aninstitutional instocks and a very brief time window, you can makevestor. The retailfast decisions and still pay minimal trading costs;investor traditionally paid higherand maximize your advantage as a swing trader. Befees to trade,cause the short-term trend is always chaotic andwhich explainsdominated by greed, fear and uncertainty, you canthe name. Today,any individual—expect one thing consistently: price is going to overeven one payingreact to any and all news. So if a stock’s earnings arelow fees with adiscount brokera few cents below analysts’ expectations, the stockage—is defined asmay fall far more than the news justifies (only to ada retail investor.just itself to a more reasonable level within a fewdays). This is a swing trading opportunity, of course.You will also notice that the “chaos window”—the period of timewhen overreaction in either direction remains a controlling factor—laststhree to five days. This is why swing trading works well on that sameschedule. It takes three to five days for buyers and sellers to recognize theoverreaction in price and for the adjustment to get sorted out. In fact, thetime institutional investors need just to correct their positions in a stock(represented by large blocks) makes it impossible for them to act anymore rapidly. The disadvantage to institutional investors becomes thegreatest advantage to individual swing traders.In this respect, you can predict how prices will change in the shortterm. A distinction has to be made here between short-term price“trends” and longer-term market trends. The primary technical system inplay in the market operates under the observations of the Dow Theory,developed by Dow Jones cofounder Charles Dow. Over a century ago,
Key PointInvestors desire predictability, but for swing traders, chaos creates opportunities. Chaos fuels greed, fear and uncertainly, andthis fact is the swing trader’s great advantage.
Breakouts from Trading Ranges
31
Dow realized that trends were the key to estimatingfuture price movement. As his theories were fineDow Theorytuned over the years, the Dow Theory evolved intoa major technicala series of rules and observations which are usuallyschool of thought,applied to the market as a whole and representeda belief thatoverall marketby the Dow Jones Industrials and other indexes.movement isThe Dow Theory observes that a number ofpredictable basedon primary andtrends can be observed within the broader market.secondary trendsA long-term trend, once established by an indexand confirmingand then confirmed by another, establishes a marsignals. The DowTheory states thatket direction. However, short-term trends are disshort-term trendscounted under the Dow Theory as unreliable.are not reliablefor predictingThis is true. If you are concerned with longlong-term priceterm trends for the entire market, you cannot relychanges.on a two- to five-day price movement. More time isneeded, and a longer-term primary or secondarytrend has to be established. But swing traders are not concerned withthese kinds of trends. The “trend” a swing trader follows is the short-termtrend itself, which can be defined as the market’s overreaction to virtuallyall news and all changes within the company and the individual stock. Inthis respect, swing traders observe the movements created by greed, fearand uncertainty, and make their decisions based on those momentaryfactors. You may pick stocks based on long-term growth and fundamental strength, but you trade on emotions, not fundamentals. This is whereshort-term chaos can be used to maximize your advantage.
Breakouts from Trading RangesThe short-term price movements within a trading range might be calledinsignificant. From a long-term point of view, this makes sense given thefacts. Short-term trends cannot be relied upon to estimate long-termgrowth. Fundamental analysts will agree with this universally. Even technical analysts agree; but for swing trading, short-term price cycles are dominated by greed and by fear, and that is the key to swing trading success.When prices shift in response to emotions, they are invariably exaggerated. So a greed-driven price increase will exceed any rational or justified growth in a stock’s price; and fear-driven price declines will fallbeyond a rational or justified level as well. In this regard, swing traders
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THE BASIC TECHNICAL RULESKey PointGreed and fear create over-reaction, thus exaggerated swings inboth directions. By recognizing this tendency, swing tradersprofit from the tendencies of most investors. Remaining cooland collected leads to profits.
base their trades on emotions and not spend time analyzing the underlying causes for price movement. Those causes do not matter because pricecycles are not reacting to any underlying cause; they are being driven bythose emotions.This is a very short-term shift in price. Swing traders may also befundamental analysts and as long as you do not mix up the two differentschools of thought, you can perform in both roles. But the time comeswhen price moves above resistance or below support. This can occurwhen the emotions of greed or fear are so exaggerated that a frenzy takesover, in which case it is likely that the price willeventually return to the established trading range.This is the exception; it is more likely that a breakbreakouta pattern in whichout occurs because the stock price is on the way toprice movesestablishing a new trading range.above resistanceA breakout occurs in many different variaor below supportand establishes ations, and following some specific charting patnew trend and,terns. Chartists rely on some of these patterns toeventually, a newtrading range.predict a breakout. At times it is difficult to properly interpret a current chart pattern, but easier toidentify in hindsight. Two breakout examples areprovided in Figure 2.2.gapA breakout can be more dramatic than the exa price pattern inamplesshown, with price levels moving far above orwhich one day’sopening price isbelow established levels. A relatively low-volatilityhigher than thestock can become highly volatile for a period ofprevious day’stime, only to settle down into a newly establishedhighest price orlower than thetrading range at a different level than previously.previous day’sWhen you look at a long-range stock chart, youlowest price.can spot the overall trends over many months or
Breakouts from Trading Ranges
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Breakout Above Resistance
Price
Resistance
Support
Breakout Below Support
Price
Resistance
Resistance
Support
Support
FIGURE 2.2 Breakout Above Resistance; Breakout Below Support
years, and this is where moving averages are valuable in identifying specific trends. But short-termchanges in stock price levels can be very volatile, ifcommon gapanother term foronly for a brief period of breakout and establishthe gap, whichment of a new trading range.distinguishes itAnother significant trading pattern is the gap.from other formsof exceptional gapAs a general rule, stocks tend to open a new daychart patterns.within the high-low boundaries established on theprevious day. The gap, also called the common gap,is not unusual. When a stock’s price opens above the high point of theprevious day or below its low point, a gap has occurred; and depending
THE BASIC TECHNICAL RULES
34
breakawaygapa gap involvingprice movementinto new territorybeyond the established tradingrange.
exhaustiongapa type of gap inthe direction of anextended pricemovement, signaling that thecurrent trend isabout to end andprices will levelout or begin moving in the opposite direction.
runaway gapa gap appearingas part of a strongand sustainedprice trend, reinforcing the pricedirection, andpossibly showingup as a series ofgaps one afteranother.
on the ensuing price activity, a gap may come inseveral different forms.The breakaway gap involves price moving into arange where it has not been in the recent past, this isa “breakaway” from the previously established trading range. In comparison, the common gap takesplace within an established trading range.Two additional kinds of gaps are important totechnicians. First is the exhaustion gap, which appears after an extended period of price movementupward or downward. While the exhaustion gapcontinues in the same direction, it signals that theprice move may be coming to an end and the pricetrend will reverse. A runaway gap appears when aprice movement is gaining in strength; this kind ofgap reinforces the price direction, and a series ofrunaway gaps may even appear one after the other.The major types of gaps are summarized inFigure 2.3.Gaps are important to swing traders becauseof what they often signal. Gaps accompany majorchanges in directions occurring at the beginning ofnew price movements and also at the end of thesame trends. If you watch charts and see patternsindicating the timing is right to make a trend, andform of confirmation strengthens your decisionand improves your timing. Gaps serve as one of thebest forms of confirmation to enter or exit a trade.
Key PointGaps are very important chart patterns because they invariablysignal and reinforce important strength in existing trends, orforetell movement about to occur.
Important Chart PatternsCommon Gap
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Breakout Gap
ResistanceResistance
Support
Exhaustion Gap
Support
Runaway Gap
FIGURE 2.3 Common Gap, Breakout Gap, Exhaustion Gap, and RunawayGap
Important Chart PatternsAs a swing trader you do not have to become an expert in all aspects oftechnical analysis—and some of it is quite complex. However, you doneed to master the basic charting principles and these are relatively easy.There are two general tiers to technical analysis. The largest andmost complex is often overly theoretical and intensely mathematical.This level tends to be taught to students, and is more academic thanpractical. By the time you complete your analysis on this level, the stockhas moved onto its next phase and the information is out of date. On amore immediate and accessible level are a few important basics. This iswhere you can quickly gain the knowledge you need to improve yourtiming and your profits with swing trading.The best-known signals are patterns called double top and doublebottom and these are fairly simple indicators to spot and to interpret. Adouble top involves two tests of resistance, with a decline in price in between. Because it is a double test, the double top is considered a bullish
THE BASIC TECHNICAL RULES
36
signal, and the stock price is expected to retreat.The concept here is that there was not enough enthusiasm among investors to push the price higher,so price retreats. The double bottom is the opposite, a test of support. Because support is strongenough to hold up under this two-part test, theprice subsequently rises.The double top and double bottom are illustrated in Figure 2.4.
double topa price pattern inwhich resistanceis tested twicewith a pullback inbetween. As longas resistanceholds up, price isexpected to decline after thedouble top.
Double Top
Price
Resistance
Support
Double Bottom
Price
Resistance
Support
FIGURE 2.4 Double Top; Double Bottom
Important Chart Patterns
The head-and-shoulders pattern is an extended variation of the double top or bottom pattern. This is characterized by three price peaks ordeclines, with the middle one extending furtherthan the first and third (in a letter M shape). Ahead-and-shoulders top occurs at or near resistance;the interim trading areas between the peaks iscalled the pattern’s neckline. Volume often is strongat the first “shoulder,” and relatively weak by thelast phase of the pattern. The head-and-shoulderstop is a test of resistance and because it does notbreak through, it anticipates a price decline.The head-and-shoulders bottom tests supportin the same way as the top tests resistance, but inthe opposite pattern, in a letter W shape. Volumeof the last of three head-and-shoulders extensions islikely to be lower than for the first shoulders andthe inverse head, indicating a lack of enthusiasmamong investors for a price decline. The head-andshoulders bottom anticipates a rise in the stock’sprice.The two head-and-shoulders patterns each anticipate price movement in the direction opposite ofthe tests; and may also anticipate breakouts from theestablished trading range (below support after thetop pattern, or above resistance after the bottompattern). Both of these are illustrated in Figure 2.5.
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double bottoma price patterntesting supportwith a price increase in between.Because supportholds up againstthis two-part test,the double bottomanticipates a subsequent increasein the price level.
head-andshoulders topa price patternwith three peaks,the middle onehigher than thefirst and third.This letter Mshape patterntests resistanceand anticipates aprice decline tofollow.
necklinethe price areain between theprice extremesof the head-andshoulders pattern.
Key PointThe head and shoulders anticipates a reversal in price because itincludes three separate tests of the limits, accompanied byweakening volume. The reduction in enthusiasm of investors isthe real signal.
THE BASIC TECHNICAL RULES
38TopResistance
Support
Bottom
Resistance
Support
FIGURE 2.5 Head-and-shoulders Patterns Top and Bottom
head-andshouldersbottomthe inverse of atop, consisting ofa head testingsupport with twoshorter shouldersbefore and after,creating a letter Wshape. The pattern anticipates aprice increase.
While the double top or bottom and headand-shoulders patterns provide visual signals anticipating specific price trends, another importantcharting feature is the broadening formation. Thereis a tendency for price ranges to expand over time,often with accompanying expansion of daily volume. Several specific types of broadening formations are useful to swing traders to recognizepatterns and to anticipate or confirm buy and sellsignals.
Important Chart Patterns
The broadening formation is illustrated inFigure 2-6.A related pattern is the triangle. This is the opposite of a broadening formation in which a trading range becomes narrower than the precedingpattern. This pattern implies uncertainty and whatmarket watchers like to term “consolidation.” Butwhile it precedes some future price movement, it isdifficult to determine with any consistency the direction that price movement is going to take.The triangle is illustrated in Figure 2.7.The triangle has been given other names suchas “flags,” “pennants,” and “wedges,” but the overall observation is the same: Any change to an existing trading range anticipates a future pricedirection. A broadening formation reveals the likelihood of stronger volatility in the future, and triangles imply momentary uncertainty.No pattern can be reliably used to guaranteeprice movement. Even with the strongest of signals,short-term uncertainty dominates every stock’sprice. But these patterns, when incorporated into
FIGURE 2.6 Broadening Formation
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broadeningformationschart patternsshowing wideningtrading range fora stock, developing over time andproviding specificsignals for swingtraders.
trianglea price pattern inwhich the tradingrange narrows, asign of uncertainty about thestock’s pricemovement and aprecursor of acoming upward ordownward trend.
THE BASIC TECHNICAL RULES
40
Key PointThe triangle pattern can be equated with uncertainty that oftenis found between periods dominated by greed and fear. Forswing traders, this pattern can imply holding off any subsequent swing trade opening trades until that uncertainty givesway once more.
FIGURE 2.7 Triangle
the more specific daily price analysis used by swing traders, can serve aspowerful confirmation tools. When these are used along with the additional information provided by candlestick charting analysis (discussedin Chapter 3), your arsenal of swing trading tools is vastly improved.
Spotting the Patterns to Trade EffectivelyThis brief explanation of charting patterns and signals is by no means exhaustive. Chart patterns are general indicators that may confirm othersignals, and that is all. As you develop your swing trading strategy basedon a day-to-day analysis of price trends, you will find the broader charting tools useful to time decisions. The purpose is to improve the timingand not to ensure 100 percent success. No system can do that.
Spotting the Patterns to Trade Effectively
41
It is always useful to keep market theories in mind. The randomwalk theory tells you that all short-term price movement is arbitrary. Onthe other extreme, the efficient market hypothesis claims that all currentprices are fair because they reflect all known information about a stock.Neither of these theories is entirely reliable. They do, however, provideguidance to the market and promote an understanding of how and whyprices move.All theories aside, short-term price movement is always guided bygreed, fear, and uncertainty. As a period of uncertainty becomes extended, a fourth emotion—impatience—is equally destructive as theother three. As long as you recognize that this range of emotions rulesshort-term price movement, you can employ swing trading to take advantage of the cyclical changes in a narrow window.Some specific guidelines for using chart patterns within your swingtrading strategy:1. Recognize the limitations of pattern analysis as well as the benefits.Chart patterns are by no means the last word in timing of trades.Chart patterns may be thought of as the raw material of a moreextensive timing strategy. As you will see in the next chapter, theday-to-day price trends contain their own specific formationsand patterns that are not actually part of the broader chartist’srealm. A chartist looks for longer-term patterns with double topsor bottoms, head and shoulders, and other visual patterns over anextended period of time; and gaps provide an indication of morerapid changes in the moment. But these trends are limited invalue for swing trading. Because you will be observing trendsfrom one day to the next, your concern is focused on the actualtwo- to five-day swings within a few points and based on pricestructure itself—and not so much on how the pattern fits intothe larger chart pattern.2. Remember, price is not a conscious force. There is a tendencyamong chartists to begin thinking about price and price movement as conscious forces. The names given to some patterns andthe trends themselves are given descriptive names as well.Chartists refer to “testing support” or a price “trying to breakthrough” resistance, as though it were a conscious effort. Thismay help in describing or understanding what is going on; but itis also important to recognize this as a trap. If you come to think
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THE BASIC TECHNICAL RULES
of price as having some type of free will, that facilitates the moredeadly trap of acting on emotion and reacting to all price trendsemotionally. Greed, fear and uncertainty rule most decisionmaking, but as a swing trader you will out-perform the marketby remaining coldly detached and observing the short-termtrends for the emotionally-driven cycles that they are.3. Don’t depend on any one indicator; use many to confirm one another. Every investor has a favorite indicator, either for stock selection of for timing of decisions. A lot of formulas are in use,and a lot of strategies that work once or twice might not work atall in the future. Cycles are notoriously unreliable and uncertain.For this reason, swing traders can and should use charting indicators and trends to confirm what they observe through a more detailed daily price cycle, and not as a stand-alone indicator. Themore confirmation you have for what appears to be occurring ina stock’s very short-term cycle, the better your timing is going tobe. The value of chart analysis is that it is instantaneous andwidely available free of charge. So you can either base your swingtrading on candlestick charts and look to other kinds of chartsfor confirmation; or overlay the traditional chart patterns on thecandlestick chart. In either form of analysis, your timing will improve when you base decisions on analysis and confirmation, andnot on impulse.4. Learn how to recognize both patterns and false starts. Perhaps thegreatest challenge in charting is to know when a pattern is emerging and when a momentary change is only a false start. Lookingback to last week’s chart, you can easily identify the signals andsee what you should have done at exactly the right moment. But ifyou look at the same chart today, what will happen next? Theskill of chart reading relies not only on identification of a specificpattern, but also on being able to distinguish a genuine important signal from a false start. One fact is certain: Among all of thereal signals are numerous false starts. Swing traders can use various chart patterns to minimize acting on false starts, but no onecan eliminate them completely.
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Charting is a key element to swing trading. In fact, the strategy depends on price patterns to work. But the traditional technical analysisand charting of a stock’s price are only one form of analysis. The study ofcandlestick charts makes swing trading more effective than the traditional charting tools, and improves your timing immensely. The nextchapter explores candlesticks in depth.
3Chapter
Candlestick Chartingfor Swing Trading
he method you select to track stock prices can make a big difference not only in timing of trades, but also in how you recognizeopportunities. The traditional charting method showing the trading range and opening and closing prices is a valuable preliminary tool.For swing trading, however, you may want to expand your charting to include the candlestick.candlestickThe candlestick was originally developed huna chart formationdreds of years ago in Japan to track rice futures, andshowing eachin the late 20th century it became popular in theday’s tradingrange; high andUnited States. One inhibiting factor before modernlow price; openday trading has been the problem of constructing aing and closingchart quickly. With the Internet, it is easy today toprice; and thedirection the pricefind free and instant charts for thousands of stocks.moved for theIn the past, any service offering charting (of anyday. A white (orclear) candlestickkind) was invariably delayed and normally offeredreveals that theonly for a fee. So with the Internet, candlestickprice closedcharting has become a popular venue for stockhigher than itsopen; and a blackprice tracking, especially when used in conjunctioncandlestick rewith other methods (including moving averagesflects a lowerclose for the day.and volume analysis).
T
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CANDLESTICK CHARTING FOR SWING TRADING
46
What the Candlestick Reveals
real bodyin a candlestickchart, the rectangular central part.A white real bodyshows the stockmoved up fromopening to closing price. A blackreal body showsthe stock moveddown from opening to closingprice.
As with all types of analysis, a single candlestickviewed by itself is of no value. You need to studythe significance of a particular formation as part ofa series; the tracking of candlesticks over severaldays is very revealing, especially in the way that formations appear—including not only the overall direction, but in whether the stock’s daily pricesmove higher or lower, and for how long.A candlestick consists of several parts; the twotypes of candlestick formations are summarized inFigure 3.1.
HighUpperShadow
Close
Open
RealBodyOpen
LowerShadowLow
Close
FIGURE 3.1 White and Black Candlesticks
Key PointNo system—candlesticks included—summarizing stock pricesgive you a sure-fire guarantee about the next move. But someindicators are more reliable than others.
