Friday, January 28, 2011

Discussion 8 : Hesitations, Uncertainties, Indecisions

I know this man, Joseph, on the coach that I took when I made a return trip to KL for my ex-employment's 'short term relocation'. Being the only other man on the coach (there were only 2 passengers on board at that time!), he spoke to me to kill boredom. He is friendly, and has a pair of interestingly positive looking eyes.

Later on, I found out that he is a full time gambler. He frequents casinos as if he's going to work! I'm amazed that he did not even have a second thought of concealing that (even if it is a fact). Now that I am recalling that incident, he seemed to be proud to admit that he is a gambler.

After a while of talking, I immediately withdraw my negative thoughts on him. To me, he's not a gambler. I can see that he is going to be a very successful man, when I realize that he has developed a number of interesting formulae to defeat the casino.

He said, mind reading is essential to win a hand. Many gamblers are very often driven by two demons - greed and fear. Of the two, fear seems to be a greater demon. That is why gamblers often fold a hand when they are uncertain of the strength of the cards that they are holding. Even if they do plan on raising a weak hand, they'll give themselves out by means of body language and microexpressions. Their bodies can't lie. They fear losing money!

Very often when you see a stock price goes on an uptrend, many investors euphorically buy the shares. When the stock prices seemed to be at an unexpected high, they lose direction. They are uncertain. Will the prices go further up? Or will they go lower from here? When the S&B Money starts to sell, causing the price to retrace, out of fear, they frantically sell off their shares, just to play safe. And what's the result? An uptrend turns into a downtrend. :S

In the stock market, while we don't have faces and bodies for us to analyze, we have an extremely reliable tool to show us the 'body language' and 'microexpressions' of spotting indecisions in the stock market - Candlesticks.


DOJI - INDECISION OF MARKET DIRECTION

Illustration (i) : Doji
Firstly, remember, the plural for doji is doji. :-)

Illustration (i) shows how a doji looks like. A doji has none or virtually no real body and has a long upper and/or lower shadow. It means the stock opens and closes at or virtually at the same price, with price fluctuations in between. This shows market indecision.

Doji means "to hesitate" in Japanese. It is a type of candlestick pattern which signals that a trend reversal is imminent. For a stock price to continue its uptrend, there should not be any huge hesitations in between. It takes conviction of buyers to sustain a rally.

Illustration (ii) : Southern Doji & Northern Doji
Doji can also be found at the bottom of a downtrend. Some technical books name doji formed in an uptrend as Northern Doji (ND), while in a downtrend as Southern Doji (SD). See illustration (ii). However, most of the time, the signal derived from a SD isn't going to be as strong as one generated from a ND.

Remember, fear prevails over greed. It is always faster for a stock price to comet down than for it to climb up. In times of indecision reflected in a SD, traders would need more confirmations to support a trend reversal signal, compared to those reflected in a ND.


TYPES OF DOJI

Illustration (iii) : Dragon Fly Doji, Rickshaw Man, Gravestone Doji

Some doji are given different names depending on how they look like. Observe illustration (iii).

Long-legged Doji (LLD)
This doji has a long upper and/or lower shadow. The longer the shadows are, the stronger the signal is. This is because a major indecision is usually characterized by major intraday movements. Long-legged doji that have their open and close price near, or at the middle of the shadows are nicknamed "Rickshaw Man", which means, "something that is inevitable". They derive this from an urban saying,

"There is no way you can run from a Rickshaw Man who makes his living running a rickshaw all day long. He will definitely catch you in the end!"

Dragonfly Doji (DD)
The formation of DD resembles the shape of a dragonfly, thus deriving its name. Also, if looked at closely, it seems like an incomplete version of a Hammer or Hanging Man. Depending on where you see it, it shows a trend reversal is imminent. The longer the lower shadow, the stronger the signal is.

Gravestone Doji (GD)
The flip of DD is GD, with the shape of GD resembling a gravestone. Again, it looked as if it is an incomplete version of Inverted Hammer or Shooting Star. The strength of the signal is usually determined by the length of the upper shadow. GD, like DD, can be found in both uptrend and downtrend, and usually gives a signal of trend reversal.


DOJI - HOW TO USE

Look at the previous trend.
Determine your doji whether it is a ND or SD. Pay extra attention if it is a ND. Doji tend to send a more reliable reversal signal at the top than at the bottom. Also, pay attention to doji that appear at near resistance or support level. At times, such appearances confirm the end of the trend.

Wait for confirmation.
Doji, like other single candlestick patterns, have the tendency to give False Signals. Therefore, confirmation is a must! There are typically four types of confirmations that I would look out for:

Next Candlestick
The body of the next candlestick is important. A confirmation should be clear and unambiguous. Therefore, it is always preferable to have a long real body to signify the strength of the confirmation. For a ND, I would be looking at the next candlestick to close lower than the ND. For SD, I would expect the next candlestick to close higher than the SD.

Support & Resistance
If a trend reversal is in play, it should neither break a resistance nor a support. If the support or resistance is breached, then most likely the trend is continuing its course, and the reversal signal will most likely be a false one.

Volume
A price upward breakout, should be accompanied with good volume, particularly when we are dealing with SD. A price that shoots up to the moon without good volume would probably not sustain for long. On the contrary, for a ND, volume may not necessarily be high. In downtrends, sometimes "Prices fall of their own weights!" We will study this in greater detail in future Discussions.

Signals from Momentum Indicators (MI)
Signals from MIs are very important to gauge the trend's momentum. If a ND is formed, and MI shows that the price is in the overbought region, then it is a strong signal confirmation. Same goes to SD, where I would expect to see the prices trading in the oversold region. We will cover more on MIs in later Discussions.

Most of the time, all of the four confirmations above do not show a congruence. Some might give you a buy signal, while some may not. This is where the trader's judgement comes in. Try to find a blend that most comfortably suites you.

Illustration (iv) : BJCORP - Northern Doji
 

Illustration (v) : MYEG - Southern Doji
Illustration (iv) shows the recent occurence of Northern Doji in BJCORP while illustration (v) shows a recent occurence of Southern Doji in MYEG.

Pay more attention to the Rickshaw Man!
The strength of a doji is usually measured by the length of its shadows. Rickshaw Man, and other LLD, tend to have long upper and lower shadows, which pictorially shows a high degree of market indecisions. Rickshaw Man does have a strong record of reliability (IMHO) in KLSE. Tighten your stop losses, or take partial profits if this happens. It's not possible to run away from a Rickshaw Man! (as the saying goes) :-)

Look out for Trend Exhaustion!
This usually happens at the top after a series of white candles. When a doji is formed after a long white candle, there is a high probability that the uptrend has exhausted itself, and a consolidation or trend reversal is imminent. Doji is reliable in signalling trend exhaustion. Refer to illustration (vi) and see for yourself!

Illustration (vi) : UEMLAND - Doji Exhaustion

Doji Establishes Resistance Area
The existance of doji at the top may give birth to a new resistance area, particularly after a trend exhaustion. If a doji is formed after a long white candle, the new resistance area would stretch from the high of white candle session, to the high of the doji session. See illustration (vii).

Illustration (vii) : MAYBANK - Doji Resistance

Doji in the middle of a Box - Ignore!
Sometimes, when the prices moves sideways, we say that the prices are trading (if prices move uptrend or downtrend, we say that the prices are trending). Japanese refers this as a "Box". Knowing that doji signals trend reversals, then if there is no trend, doji plays very little forecasting implications here. The only exception to that is that when doji is formed at the top or bottom of the Box, then it acts as a confirmation of support or resistance.

Do not use Doji if Doji is commonly seen
If doji is found consistantly on the chart of a particular stock, then you might consider restricting your reliance on doji in analyzing this stock. This is commonly seen in stocks that have very little transactions or have limited volumes. With small volumes, most of the technical indicators in Technical Analysis (TA) will not work well.


Always think of what a candlestick means before making a decision, instead of making one just because a textbook says so. Very often you will suffer losses if you do that, and then coming back to say that TA doesn't work. Due to the differences in nature of overseas stock markets and KLSE, it is not possible that whatever works overseas would identically work here! As the Japanese saying goes,

"The (stock) market is like a person's face; never are two alike."

Thank you for reading, and Happy Charting!! :-)

Saturday, January 22, 2011

C.ky Series 2 : The Journey Of A Thousand Miles Begins With A Single Step.

It often disappoints me when I heard of people who do not know how to invest their hard earn money. I often ask those who are willing to share with me about their savings. From housewives to professionals such as accountants or finance executives, their answers usually without fail, frustrate me. They put all their savings in the banks, namely, fixed deposit (FD) accounts. All their savings.

I have zero, zilch, nil, amount in fixed deposit!

To achieve financial independence and to increase our wealth, we must know how to invest our hard earn savings. Putting all our surplus funds in FD won’t help us to achieve our goals.

Our aim is to be able to increase our wealth thus our purchasing power.

Let me put into a simple illustration, a fable (short story using animals to convey message) of how damaging an all FD investment can be to your wealth accumulation plans.

There is this Country M, that faces inflationary pressure due to the rise of oil. The black gold. Unfortunately, the economy is not doing so great. Thus, the government is unable to raise interest rate. Low interest rate is important to encourage economic activities to spur borrowing and spending to generate income for all.

Catty has 100 meows. The currency of country M. She decided to invest in the FD that promised her a guarantee interest of 3% p.a. As the interest is guaranteed and the investment is safe, being conservative, she feels comfortable to park her hard earn meows there. Besides, she is ignorant about other investment vehicles and basically to her, has no other choices.

Our wealth can be measured by the ability to buy things (purchasing power). Assume that at the beginning of the year, a packet of cat food cost 1 meow. So Catty could have purchased 100 packets with her 100 meows. At the end of the year, she happily took out her money from FD that gave her 103 meows in total (principal + 3 meows for interest). Unfortunately, the inflation rate for that year was 8%, thus a packet of cat food cost 1.08 meows now. Poor Catty, with the 103 meows she has, she could only buy about 95 packets of cat food now instead of 100 packets. Basic mathematics, 103 meows divided by 1.08 meows. No wonder her kitties are all getting skinnier!

A smart investor will find an investment that can give him/her a return high enough not to only cover inflation but also improves the purchasing power. My advice to Catty would be that she learns up more on investments and take the big bold step to move away from FD and starts to invest in other investment vehicles. Be it the simple sukuk investment or the slightly complicated shares. The first step is always the hardest, but, as the advice goes, the journey of a thousand miles begins with a single step.


Contributed by C.ky

Disclaimer: FD can still be useful investment vehicle to park your emergency/precautionary funds. Don’t blindly invest in other investments for the sake of investing though. Learn first!

Wednesday, January 19, 2011

Discussion 7 : The Psychologist in Stocktrading

I remembered I attended an interview for the position of Internal Auditor (IA) long ago with a company located somewhere in Bayan Lepas. It was a company operating in the trading of consumer goods such as liquor and tobacco in duty free zones, and has many outlets all over Malaysia.

In the second interview, it was the Director of Audit and Risk Assessment who conducted the interview for me. While I don't really recall the exact lines we exchanged during the interview, I remembered these were about the few lines that took place during that event:

"Why bother yourself to study Certified Fraud Examiner (CFE)? How does it add value to being an IA?"
"CFE allows me to detect and prevent a fraud from taking place."
"How so?"
"We can technically see vulnerable openings in an internal control (IC) system and can also read the probability of the entrusted personnel of committing fraud under such environment. In CFE, we learn a small degree of criminal psychology to help us determine so."
"You can't do that! You can't rely on psychology to detect fraud! Psychology is no evidence!"

Well, he has already gone all defensive. >.<

The reason I shared this with my readers is to show that people might behave ignorantly when they are persuaded to comprehend something that differs from their ideas, or the norms. People naturally don't like those who are different from themselves. So, it is perfectly normal for a typically average person such as that director who interviewed me, to react in such passion.

Honestly, I don't mind, because I believe that when great peoples see quality, their minds concur each other almost instantly. :-)

In stocktrading and investment, the philosophy is the same, and candlesticks in essence, is CFE to an IA.

Candlesticks act as a tool to recognize an opening in the stock prices for good entries (as in detecting openings in IC system) and to read the psychological behaviour of investors towards the stock (as in determining the probability of a potential fraudster to commit fraud). Literally, they are your little psychologists in stocktrading and investments.


In Discussion 4 (Part 2), I have introduced to my readers two sets of candlestick patterns that are useful to recognize trend reversals. Those are the Hammer and Engulfing sets, which consist of :-
  1. Hammer
  2. Inverted Hammer
  3. Shooting Star
  4. Hanging Man
  5. Bullish Engulfing
  6. Bearish Engulfing
Please ensure that you know these candlestick patterns prior to continuing with this Discussion. I will now proceed with candlesticks in the next few Discussions to further fortify your understandings on this subject.


THE PSYCHOLOGICAL MAGIC OF CANDLESTICKS

Firstly, having known how to use the candlesticks, have you ever asked yourself what is the logic behind candlestick patterns? If you had, please recall your answers now. If you have not, then start thinking now, before going on to the next paragraph.

Consider this situation in a downtrend:

1st Session (9.00am to 12.30pm) = Stock opens at RM10.00, closes at RM5.00
2nd Session (2.30pm to 5.00pm) = Stock opens at RM5.00, closes at RM12.00

How would both candlesticks look like?

Illustration (i) : Hammer Formation
In the 1st session of trading, you would be able to see that a black candle is formed. In the 2nd session, a white candle. Now, how would the candlestick look like for the entire day? See illustration (i).

Now, do you understand how a Hammer is formed? During the morning, bears clawed the stock downwards by 50% (Note: For illustration purposes only. In reality, it won't be that drastic!). However, after noon, the bulls made a comeback to thrust the price to close higher than today's opening. At the end of the day, bull wins.

This shows that in investors' psychology, the stock's value should not be any lower than RM5.00 (which means, RM5.00 is the support). When the sellers (panic-struck Dumb Money) put the stocks up for a big cheap sale, buyers (Big Money and Smart Money) retaliate instinctively and begin buying (accumulating) the lovely RM5.00 pizza at a low.

Due to the subsequent increase in demand for this stock, the price would then begin to soar higher and higher, making subsequent higher lows and higher highs. The once price downtrend has now turned into an uptrend.


[Terminologies
Smart Money usually refers to Sophisticated Investors (SI) who possess a lot of funds, have many years of investing experiences and practices highly complex investment strategies.

Big Money refers to investment professionals such as Fund Managers, etc...

Dumb Money are retail investors like you and me. In U.S., we are more commonly known as "The Suckers" *sob*]


Now, consider this situation in a downtrend.

1st session = Stock opens at RM5.00, closes at RM10.00
2nd session = Stock opens at RM10.00, closes at RM6.00

Illustration (ii) : Inverted Hammer Formation
The Inverted Hammer is then formed. The bulls retaliate to a downtrend by pushing the stock price to a day high, but then are eventually suppressed by the bears. Even though the rebel failed on this day, the message of revolting against the bears is clearly seen. The days of the bears' glory are numbered.

As the panic-driven Dumb Money made their exits at lows in distress, huge amount of Smart and Big (S&B) Money flow into this stock and send the stock price rocketing towards the moon.

However, when these are formed on top of an uptrend, a Hanging Man shares the same psychology as Inverted Hammer, while Shooting Star shares the same psychology as Hammer.

Illustration (iii) : Hanging Man Formation
The S&B Money would first send the price to an uptrend. When the Dumb Money finally realizes the train is moving up, out of greed, they quickly jump aboard the train, regardless of the ticket price! Once the S&B Money sees the euphoria, they evilly sell their stocks at a high (distribution) to the Dumb Money. As the Dumb Money buys the stock, they don't realise that they are paying a high price for a downwards heading train! This is how the S&B Money 'sucker' the Dumb Money. :'-(

Illustration (iv) : Shooting Star Formation
In the Hammer set and its variation set, the candlestick body's colour isn't important. The whole idea of the candlestick pattern is to show us that the S&B Money has taken noticeable moves to 'overthrow' the current trend. This is when we should be prepared for a potential trend reversal.


As a distinguished investor/trader, these candlesticks play an integral role in determining the S&B Money's directions. We would want to hitch a ride with the S&B Money, rather than with the Dumb Money, aren't we?

Monitoring the candlesticks enable us to understand the psychology of investors, which in turn allows us to make informed decisions on when the trend is likely to make a reversal, and most importantly, allows us to time a trend ride with the force (S&B Money).

So, those who remain not agreeing that investors' psychology is useful, or still thinks that psychology is not evident and therefore can't prove much, you may stay on as a 'sucker' for all I care. For those who agree, welcome aboard the S&B train! It'll be a much more comfortable ride. :p

Open up your minds now. There are a lot more to come.


[P/S: Will you be able to figure out the psychology of the Engulfing set on your own? Please try so before Discussion 9. Put on your thinking cap! :-) ]

Sunday, January 16, 2011

C.ky Series 1 : Grandmother's Advice

Sharing the same objective of encouraging my readers to incorporate Fundamental Analysis (FA) in their investment decisions, my mentor has decided to contribute an article, mainly to highlight the importance of FA in evaluating an investment opportunity.

My mentor had successfully completed all three examination levels of one of the Investment world's most sought after qualifications, Chartered Financial Analyst (CFA) at a youthful age. An individual highly passionate in exploring the frontiers of the Financial world and has over the past 20 years been actively involved in investments of all major vehicles, such as stocks, bonds, real estates, commodities, currencies and derivatives. As the apprentice, I feel privileged to have benefited and learned extensively, particularly in the areas of FA, which my mentor uses all the time, to solidly support all the investment decisions made.

Although we differ in our main approach, we have a common goal - to become a Sophisticated Investor (SI). I hope my readers would benefit much from my mentor's contributions, as much as I have had over the past 7 years.


My mentor writes,

"Grandmother’s advice: Cart alone, has no horse power. Don’t put the cart before the horse.

Often people said, you are either a fundamental investor or a technical investor.  I, choose to be both. However, I am of the opinion that we should check the fundamental first, before using technical to enhance our return. It’s always dangerous to just purely rely on technical analysis alone.

Let me put into an analogy the danger here. You were looking for a house to buy. There was a house that was put in the market for sale at a price way below the market price of other recently done transactions in that area. You believed that the price won’t get lower than that already attractive price (trend). And you heard from the broker (chart) that there were other people showing interest in the house (volume). So you said, “This a good sign.”  You quickly jumped into purchasing it without checking the fundamentals because you thought the price has reached the lowest and other people were also showing their interest. After you have purchased the house, you discovered that there was a murder in the house! That is why it was selling so cheaply! 

Trading shares by using technical analysis alone is akin to buying the house without checking other factors beside prices and other people’s interest. This other people may not have heard of the murder too.

Always check the fundamental first, such as the economy outlook and industry outlook (which may affect the capital gain of the shares = house value appreciation), the earning prospect of the companies (earnings / dividends = rental potential), type of industry (booming or declining = location), intrinsic value of the company (interior of the house) and other contingencies or issues that can affect the fundamental existence (perhaps a murder case!). Once we are satisfied with the fundamentals, let the technical play starts.

If we have bought a good house at a good location, and the price dropped after we have purchased it, why worry? We can still enjoy the rental and if the price rose, we can take profit and wait for next opportunity. So, it is the same here, buying into fundamentally strong stocks can give us a peaceful, good night sleep.

Technical analysis tells us when to buy and when to sell, to enhance our return. Fundamental analysis tells us what to buy and what not to buy, to reduce the risk of loss. So, always check the fundamental first. Don’t put the cart (technical analysis) before the horse (fundamental) and remember, cart alone, has no horse power.


Contributed by C.ky who wishes to honor the memory of C.ky’s beloved and respected grandmother."

Discussion 6 : Does It Make Sense?

Having read a few articles that I have contributed solely on Technical Analysis, most of my readers who are new to investments might be feeling a little 'high on the horse'.

Halt! Read at least THIS Discussion before executing your big time plan!

Just hours ago (as I'm writing this article), my mentor and I attended a Market Chat organized by Hong Leong Investment Bank. There, I bumped into one of my old friends, who was also an ex-student of my mentor. I found out that she has been visiting my blog recently and is very interested and geared to start managing her own investments portfolio.

"I can't read figures, and I don't like reading figures. I like graphics. I like pictorial diagrams. Technical approach breathes new life into my dreams of getting rich."

After the course of Market Chat, we met again at the lift. She excitedly said this to me,

"I couldn't understand a thing of what the speaker said just now. It was too technical for me. I don't care of the market outlook or if the economy crashes. I don't know what GDP, MGS or QE are. The most important session of the evening is at the last moment when he shared with us the list of recommended shares that will outperform the market this year. But as you said, I will go back and read the charts first before doing anything."

I then asked her to read my next article (which is this Discussion) this weekend before reading the charts.

As I have mentioned in Discussion 2, a Sophisticated Investor (SI) would use a combination of both Fundamental Analysis (FA) and Technical Analysis (TA) in determining whether to confirm or dispel an investment decision. I don't recall asking my readers to neglect FA!

Every investment has to make sense. I am using this strong word here - sense. 'Making sense' is a phrase that I have shunned using for months after gotten into an ugly conflict with my superior in my previous employment. While I don't know why many people find it offensive with this phrase, I understand that many people don't like hearing it. Well, reality sounds harshest when it is closest to the truth. The 'making sense' part in investments refers to FA.


FINANCIAL FUNDAMENTAL

For investors, the Financial Fundamental of the stock's underlying company must be strong.

Imagine your target company's debt equity ratio is 200% (debts twice the equities) and is having millions of negative cashflow from Operating Activities (OA). In addition to that, you realized that the company is underperforming industrial average by at least 20% for 3 years in a row! Key management personnel are changing almost on a bi-annual basis.

I can't sleep at night if I ever invested into this stock. This investment just doesn't makes sense. Ask yourself, "Who would've wanted this stock?" This means that there is a high probability that the charts are only showing False Signals.

Most of the time, if I were to go long for a long period of time with a stock, I would shortlist to monitor a few companies with good OA cashflow and had a good equilibrium on capital management policies - an optimization of debt and equity. They must also be healthy on other useful financial statistics such as ROE, profit margin, and dividends policy.


MACROECONOMIC - FISCAL AND MONETARY POLICIES

Investors/traders should also know at least the basic of macroeconomic and how it plays an influence on the stock market as a whole. You need not to be as skillful an economist, but the foundation studies must be there so that 'you know what you are doing'.

Let's say your target company is operating in the Automobile industry (Cyclical Consumer Products). If the economy is currently experiencing high inflation and high interest rates, will you be investing into this company, even when the chart shows that there is a good setup? I will never do that.

In times of rising interest rates, many consumers will restrict spending. Borrowing costs would be high. Purchasing power is low. Cars would then be more expensive. Will they even consider buying a car right now?
At this moment, unless there are other good reasons supporting the chart readings, I would fire aggressive stocks from my hitlist!

On the other hand, I would be more interested in defensive sectors such as those in Food, Healthcare, and Cosmetics  (Non Cyclical Consumer Products). Cosmetics remain to be my favourite bet in an early bear :-). Think, no matter how bad the stock market is, ladies will never stop making up! :p

I might even consider to invest in bonds at this time. This is an excellent time to find a good bargain for fixed income securities. Bond prices are negatively correlated with interest rates. If interest rates are expected to drop in the future, bond prices will increase to maintain its attractiveness against other investment vehicles, such as stocks.


FLUCTUATIONS IN OTHER FINANCIAL MARKETS

To name two of the most important ones:

Commodities Market
If oil prices were to increase, I would be wary prior to investing in companies operating in Transportation. Investors/trading would have to research and see if the target companies have sufficient and reliable oil hedging policies in place. Jumping to invest/trade in one that has none, basing solely on the chart, doesn't make any economic sense at all.

Oil and Gas companies tend to make good progresses during these times. So, is it making more sense to invest/trade in these companies while oil prices increase?

Futures Market
For day traders, or swing traders, futures market is an important component to trading success. Futures market pre-empts the behaviour of stock market and acts as a good indicator to what your trading strategy would be, at least, in the early hours of the market. It makes no sense to start long in the stock market when the futures market shows declining figures!

Also, as the day progresses, the stock market would then most likely guide the direction of futures market. So, if the stock market progresses as a big bull, shorting in the futures market would seem similar to digging a hole, jumping into it, and then covering yourself up. There is no meaning for that person to stay alive after making such decisions. >.<


Investors/traders should also keep abreast of other financial and non financial information available on the media to base their decisions on. Every morning, prior to commencing my trading day, I would sit down with a cup of black coffee and scan through news via theedgemalaysia.com and thestar.com.my.

Other than that, I will also login to my trading platforms to scan through available investment and business news. I will also look into the futures index (FKLI), if I intend to trade on the 30 counters forming the KLCI index. If the futures market doesn't show a positive sentiment, I might even consider beginning my day by shorting the futures.

Knowing FA to pair with the deadly tools you learn in TA would further enhance your investment/trading profitabilities, even if your investment horizon is extremely short, such as intra-day trading. As a day, as well as swing trader, I always find FA very useful in helping me to determine a sensible tolerant level for stop losses.

Depending on your investment/trading preferences, your main approach could be either FA or TA, but in either approach, you must also incorporate a sufficient degree of the other school of thought. Never isolate the other!

Always make your investments/tradings as sensible as possible. Don't invest/trade in anything that doesn't make sense to you. As what Robert Kiyosaki always says in his books (unless you are shorting the futures),

"You make your profits when you buy, not when you sell!"

Monday, January 10, 2011

Discussion 5 : Move Your Averages!

When I say averages, I am definitely NOT referring to Dollar Cost Averaging (DCA). In Discussion 1, I have clearly indicated the shortages and irrationality of using DCA.

However, I strongly encourage my readers to add Moving Averages (MA) to their charts. In my opinion, MA is an invaluable indicator that should be utilized together with most indicators available in Technical Analysis (TA).

So what MA actually is?
MA is the running average price of a stock over a period of time.


CALCULATION OF MOVING AVERAGE

For instance, we have a set of stock prices ranging over a period of 5 days as such:

Day 01 = RM1.60
Day 02 = RM1.20
Day 03 = RM1.40
Day 04 = RM1.30
Day 05 = RM1.50

On Day 5, the 5 day MA for the stock prices would be

MA5d = {RM1.60 + RM1.20 + RM1.40 + RM1.30 + RM1.50} / 5 days
       = RM1.40

Come Day 6, the stock price dropped to RM1.45. The 5 day MA for Day 6 would be

MA5d = RM1.40 + {RM1.45 (Day 6) - RM1.60 (Day 1)} / 5 days
       = RM1.37

Always take note that in calculating MA, the old data (Day 1) would be discounted to make place for the new data (Day 6), forming the "running" or "moving" nature of the average. That's why it is called "Moving Average"!

The MA line would then be plotted on your chart.


WHY USE MOVING AVERAGE?

In stock trading, it is always important to know that even when the candlesticks show that the stock price is currently in an uptrend, it is equally significant to also monitor its MA.

MAs that are usually used in stocktrading is MA14d, MA20d, MA26d, MA50d, MA70d, MA100d and MA200d. Personally, I have a tendency of using MA20d, MA50d, MA100d and MA200d.

There are three main usages of MA:
1) To smoothen out variations and clearly presents the price trend over a period of time.
2) Time entry and exit via Bullish Crossover and Bearish Crossover.
3) Acts as Support and Resistance in a price trend.


SMOOTHENS OUT VARIATIONS AND CLEARLY PRESENTS THE PRICE TREND

Sometimes people ask me, "Why does a stock price sometimes moves up and sometimes moves down?"

That is a very simple, yet good question. If you could understand the principle behind price movements, then you will not experience devastating heartbeats when prices move against your wish! :-)

In investing, as well as business, we know that the selling price of inventories (stocks) is mainly driven by the public's supply and demand. In stock trading, shares are viewed as our inventories (as in business), and the stock price (selling price) is similarly driven by the market's supply and demand.

Ali is a fast food chain business owner specializing in serving poultries. He would be experiencing great sales and profits during calendar events such as Christmas, when demand for turkey rose. He would sell the turkey at a high. During news outbreak of 'bird flu', he would be forced to sell at a low, even when he had bought the birds at high.

Same goes to stocks. How often do you see stock prices change drastically during these events? Very often. Just look at the recent rumoured election and its impact on the FBMKLCI. However, all these changes are only temporary. Ali would have his sales recovered after a year of bird flu, or maybe his sales price would drop back to normal a week after Christmas.

These sudden surge or decline in prices are what statisticians normally term as Seasonal Variation (SV). When we look at the candlesticks, it clearly shows a sudden price break-out, but in fact, it is due to events such as the company won a favourable contract overseas.

At this moment, speculators would come in and push the stock price to a great high, sometimes even ridiculously high. Uninformed investors would then think that the prices are going up, so they re-mortgage their houses, sell their cars, and bought this stock at a high.

Next day, after the analysts are done calculating the company's new net worth, the speculators start to sell all these stocks, causing the prices to go down during the next few weeks. Later, you would be able to see a lot of bankruptcies in the newspapers.

To make the matter worse, the price trend thereon looks uncertain. Is it now going up or going down? Should I be trading in this stock now?

Therefore, statisticians develop MA to smoothen out these SVs. MA takes an average over a period of time, so that these sudden price surges do not manipulate the trend by much. See illustration (i) and (ii). It shows the share prices of TIME during and after the abnormal price outbreak on 12 November 2010.

Illustration (i) : TIME Surge
Illustration (ii) : TIME Decline

In illustration (i), we can see that prices for TIME dotCom went on an unusual high (RM0.57) on 12/11. In illustration (ii), the price drops in the next few days to RM0.39, a decline of 31.6%. Despite these unusual movements on 12/11, the MA20d did not sway much. The trend still shows that TIME dotCom is chopping its way to the sides.

Traders could then base on this MA20d to make their decisions on whether to trade or not to trade in this stock. In my opinion, I would not trade a stock until it is trending upwards.

(Note: In illustration (ii), I would be rather careful on 12/11 to decide whether to enter into TIME or otherwise. Have a look at the "Dark Cloud Cover" formed on 11/11, which gives a Bearish Reversal signal. Due to the prior trend not being an uptrend, I would wait for another day to see how the candlesticks, and other indicators look like. I'd rather fold a deal than to expose myself to an unmanaged risk!)


MOVING AVERAGE BULLISH AND BEARISH CROSSOVERS

In charting, I would be using more than one MAs most of the time. As indicated earlier, I use 4 MAs - MA20d, MA50d, MA100d and MA200d.

The shorter the MA period, the faster the MA is, and vice versa.

This is because the shorter the period is, the faster the new data would play an impact on the MA line. Therefore, it can be said that MA20d is faster than MA50d, and MA200d is slower than MA100d.

Buy and sell signals are generated when the MA lines of different speed crosses over one another.

When a faster MA crosses over a slower MA from the bottom, a buy signal is generated.
When a faster MA crosses over a slower MA from the top, a sell signal is generated.

The former is termed Moving Average Bullish Crossover.
The latter is termed Moving Average Bearish Crossover.

Look at the chart now.

Illustration (iii) : MA Bearish Crossover
Illustration (iii) shows a snapshot of the prices during late 2007 and early 2008 of GENTING. Notice that all four points show a faster MA crosses over a slower MA from the top. These are all known as MA Bearish Crossover, which in turn, means a signal to sell.

