I hope this video supplements what I have written.
Morning and Evening Star Candle Formations
These two formations are quite rare, but when they do occur, they tend to be very powerful. These Japanese patterns are similar to what you may know as an island reversal. If you don't know what an island is, then this post will be especially useful for you.
Let's start off with the morning star. This formation is a bullish reversal pattern, and comes after a lengthy downtrend. Another key point is that this formation usually has 3 candles, although my examples have 4. The first candle should be red, indicating that the bears are in control. The second candle must gap down. Gaps are know in Japanese technical analysis as windows, but I will call them gaps. Anyway, by gap down, I mean that the second candle's high must be lower than the previous candle's low, creating a void or empty space between the first two candles.
At this moment, there is nothing bullish about what I am describing, since the fact that the price gapped down is a very bearish indication. However, here is where it starts to get bullish. The third candle must gap up. I prefer it when the low for the third day is higher than the high on the second day. In english, this means that, again, there is a space between the second and third candle. The result of all this is that the second candle is completely abandoned on the chart. This formation is so powerful because it basically shows that the market has totally rejected the price action that occurred on the second candle, or the island.
The evening star is the exact opposite formation, and comes after a long up trend. Please refer to the above chart for an example. To get the rules for an evening star, just take the rules I just mentioned for the morning star and reverse them.
The above chart is of XGD, which is a gold stocks ETF that trades in Toronto. The first example shown was a morning star formation, with a textbook like island forming right at the bottom. If you have trouble reading the comments, then click on the image to see a larger view. The second example shows an evening star. Notice how there are 2 gaps needed for this formation, so that an island is created. If you look at the above chart, there is no other time this formation occurred, which shows that these are in fact quite rare, but as I hope you can see, also very powerful formations.
Let's start off with the morning star. This formation is a bullish reversal pattern, and comes after a lengthy downtrend. Another key point is that this formation usually has 3 candles, although my examples have 4. The first candle should be red, indicating that the bears are in control. The second candle must gap down. Gaps are know in Japanese technical analysis as windows, but I will call them gaps. Anyway, by gap down, I mean that the second candle's high must be lower than the previous candle's low, creating a void or empty space between the first two candles.
At this moment, there is nothing bullish about what I am describing, since the fact that the price gapped down is a very bearish indication. However, here is where it starts to get bullish. The third candle must gap up. I prefer it when the low for the third day is higher than the high on the second day. In english, this means that, again, there is a space between the second and third candle. The result of all this is that the second candle is completely abandoned on the chart. This formation is so powerful because it basically shows that the market has totally rejected the price action that occurred on the second candle, or the island.
The evening star is the exact opposite formation, and comes after a long up trend. Please refer to the above chart for an example. To get the rules for an evening star, just take the rules I just mentioned for the morning star and reverse them.
The above chart is of XGD, which is a gold stocks ETF that trades in Toronto. The first example shown was a morning star formation, with a textbook like island forming right at the bottom. If you have trouble reading the comments, then click on the image to see a larger view. The second example shows an evening star. Notice how there are 2 gaps needed for this formation, so that an island is created. If you look at the above chart, there is no other time this formation occurred, which shows that these are in fact quite rare, but as I hope you can see, also very powerful formations.
The Gravestone Doji Candlestick Pattern
One thing I like about Candlestick charting is the colourful names associated with many of the patterns. As you could probably guess by the name of this pattern, the gravestone doji is a bearish pattern.
To begin, let us define what a doji is. The word doji comes from an ancient Japanese word that basically means knife. Essentially, a doji is simply any candle where the opening price is equal to, or very close to equal to the closing price. This results in a very narrow real body, that does in fact look like a knife if you use your imagination. This shows that the bulls and bears have battled it out, and at the end of the day, the result was a draw between the two.
Doji are more important after long up trends or downtrends. But contrary to popular belief, they are not a particularly bullish or bearish signals. They just mean that the bulls and bears are at equal force, and the trend may reverse or trend sideways. In other words, doji represent a tie between bulls and bears, and not a victory.
The gravestone doji is a stronger signal. Ideally, the gravestone doji will appear after a long uptrend, and the chart will be overbought in terms of RSI. The bulls, who are in control, push the price significantly higher in mid session. Then, the bears come out, and begin dominating the bulls, and close the price very near the opening. This results in a long upper shadow, and small real body. Optimally, there is no lower shadow. Please refer to the chart below for an example of this.
Furthermore, this candle represents that the bulls have lost control, and the up trend is in serious jeopardy. In the above weekly chart of the XAU, both these gravestone doji forecasted massive declines in the index. Remember, candle patterns work for any time frame, but the patterns that appear on longer term charts are usually more powerful as this weekly chart demonstrates.
To begin, let us define what a doji is. The word doji comes from an ancient Japanese word that basically means knife. Essentially, a doji is simply any candle where the opening price is equal to, or very close to equal to the closing price. This results in a very narrow real body, that does in fact look like a knife if you use your imagination. This shows that the bulls and bears have battled it out, and at the end of the day, the result was a draw between the two.
Doji are more important after long up trends or downtrends. But contrary to popular belief, they are not a particularly bullish or bearish signals. They just mean that the bulls and bears are at equal force, and the trend may reverse or trend sideways. In other words, doji represent a tie between bulls and bears, and not a victory.
The gravestone doji is a stronger signal. Ideally, the gravestone doji will appear after a long uptrend, and the chart will be overbought in terms of RSI. The bulls, who are in control, push the price significantly higher in mid session. Then, the bears come out, and begin dominating the bulls, and close the price very near the opening. This results in a long upper shadow, and small real body. Optimally, there is no lower shadow. Please refer to the chart below for an example of this.
Furthermore, this candle represents that the bulls have lost control, and the up trend is in serious jeopardy. In the above weekly chart of the XAU, both these gravestone doji forecasted massive declines in the index. Remember, candle patterns work for any time frame, but the patterns that appear on longer term charts are usually more powerful as this weekly chart demonstrates.
The Hammer Candlestick Pattern
This is one of my favourite formations in Japanese Candle charting. Here is how it works. The hammer must come after a prolonged downtrend. Ideally, the chart is in oversold territory, and the news and experts are saying that the bull market in gold is over.
The hammer is a one candle line. On the opening, the price should immediately continue lower, which is natural, since it is in a downtrend. The bears should push the price down at least 2-3% at some point during the day. Then, when there does not seem to be the faintest ray of hope, the bulls must come out of hidding, and begin eating away at the bears advancement. By the end of the day, the bulls actually close the price near the day's high, and above the previous day's close. Please click on the following chart to see 3 examples of this in action.
The rationale behind this candle is that it shows a major shift of physchology taking place. The bears are left stunned at what just happened. The bulls feel much more confident after this victory, which is why this candle usually marks significant bottoms. As you can see in the above chart, these lines physically look like hammers, and it is said that the market is hammering out a bottom at these times. Example number 3 in the above chart has still not proven to a major bottom, but time will tell if I am right. Like all candle lines, the hammer is equally potent on weekly charts, or any other time frame.
The hammer is a one candle line. On the opening, the price should immediately continue lower, which is natural, since it is in a downtrend. The bears should push the price down at least 2-3% at some point during the day. Then, when there does not seem to be the faintest ray of hope, the bulls must come out of hidding, and begin eating away at the bears advancement. By the end of the day, the bulls actually close the price near the day's high, and above the previous day's close. Please click on the following chart to see 3 examples of this in action.
The rationale behind this candle is that it shows a major shift of physchology taking place. The bears are left stunned at what just happened. The bulls feel much more confident after this victory, which is why this candle usually marks significant bottoms. As you can see in the above chart, these lines physically look like hammers, and it is said that the market is hammering out a bottom at these times. Example number 3 in the above chart has still not proven to a major bottom, but time will tell if I am right. Like all candle lines, the hammer is equally potent on weekly charts, or any other time frame.
The Bearish Engulfing Candlestick Pattern
I am a firm believer of candle charts, and I know that I could not trade without them. It takes a while to understand the language of candle charts, but when you become fluent, the charts will speak to you!
There are many patterns in this form of charting, and this post will explain one of them. Below is a chart of the XAU. In the blue circle is an example of a bearish engulfing pattern.
The bearish engulfing pattern is a two candle formation. The first candle comes after a long uptrend, and can be any colour. The length of the candle should be relatively long. The second candle is more important. It must open higher than the previous day's candle. This shows that the bulls are in control. Then what must happen is that it then should close beneath the low of the previous day. In this way, the second candle completely wraps around the first candle. One other note, the second candle should close near the low of the day. This is referred to as a shaved bottom, and when a candle has no upper shadow, it is said to have a shaved head.
As I mentioned before, reading charts is like looking at a battle between the bulls and bears. If you look at the two candles in the above chart that are in the blue circle, you can see that previously the trend was up, which means that the bulls are firmly in control. On the second candle line, the bulls open the price well above the previous day's close. However, the bears come out, and take control away from the bulls, and close the price down hard. This represents a major victory for the bears. The above chart shows one of the most textbook like examples of this pattern I have ever seen. This was the main piece of evidence that made me go short that day.
There are many patterns in this form of charting, and this post will explain one of them. Below is a chart of the XAU. In the blue circle is an example of a bearish engulfing pattern.
