside of the open/close action. Same with candles like spinning tops/ doji type of signals. Long wicks mean investors are in a high state of emotion or confusion. A high activity day with a benign finish often leads into a new trend reversal. Its that day of confusion that kicks off the turnaround. Money never sleeps.
For example (in a daily chart), lets look at a stock that opened at $5, closed at $5.10. That’s not much action on the face of it. But during the day, investors said at one point, “This stock is only worth $3”. That’s a washout – with a slightly higher close. It often leads into a new uptrend, particularly if we witness that hammer after a downtrend.
Often at market highs, a slightly lower close on the hammer might lead into a new downtrend. I actually find that more often than not its less important if the market closed slightly lower or higher after this type of formation. The point is, the longer the wick, the more the evidence of confusion, followed by resolution. That can lead into a neartermed counter move, or even a reversal in trend.
Andrew also asked if the evidence of a series of long wicks in one direction can mean that the market is testing to that direction. Truthfully I have not studied that pattern enough to offer insights – but now that you’ve brought it up, I will try and do some research. In a quick glance, I couldn’t identify such examples…. but its an interesting concept to explore.
Dude, I totally gapped on that!
Scott asks about gaps. Not the momentary memory loses we all experience (or, in “Forgetful Joe” Biden’s case, on a moment by moment basis). I’m talking about the occurrence of a stock or market that opens up significantly higher, or lower, than the previous day’s close. A gap down is a moment of panic- a gap up is a moment of excitement.
Scott asks about BNS – which, as the chart below illustrates, is a stock that can see gaps. He wants to know if a gap “must be filled”, as the saying goes. This concept says that a gap, because its an emotional /reactional moment of excitement or panic, is not likely to last. Well, truthfully, sometimes they do last a while before that emotional reaction is reversed. We call gaps that signify trending action “runaway gaps” and “continuation gaps”.
On the BNS chart below, I have circled the many gaps. Sometimes, the big ones, like in May of 2022 (far left side of chart) are in fact filled – in that case it was a gap up with some follow-through, then a move down (and gap-down) to reverse all of that market exuberance (aka–the gap filled). Lots of other times, the gaps just indicated continuation of a trend. During the summer of 2022, the gaps pointed to more downside.
All in, I don’t automatically anticipate a gap will be filled – with the exception of big honkin’ huge gaps. A big gap means high reactionary emotions (to news, or whatever) –aka a greater likelihood of irrationality. That is almost always reversed, even if its just momentarily reversed. But that’s a rule of thumb, not a for-sure thing.
Hope that helps.
Close vs. intra-day moves
Francisco asks an easy one. He wants to know how I start my count, insofar as breakouts or breakdowns after a chart consolidation pattern of some sort. So – he wants to know if I use the level of the market close, or the level of an intra-day price to begin my “minimum 3 day” rule to verify a breakout/breakdown.
To start, recall that its a minimum of 3 days, up to 3 weeks for me to move on such a base breakout/breakdown. This leave a bit of wiggle room re how volatile the given stock is before I make that move. Anyhow–to answer the question…I use the close. Intra-day moves, as discussed in the candle question above, are just moments of exuberance. I want to see the close.
As an add-on to this question, Tyler asked if I look for 3 advancing soldiers (which is a candlestick pattern of 3 white/up days) to buy. The answer is, I just need a MINIMUM of three days (but usually more) for the stock to stay ahead of that neckline/breakout point. They don’t have to be three up days (white candles).
Say the neckline was $5. If the stock goes 5.10, 5.30, then $5.25 – its still ahead of the $5 neckline, even if day 3 was not a white candle. But again, I might give it another day or two if I am not convinced. My rule of 3 means 3 days to 3 months!. Its a spidey-sense thing that comes from 33 years of doing this stuff. And, yes, I can still be wrong. But its all about limiting your risk, and following a system.
Final thought: I do like to see a breakout, then neckline test, then a bounce off of that neckline. Perfect situation, with very high success probability. But you don’t always get these perfect setups. In any case, remember–leg in. Don’t jump in with the entire position size you want. See my course.
David & Way ask about creating trendlines and support/resistance points. To start, I strongly suggest you take the Online TA course, as it goes into more detail then I will here. But in a nutshell – my basic rules are:
- Trends (up or down) are identified by a minimum of 2 rising or declining peaks and troughs.
- Uptrends are further verified by moving averages, the length of which are determined by your trading horizon. I use the 200 day simple moving average for my needs – which tends to be intermediate (3 months to a year) in time horizon.
- Uptrends see price remain over the moving average, downtrends below the moving average.
- Consolidations are identified by a lack of trending highs and lows. They are not always symmetrical – for example, H&S consolidations, rounded tops and bottoms, etc. But I do find that longer trends end up consolidating within longer consolidations – and they can often be fairly rectangular (not a lot of spikes through a common ceiling and floor). On that topic…you will get spikes and tails that momentarily move the market outside of a consolidation. See the Online Course to learn more about identifying head fakes.
- Moving averages, unless very short, tend to be less use when a market is consolidating. Price goes up and down through the moving average constantly. They are of no use in determining when the market has returned to a bull or bear trend while the market consolidates.
- Breakouts (up or down) from consolidations are seen when the last low is taken out (breakdown) or high is taken out (breakout). You verify by counting several days. You leg in (or out) on such a signal. Further evidence of the trend (up or down) can be seen via the trend rules discussed above.
- Often, a breakout is tested once – as discussed in the above question.
David & Way asked me about trends on the IWM as an example. I didn’t bother with the moving average on the chart below, but the trendlines plainly illustrate everything I’ve just laid out: