The bulls got hit with a scare on Friday (4/16) and I got some inquiries today as to whether technically, the market had weathered the storm, to date anyway. Friday saw a pullback to up trendlines (as well as to the area of the March highs). Despite a 13 to 1 lopsided down volume versus up volume on the NYSE, the uptrend is intact so far on the charts. This is not to say that Friday's action doesn't provide a cautionary flag. Volatility figures certainly jumped and we haven't seen that in a while. The seeds of possible change were planted but April so far is keeping with its tendency to be strong seasonally .

Friday's advance/decline figures weren’t as bearish as the lopsided upside versus downside volume, as selling was especially concentrated in a few financial stocks; e.g., Goldman Sachs of course (GS), Citi (C), Bank of America (BAC), JP Morgan Chase (JPM). BAC and JPM are in the Dow 30 (INDU), which I hesitate anymore to call the Dow 'Industrials', which pulled the Dow and S&P lower. The Nasdaq held up better of course.

Today, oil stocks, which weigh heavily in the (capitalization-weighted) S&P 500 are helping pull the major indexes higher. But, you don't need me to tell you that. Rather, I'll do a current 'technical update' section and then get started on a series on the 'basics' of technical analysis that I last did in 2003. Sort of my (Essential Technical Analysis) book in bite-sized chunks. This for the benefit of OIN subscribers who would welcome some basic information or a review of technical/chart analysis.

Since my 'basics' series begins with a primer on trend and trendline analysis, I will start with a survey of the two most commonly used chart TYPES: bar charts and candlesticks, with a small nod to the close-only line charts. More often than not you see candlestick charts these days and they do provide a strong visual reference to the daily or weekly range between the Open and the Close, both being the 'moment of truth' so to speak as to where buyers and sellers are willing to meet initially (the Open) and then settle up at the end of trading (the Close). Today, for a change, I'll use more than my typical bar charts (except for Point & Figure).

Being a long-time trader/analyst type I got used to bar charts and don't perhaps need to rely on much on the candlestick visual clues but they sure are pretty. Thanks to the tireless promotional efforts of a former colleague, Steve Nison, starting back in the 80's, candlestick charts started getting used more. Steve wasn't much of a trader, but he sure was and is one heck of a promoter. You come along at the right time with the right idea and you get associated with it big time.

CURRENT TECHNICAL UPDATE:

As I often have said, because it’s a basic axiom (self-evident truth) of how trends operate: "resistance, once penetrated tends to 'become' support later on" ... and vice versa: "support, once penetrated tends to 'become' resistance at a future time".

The most compelling aspect as to showing an intact uptrend is that the recent dip in the S&P 500 (SPX) and the Dow held lows in the area of the March intraday high as highlighted on my first two charts. To add to technical evidence that prices rebounded from support is that SPX bounced off from its 21-day average.

Moreover, while there were intraday lows BELOW the current up trendline, Closes were above that line and stayed within its current uptrend channel. The use of Candles in plotting my first chart, slows that the 'real body' of trading stayed within SPX's uptrend channel. More on the real body concept further on. All in all, no technical 'damage' is apparent.

While two key technical indicators (seen above) are showing prolonged bullish extremes, which on a contrary opinion basis suggests a market vulnerable to a correction, PRICE action and the primary consideration technically, remains bullish.

The Dow chart mirrors the S&P, except that INDU, not being capitalization weighted, held up slightly better in terms of a penetration of its up trendline and holding a bit above its 21-day moving average. There's a widespread tendency for use of the 20-day average, versus the Fibonacci '21' length setting which I prefer, but there's little practical difference between them.

I'll just add the Nasdaq Composite (COMP) daily chart here as COMP's intraday (Friday) low made an exact touch to what becomes the THIRD point establishing an even more 'solid' up trendline. Needless to say, participation in calls on the tech heavy Nasdaq has been the place to be; especially the Nasdaq 100 (NDX). Adding to positions here is high risk in my estimation. Too many traders are bullish for me to join that crowd at current levels, but those who bought the dip to the trendline are making out ok so far.