The bearish engulfing pattern is a two candle formation. The first candle comes after a long uptrend, and can be any colour. The length of the candle should be relatively long. The second candle is more important. It must open higher than the previous day's candle. This shows that the bulls are in control. Then what must happen is that it then should close beneath the low of the previous day. In this way, the second candle completely wraps around the first candle. One other note, the second candle should close near the low of the day. This is referred to as a shaved bottom, and when a candle has no upper shadow, it is said to have a shaved head.
As I mentioned before, reading charts is like looking at a battle between the bulls and bears. If you look at the two candles in the above chart that are in the blue circle, you can see that previously the trend was up, which means that the bulls are firmly in control. On the second candle line, the bulls open the price well above the previous day's close. However, the bears come out, and take control away from the bulls, and close the price down hard. This represents a major victory for the bears. The above chart shows one of the most textbook like examples of this pattern I have ever seen. This was the main piece of evidence that made me go short that day.
MACD Histogram, and How it Works
This indicator works really well at identifying the trend at hand, and letting you know when that trend has reversed. The MACD histogram uses moving averages in its construction. The first step in creating the histogram is to take the difference between 2 moving averages. Once this difference is determined, you then take a moving average of the differences. You then have 2 lines, and the MACD histogram measures the amount of space between the 2 lines. I know this sounds complicated, and it is, but the good thing is that its interpretation is much easier. Below is a chart of GDX, and an MACD histogram beneath.
When the histogram is above the zero line, it means that the bulls are in control, and the trend is up. The opposite is true for when it's below the zero line. In the above chart, I have drawn blue rectangles around the bullish areas. This indicator is also good a picking out divergences. For example, if the price is rising, but the MACD is falling, this indicates that the price is rising but losing momentum.
I use Fibonacci numbers in my MACD, and I have noticed that renowned technical analyst John Murphy does the same. I may talk more about Fibonacci in another post. Anyway, the configuration I have is a little slow at changing when the trend turns, but the number of whipsaws is very small. Therefore, my configuration is better suited for longer term swing traders than for shorter term day traders.
When the histogram is above the zero line, it means that the bulls are in control, and the trend is up. The opposite is true for when it's below the zero line. In the above chart, I have drawn blue rectangles around the bullish areas. This indicator is also good a picking out divergences. For example, if the price is rising, but the MACD is falling, this indicates that the price is rising but losing momentum.
I use Fibonacci numbers in my MACD, and I have noticed that renowned technical analyst John Murphy does the same. I may talk more about Fibonacci in another post. Anyway, the configuration I have is a little slow at changing when the trend turns, but the number of whipsaws is very small. Therefore, my configuration is better suited for longer term swing traders than for shorter term day traders.
How Candle Charts are Constructed
Welcome to stage 3. In the previous posts, we looked at the differences between line charts, and bar charts, and why the bar chart is advantageous. In this post, we will look at a form of charting that is, in my opinion, even better than a bar chart. This form of charting is know as Candlestick Charting. Candlestick charting, like the bar chart, displays open, high, low, and close, but does so in a much more colourful and easy to read way, as shown in the chart below.
In the above chart, each candle represents one day of price action. Each candle is made up of 3 sections: The real body, the upper shadow, and the lower shadow. The real body shows the analyst the relationship between this open and the close. If the price of a stock goes up, the real body will not filled in. If the price of the stock goes down, which means that the close is lower than the opening, the real body will be filled in. The candle will be filled in red if the stock goes down that day and closes lower than the previous days close. It will be filled in black if the price closes lower than the open, but still manages to close above the previous days close. The chart below will better illustrade this.
The advantage with this type of chart is that it is easier to read, and that there are many interestingly named formations that analysts look for. I believe that Candles are so important that I will create a page dedicated to explaining all the major formations and showing real life examples of them. In the meantime, I hope this gives you a basic understanding of candles.
In the above chart, each candle represents one day of price action. Each candle is made up of 3 sections: The real body, the upper shadow, and the lower shadow. The real body shows the analyst the relationship between this open and the close. If the price of a stock goes up, the real body will not filled in. If the price of the stock goes down, which means that the close is lower than the opening, the real body will be filled in. The candle will be filled in red if the stock goes down that day and closes lower than the previous days close. It will be filled in black if the price closes lower than the open, but still manages to close above the previous days close. The chart below will better illustrade this.
The advantage with this type of chart is that it is easier to read, and that there are many interestingly named formations that analysts look for. I believe that Candles are so important that I will create a page dedicated to explaining all the major formations and showing real life examples of them. In the meantime, I hope this gives you a basic understanding of candles.
