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Key Reversals and Candlestick Patterns

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According to what I read from you recently in a past traders article, was the action today (tues, 6/7) a key reversal? I notice that you don't use candlestick charts that I recall. I think these chrts can also predict future market action when there are certain candlestick types. Any comments on these?

I usually also read your index trader article when I get the weekend newsletter but didn't see it this last time. Can you update what you have been thinking about the indexes.

Yes and no, on key reversals on Tuesday (6/7). Yes, there was a one-day 'key' downside reversal in the Nasdaq 100 (NDX), but the same type reversal was not seen in the S&P 100 (OEX).

However, the OEX pattern did suggest a top based on some other ways of looking at the charts. The S&P 100 did not make a new high for the move, but nearly matched the peak of the previous week. However, after this strong rally, Tuesday's high was followed by a sharp intraday downside reversal with a close near the day's low.

If there had been a new high, above last week's S&P peak, it would have been a classic "bear trap" reversal. What we saw yesterday (Tuesday) was akin to it. A pattern of a new high followed by an immediate downside reversal, is sometimes called a 'bull trap' reversal. The bulls get blindsided so to speak.

You may recall that I've been saying that traders were "too" bullish by my 'sentiment' indicator and in my estimation, to suggest that this rally was going into a next up phase straight away. The market doesn't usually work that way. As well, a double top was pretty evident in the OEX hourly chart.

A double top is 'confirmed' so to speak (until then its only a 'possible') when a prior downswing low is pierced; in the hourly chart above, that clearly at the line of support at the prior low at 564.

I'll repeat some essentials from my last week's Trader's Corner on what constitutes a "key reversal", but if you want to go back and see the entire article, you can by clicking here

Also, I'll say a bit about, and show, a recent candlestick chart in the OEX, which did suggest an impending top by the "hanging man" candlestick pattern. So, in a sense, the candlestick chart showed something here that the regular bar chart didn't.

The same predictive elements show up in different ways on bar charts, so I don't feel handicapped by not usually looking at or for particular candlestick patterns. However, the recent 'hanging man' candlestick suggested a top was forming in the OEX. This pattern and one that followed it is worth describing as to its potential meaning.

A strong sign of a trend reversal and which is often the start of an intermediate or long-term trend change, is the formation of a 1 or 2-day KEY reversal.

A downside key reversal day: a day where there is a higher intraday high than the prior day AND the CLOSE is below the prior days LOW (a 1-day key downside reversal); or, the close is below the prior two days (a 2-day key reversal). In the case of Monday and Tuesday's price action in the Nasdaq 100 (NDX), as seen in the chart below, we're talking about a 1-day key downside reversal.

A garden variety downside 'reversal' (not using the descriptive "key" adjective) is where the reversal's close is under the prior day's (or, days') close, rather than under the prior low.

[The Key Upside reversal is the reverse of the Downside key reversal: a lower low than the prior day or prior two days, with a close above the high of the prior day (or the prior 2 days).]

There is more to the NDX chart above, in terms of analysis of its pattern, than simply the 1-day reversal: the Index was hitting resistance in the 1570-1575 zone implied by a cluster of prior highs. The Index was also banging against resistance implied by the previously broken up trendline, on its return to this trendline; this is noted by the red (down) arrow at the dashed up trendline in the NDX daily chart above.

In the S&P 100 (OEX) daily bar chart below, there is not the same 1-day reversal based on Monday and Tuesday's price action of this week (6/6) that is the same as the Nasdaq 100 (NDX) 1-day Tuesday reversal.

Tuesday's OEX close was not even under its prior day's close, let alone below the prior day's low, as can be seen on the last 'bar' on the OEX daily chart below. The spike back up to near the prior high for the current move, followed by the steep decline and close near the low, is bearish action; but not a key reversal.

However, what is significant for a possible top in OEX is the fact that the Index has basically gone sideways since hitting resistance implied by its previous bullish up trendline. This 'line' defining the low end of the previous rising trend, now appears to be acting as resistance.

More price action is needed to 'confirm' a possible top; especially a retreat to below the low end of the recent sideways price range; e.g., a daily close below 564-565.

Of possible significance for a top is what someone who interprets Japanese Candlestick chart patterns might have to say about the same recent price action in the S&P 100 (OEX), when seen using a candlestick chart:

Japanese Candlestick Pattern

The Hanging Man is a Japanese Candlestick 1-day pattern that, when occurring in an uptrend, tends to indicate a bearish market ahead and a reversal of the previous (up) trend.

A Hanging Man pattern is a short 'real' (price distance from open to close) and a lower shadow (intraday low) at least twice the length of the 'real' body.

The Hanging man consists of a single candlestick with either a filled real body or a hollow real body. The Hanging Man is identical to the Hammer, except the Hanging Man occurs at the top of an uptrend while a Hammer occurs at the bottom of a downtrend.

Japanese Candlestick Pattern

An Evening Star is a Japanese Candlestick pattern consisting of three candlesticks indicating a bearish top pattern usually. It consists of the following candlestick pattern characteristics, from left to right on a chart:

1. The first candlestick's real body is long and hollow.

2. The second candlestick, known as the star, is gapped up from the body of the first candle. The star can have a filled or hollow real body.

3. The third candlestick's real body is filled and closes lower than the Close of the first candlestick. The third candlestick's real body is usually long.

Colorful names, like 'Hanging Man' and 'Evening Star', for a colorful art!

Lastly, in relation to your query on my most recent (weekend) Index Trader article, it was posted on the OI web site after the Option Investor Newsletter was e-mailed over the weekend. Check the web site later on, even the next day, in the rare event of a delay. My most recent Index Trader column ("WANING UPSIDE MOMENTUM") can be seen by clicking here

Good Trading Success!

Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Contact Support with 'Leigh Stevens' in the Subject line.

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