What the Candlestick Reveals
The difference between these two candlesticksis in the real body itself. A white or clear real body—known as a white candlestick—reveals that the day’sclose was higher than the open—it was an up day. Ablack real body—a black candlestick—reveals the opposite: the close was lower than the open for the day.The extensions above and below the real bodyare called shadows. The upper shadow is the tradingrange for the day between the real body and thehigh of the day. The lower shadow is the tradingrange between the real body and the low of the day.The candlestick provides a wealth of information about a stock’s trading for each day. The fullextension from top to bottom is the day’s entiretrading range. The real body shows the distance between opening and closing price and also revealswhether the stock moved upward or downward onthe day. These combinations of visual summariesbecome very important when candlesticks are studied as part of a trend on a stock chart.Four variations on the usual candlestick formation—a real body with a shadow above and below—are important because they reveal importantshifts or reversal points within trends. These fourvariations on the candlestick pattern are summarized in Figure 3.2.
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whitecandlesticka candlestick witha white or clearreal body indicating that the stockmoved up on theday.
blackcandlesticka candlestick witha black real bodyshowing that thestock moveddown on the day.
shadowin a candlestick,the area aboveand below thereal body; thetrading rangeabove and belowthe opening andclosing prices.
Key PointThe candlestick’s main advantage is that it reports everythingabout a day’s price movement, in a simple graphic form.
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uppershadowin a candlestick,the trading rangebetween the day’shigh price and thetop of the realbody (opening orclosing price).
lowershadowin a candlestick,the trading rangebetween the day’slow price and thebottom of the realbody (opening orclosing price).
shaven heada candlestick withno upper shadowand a white realbody. This appears on a daywhen the stockrise and closed atits high of the day.
ShavenHead
The shaven head is a candlestick with no upper shadow and a white real body. This formationhas significance because it shows that the stock didnot trade above its high for the day. The white realbody shows that the stock rose in trading. As withall candlesticks, a particular outcome is importantonly to the degree that it fits into a trend and pattern; so it is not prudent to assign a particularmeaning to this candlestick by itself.The opposite of the shaven head is the shavenbottom. This shows up when a stock closes at itslow for the day. It has no lower shadow and the realbody is black.The shaven candlesticks are illustrated in Figure 3.2.A spinning top is a descriptive name given tocandlesticks with small real bodies and the combination of a large upper shadow and a small lowershadow, indicating a broad trading range but minor gaps between opening and closing prices.These can occur in up as well as down markets. Examples are shown in Figure 3.3.
ShavenBottom
FIGURE 3.2 Shaven Candlesticks
What the Candlestick Reveals
49
Key PointThe imaginative names of candlesticks are useful in helping youto visualize not only the formation, but also its significance in aswing trading strategy.
Up Day
Down Day
FIGURE 3.3 Spinning Tops
The doji is a candlestick with little or no realbody. It is shaped like a cross, indicating that thespace between opening and closing prices is verysmall, even though trading took place above andbelow. When this appears in a trend, it often signalsthat reversals are about to occur; so the doji is veryimportant as part of a candlestick-based trendanalysis. Swing traders may close attention to thesenarrow range days. Also called the common doji, itis distinguished from three other types.Three other doji variations may be seen in candlestick charts. The first is the long-legged doji,which is unusual. When you see a very narrow spacebetween opening and closing prices accompaniedby a larger than normal trading range, it often indicates that the current trend is coming to an end.The gravestone doji is a bullish formation.With little or no space between opening and closing prices, traders attempted to trade above those
shavenbottoma candlestick withno lower shadowand a black realbody; this appears on a daywhen the stockfell and closed atits low of the day.
spinning topa candlestick witha large uppershadow and asmall lowershadow and witha small real bodythat is eitherwhite or black.