CHART TYPES:

As I started out saying as to charts, the most common 'types' in use are of course candlesticks and bar charts. There are some advantages to candlestick charts, especially for the occasional 1-day signal that comes from a particular reversal type candle such as the 'hammer' and the 'hanging man'. There are other such special patterns. It's not that you don't see the same potential reversal type pattern with bar charts but candles are colorful and unique in its terminology for certain key candle patterns.

BAR CHARTS:

A bar refers to a vertical line on a graph, the bottom of which is drawn at the point that represents the price low of a trading period and the top of which is draw at a point that represents the highest price for the same period relative to a price on a right hand vertical price scale. A price chart consists, with one chart-type exception Point & Figure charting, of a left-to-right, horizontal scale on the bottom that measures how much time has passed: the time scale. The vertical, up and down scale on the right measures prices for the time period shown; i.e., the price scale. These scales, if you remember your geometry, are also called the "x" and "y" axis, respectively. In case you ever want to remember which is which, the y of the y-axis has an up and down direction because of the 'tail' that goes down below a horizontal line if you were writing on lined paper.

The bar has another mark like a hyphen (-) on the point on the left side of the bar that represents the opening price and another on the point of the right side of the bar that represents the level on the price scale where this market or stock closed. If all four of the price possibilities: Open, High, Low and Close are shown, you may see it referred to as an "OHLC" chart. If the bar omits the opening price and is just the High, Low and Close, it can be also be called an "HLC" chart. The OHLC and HLC references show up as choices on some charting software.

Another aspect that we want to know about any "bar" is the time period that the bar measures for its Open, High, Low and Close. A bar can represent trading for 15, 30 or 60-minutes, a day, a week, a month or even a quarter. Other time periods are possible as well, if you have the data for it and the software that will display it. Intraday charts, like 60-minute or hourly charts, tend to appeal to day traders or short-term traders who trade 2-3 day price swings. I like long-term (e.g., 2-3 months or more) hourly charts for the detail that they provide as an adjunct to daily charts.

OK, I said that this would be basic! Not so basic-basic now is the more complex Candlestick charting.

CANDLESTICK CHARTS:

I mention in my book that Munehisa Homma, a famous and extremely successful Japanese rice trader active in the mid-1700s, devised trading principles that evolved into the candlestick method of charting and pattern recognition. Drawing the chart requires the same price points as the bar chart but the Open is always part of a candlestick chart. In the Japanese candlestick method, greatest emphasis is put on the Opening and Closing prices. Steve Nison, in his first book, Japanese Candlestick Charting Techniques, which helped popularize this charting form in the west, mentions the Japanese proverb that says: "the first hour of the morning is the rudder of the day". the Open is where all overnight news and expectations for the day ahead is translated into an actual starting value for a stock or index.

NOTE: a single 'bar' is a candle, the chart type is candlestick chart. My next chart and from my book, is a candlestick chart expanded to see more detail for a short time span for a stock; what and when is not important for the example.

The thick part of the candlestick is called the real body and represents the price span between the Opening and Closing prices. Any real body that is not filled in ('hollow') indicates that the close was higher than the open. When the Close is below the opening price, that candlestick has a real body that is filled in with a color; black in this case for my black & white book.

So, solid is down and white is up in terms of the Close relative to the opening. The thin lines are called the shadows and the top most point of the upper one marks the high and the lower most point represents the Low of whatever period is being measured. In at least two of the candlesticks – both with hollow thick (real) bodies, you’ll note one daily candlestick figure that has no thin 'shadow' line above and one with no thin line below. This is because the High was the same as the Close in one instance and the low was equal to the open in the other.