How Bar Charts are Constructed
Welcome to stage 2, the next stage of the evolution of the stock chart. On my previous post, I mentioned why a line chart is missing some key pieces of information. The next chart, shown below, is the same chart as the one before, except it includes open, high, low, and close. These four ingredients are essential for understanding many technical patterns.
Let me explain why it is so essential to at least upgrade to this type of chart. Think of the stock market as a battlefield. The bulls, which are those who think the stock will rise, are perpetually at war with the bears, which are those who think that the stock will fall.
You can use the relationship between open, high, low, and close to gauge who is winning this battle, and on which side you should bet your money. The next graph is a zoomed in version of the above graph, and should help you see what I mean.
Looking at the above chart, at example one, you can see that prior to this day, the bulls are dominating the bears, as evidenced by rapidly rising prices. On the day that example one occurred, the price opened at a higher price than the previous days close, and there is nothing special about this, since GDX (a gold stock fund) was in an uptrend. What is interesting however, is what happened after.
What occurred is that the bulls, feeling confident, pushed prices much higher during the day, but then, the bears came out and took control away from the bulls, and wrestled the price much lower. So low, in fact, that by 4:00 when the market closed, the price was below the opening price. This was clearly a harbinger of things to come, as this day marked the top of the uptrend. Clearly, you would have missed this with a close only chart.
Now, let's have a look at example 2. Example 2 is basically the exact opposite of example one. The bears were clearly in control, as shown by the downtrend. The bears push prices deep into the red, but then the bulls step in and close the prices near the high of the day. This represented a major victory for the bulls, and it was clear that it was safe to bet your money on them.
To move on to stage 3, please click here.
Let me explain why it is so essential to at least upgrade to this type of chart. Think of the stock market as a battlefield. The bulls, which are those who think the stock will rise, are perpetually at war with the bears, which are those who think that the stock will fall.
You can use the relationship between open, high, low, and close to gauge who is winning this battle, and on which side you should bet your money. The next graph is a zoomed in version of the above graph, and should help you see what I mean.
Looking at the above chart, at example one, you can see that prior to this day, the bulls are dominating the bears, as evidenced by rapidly rising prices. On the day that example one occurred, the price opened at a higher price than the previous days close, and there is nothing special about this, since GDX (a gold stock fund) was in an uptrend. What is interesting however, is what happened after.
What occurred is that the bulls, feeling confident, pushed prices much higher during the day, but then, the bears came out and took control away from the bulls, and wrestled the price much lower. So low, in fact, that by 4:00 when the market closed, the price was below the opening price. This was clearly a harbinger of things to come, as this day marked the top of the uptrend. Clearly, you would have missed this with a close only chart.
Now, let's have a look at example 2. Example 2 is basically the exact opposite of example one. The bears were clearly in control, as shown by the downtrend. The bears push prices deep into the red, but then the bulls step in and close the prices near the high of the day. This represented a major victory for the bulls, and it was clear that it was safe to bet your money on them.
To move on to stage 3, please click here.
The Foundation of Candlestick Charts
Welcome to stage 1 of understanding my charts... I understand that those who are new to technical analysis may look at a chart on my home page, and think that there is no way that could make sense. If that is you, then this page will help. I will explain step by step how a regular chart can evolve into that, and the many benefits my charts have to offer. Let's start off with the most basic chart, a line chart:
This chart should make more sense. This chart is created by taking the closing price each day, and plotting it according to the date. A line connects all the closing prices together. Beneath the line, bars show the number of shares that traded hands during that day.
This chart is simple, which is good, but it has some limitations. The main limitation is that is chart only looks at closing prices. You see, there is much more to a stock price than just the close. When the stock exchange opens at 9:30 in New York, or Toronto, the first shares that trade hands are done so at the opening price. Secondly, there is the high and low price for the day, or the extreme points the stock reaches throughout the trading day. The chart above does not take these other pieces of data into account.
Naturally, analysts figured that it would be a better idea to look at the opening price, the low price, the high price, and the closing price to gain a better understanding of the stocks behaviour, which brings us to the next chart.
This chart should make more sense. This chart is created by taking the closing price each day, and plotting it according to the date. A line connects all the closing prices together. Beneath the line, bars show the number of shares that traded hands during that day.
This chart is simple, which is good, but it has some limitations. The main limitation is that is chart only looks at closing prices. You see, there is much more to a stock price than just the close. When the stock exchange opens at 9:30 in New York, or Toronto, the first shares that trade hands are done so at the opening price. Secondly, there is the high and low price for the day, or the extreme points the stock reaches throughout the trading day. The chart above does not take these other pieces of data into account.
Naturally, analysts figured that it would be a better idea to look at the opening price, the low price, the high price, and the closing price to gain a better understanding of the stocks behaviour, which brings us to the next chart.
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