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dojia candlestick withlittle or no realbody, shaped likea cross. Thisdemonstratesvery little changebetween openingand closingprices, with trading occurringabove and belowthose levels.
levels but were not successful. This often precedes aprice retreat.A final type of doji is the dragonfly doji, whichis an opposite formation from the gravestone. Withthe dragonfly, there is little or no distance betweenopening and closing prices, but trading takingplace on the day below that level. When this formation appears, it often precedes a price rise in thefollow sessions.These four types of doji formations are summarized in Figure 3.4.
Common
Long-legged
Gravestone
Dragonfly
FIGURE 3.4 Doji Candlesticks
Patterns and Combinations
The individual formations of candlestick trading are interesting and have descriptive names. However, for swing trading the two- to five-day tradingpatterns are far more revealing and important.
Patterns and CombinationsCandlesticks—as with all forms of trend analysis—have to be studied and interpreted as part of atrend. For this reason, swing traders need at leastthree consecutive days in order to decide whichway a stock is heading, what is likely to come next,and when (and if ) to take action.Patterns are useful not only in what they tellyou, but in what the lack of a specific pattern reveals. Impatience is a costly emotion in the market,but swing traders know that they have to wait for aclear signal before acting. While an active swingtrading pattern normally extends from three to fivedays, there may be periods in which no clear patterns emerge at all. This is equally valuable to theclearest of signals. The lack of a signal tells you thatit is not yet time to act.Patterns consist of three or more emergingtrends and, because swing trading is very short-term,you do not need to include long-term trends. Thethree or more days are enough to provide a signal.In traditional chart analysis, traders look fordouble tops and bottoms, head and shoulders formations, and other reversal signals. Swing tradersnot only seek the same types of anticipation intheir patterns; they need reversal signals to knowwhen the short-term trend is likely to stop and begin moving in the opposite direction.The candlestick reversal signals include manydifferent formations, some very strong and others
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common dojianother name forthe doji, distinguished fromother dojivariations.
long-leggeddojia candlestick withlittle or no distance betweenopening and closing prices butexceptionallybroad tradingrange aboveand below.
gravestonedojia candlestick withlittle or no spacebetween openingand closing price,but a tradingrange above thoselevels for the day.
dragonflydojia candlestick withlittle or no distance betweenopening and closing prices, but atrading rangebelow that levelfor the day.
CANDLESTICK CHARTING FOR SWING TRADING
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Key PointNo single day’s candlestick is revealing by itself. You need tostudy patterns and trends to effectively time your swing trades.
Key PointIn addition to what a trading pattern reveals, a series of tradesare also important at times for what they do not reveal. When nospecific signal is evident, it is best to take no action.
reversalsignalany chart patternor trend implyingthat the currentprice direction isabout to stop andbegin moving inthe oppositedirection.
hammera candlestickpattern occurringat the end of adowntrend. Itconsists of a longlower shadowand a small realbody, and signalsa reversal andthe start of anuptrend.
more subtle. The most basic among these are thehammer and the hangman. These are candlestickformations representing narrow range days. Both ofthese appear frequently at the top and the bottomof two- to five-day trends and are quite distinctive.The hammer has a long lower shadow combinedwith a small real body, which may be either white orblack. The hammer shows up at the bottom of adowntrend and often signals that a new reversal—an uptrend—is about to begin. The hangman is theopposite; it appears at the top of an uptrend andmay signal the beginning of a reversal and a downtrend. Like the hammer, the hangman also has along lower shadow and may be white or black.Figure 3.5 shows both of these formations asthey occur at the end of existing trends.Note that in this example both hammer andhangman were shown with black real bodies. Inboth of these formations, either a white or blackreal body will be found. An actual example of recurring hammer and hangman formations isshown in Figure 3.6 for Citicorp.
Patterns and Combinations
53
Key PointThe hangman and hammer are candlestick versions of the allimportant narrow range day that swing traders rely upon totime their decisions. These are