My next chart shows the same daily stock chart again (it was of GE some years back) with more days shown but also includes a bar chart for comparison. If you study the two different chart types, you’ll note that the candlestick figures immediately highlight the days when the close fell below the open and vice versa.

The hollow or white thick 'real' bodies are up days and the solid or filled in real (thick) bodies are down days. When the real bodies are 'short' because there is a relatively narrow difference between the Open and Close or when the open and close is the same (no thick body at all), this quickly points to indecision or a temporary balance between buyers and sellers. The candlestick depiction of Open, High, Low and Close allows an immediate grasp of more information visually. For this reason, candlesticks have become quite popular.

There is another useful aspect to candlestick charting that involves the way that reversal information is interpreted, by a particular type of pattern often occurring in a single day. Certain 'types' of candles formed during one day alone, are said to predict reversals of the immediate trend that preceded that candle. Bar charts have certain predictive patterns from one day’s price action also, but they don’t always hold a candle, pun intended, to this chart type.

While I will not enter into a description of all candlestick patterns and their colorful names, as that is a specialized study, I have a couple of examples of candle reversal patterns.

THE "HANGING MAN":

The hanging man as the name implies, suggests that a market is at the end of its rope so to speak and looks a bit like that unfortunate figure. Go back to the chart above for an example.

The three criteria to indicate this candle type are: 1. The (thick) real body is at the upper end the recent price range; whether it is solid or hollow is unimportant. 2. A long lower shadow (thin line) should be twice the height of the real body. 3. It should have no upper shadow or a very short one. The longer the lower shadow and the smaller the real body the more predictive it is for an imminent reversal of the trend that has preceded the hanging man candlestick. While the thick body can be either solid or hollow, it’s a slightly stronger indication if the real body is solid, which depicts a down from the opening close.

The hammer pattern seen in my next chart has the same 'look' as the hanging man but this candlestick pattern occurs after a downtrend has been underway for some time typically and takes its name from the saying that the market is 'hammering' out a bottom or base. The same criteria apply except for number 1: The (thick) real body is at the LOWER end of the recent price trend. The hammer seen below has a solid real body and indicates that this candle does not have to show an UP close to suggest an upside reversal. However, note the long shadow (the thin line) that comprises the lower portion of this candlestick as this is meaningful and adds to the bullish impact.

This very brief foray into the interpretation of a couple of the candlestick patterns, although these are very useful, is only an intro to candlestick charting, enough to give some basics for this chart type. The reversal patterns like the 'hanging man' and the 'hammer' don't occur on all trend reversals of course but when they happen, it's something to pay attention to. The reversal patterns are analogous to key upside or downside reversals that are more often discussed relative to bar charts.

LINE CHARTS:

Even more 'basic' in terms of WHAT is charted, are Line charts (or as they’re also known, close-only charts) are as the names imply, constructed with a line that connects ONLY closing prices for whatever period is being studied; e.g., hourly, daily, weekly, monthly. Charles Dow was only interested in Closing prices in stocks and even more basic than Candlesticks in what this chart type chooses to highlight. Dow felt, as do some current era investors and traders, that plotting a record of the intraday (or intra-week) highs and lows tends to obscure the 'real' value of a stock or index, which is settled only at the close. Some institutional fund managers will only buy on the close. The Open is not considered overly important relative to the overall trend.

Line charts can give a very different take on trendlines, but trendlines are of significant use also with these charts. My next chart is of the S&P 500 first seen above, but now rendered as a line chart. There is some 'definition' for an upper trendline (2-3 or more points), but none for a lower trendline; a line which so accurately predicted where key support developed at recent lows. I've kept the same trend channel lines but the lower line transposed over from the Bar and Candlestick charts are meaningless here. More Closes are needed that could make up 2-3 or more points to construct a lower trendline. Nevertheless, that upper trendline WILL show us the closing level needed for a breakout ABOVE the upper trendline; i.e., above 1240.


GOOD TRADING SUCCESS!