Out of those four crossovers, the one that involved MA20d crosses over the MA100d gave the most dangerous signal to sell. This crossover means, "For the past 20 days, the average stock price has performed below the average of past 100 days".

The MA100d here is more important compared to the MA200d as the MA100d being the lowest (last line of defense) for the stock price. Therefore, generally speaking, the price has been moving lower and lower, and could potentially head into an imminent downtrend.

Illustration (iv) : Downtrend after Crossover
Illustration (iv) shows what happened after the series of crossovers. The price trended downwards until early 2009.

Sometime during August, the stock price rebounded upwards for a moment, creating a Bullish Crossover. Subsequently, it created another Bearish Crossover in September. This is what we termed as False Signal.

False Signal will inevitably emerge in almost, if not all Technical Indicators at some point of time. This is the reason why most technicians will not rely only on a single indicator to base their decisions on. TA indicators should complement each other to bring out their full potential as a whole.

Always remember that by using TA, you are not sure to make money. You are only maximizing your probability of making money. Always be disciplined to cut losses when things don't go your way. I always believe in a saying, "If you have to gamble anyway, then gamble rationally, never emotionally". Do not hope that you will win a losing trade by holding onto it. You are destroying your portfolio!

Illustration (v) : MA Bullish Crossover
For the rest of the year 2009 until early 2010, GENTING rebounded and trended upwards. In illustration (v), you can see that there are 6 Bullish Crossover points supporting the uptrend.

In fact, when the Bullish Crossover of MA20d over MA50d was formed, a buy signal was triggered. It was then further confirmed when MA20d crossed over MA100d, and subsequently MA200d.

Again, a False Signal was generated during November and December 2009, and then subsequently a Bearish Crossover in February 2010 signalled the end of the uptrend. The price then dropped to slide on a down.

Some investors/traders make use of what they called Triple Moving Average strategy in analyzing their trades. In this strategy, they will plot three MAs on their chart - A fast MA, a second fast MA and a slow MA. For instance, they might use MA20d, MA50d and MA100d.

When MA20d crosses over MA50d, they will buy 1/3 of their intended trading size for that stock. When MA20d crosses over MA100d, they will buy another 1/3, and finally when MA50d crosses over MA100d, they will buy the final 1/3 to complete the portfolio. The reverse is also applicable for a bearish crossover.

However, I personally would not have used such trading strategy. It doesn't seem to make much sense to me. If you understand the limitations of MA, which I would share at the end of this Discussion, then you might not even consider this as a strategy.


MOVING AVERAGE AS SUPPORT / RESISTANCE

MAs are very useful rulers to rely on, as proven over and over again in Technical Charts, to determine support and resistance of a price trend.

Let us look at GENTING again.

Illustration (vi) : MA as Resistance
MA act as a strong resistance during a downtrend. Its characteristics of support and resistance are almost similar to the concept we have discussed in Discussion 4 (Part 2). When a stock price made a pull back during a downtrend, it would find its resistance and then continue its fall thereafter.

In a downtrend, the support can easily be found by drawing a straight line connecting a few lower lows. You can then almost gauge where the next low is. Refer illustration (vi) for a better understanding. It is the same chart that you see in illustration (iv).

Illustration (vii) : MA as Support
Illustration (vii) shows how MA acted as a comfortable support in an uptrend. When a stock retraces from an uptrend, it will seek its support before bouncing off to continue its climb. Again, you can easily gauge the next resistance in an uptrend by drawing a straight line that connects a few higher highs.

When a stock price lingers around a support or resistance, traders/investors should start to pay attention to the next movements of that stock. Should the price breaks the support or resistance, then the stock price would most probably seek its way to the next support or resistance. Otherwise, it would just rebound off the support or resistance and continue its trend.

This should help to generate the right buy or sell signal.


LIMITATIONS OF MOVING AVERAGE IN STOCK ANALYSIS

First of all, users of MAs must know the nature of the tool that they are using. MAs are most of the time categorized as a trend follower. A trend follower often lags behind the actual trend. The nature of it averaging the prices over a period of time would usually dilute the sensitivity of the newest stock prices. Sensibly speaking, the newest prices should spearhead the direction of a trend.

Therefore, there are many efforts taken to improve on the MAs to introduce higher weightings on the most recent prices. Such efforts gave birth to variations such as Weighted Moving Average (WMA) and Exponential Moving Averages (EMA). The MAs elaborated since the beginning of this Discussion are also sometimes known as Simple Moving Average (SMA).

The SMA and WMA are finite impulse response filter, while EMA in nature, is an infinite impulse response filter. SMA and WMA discounts old prices using a solid and absolute factor, while EMA discounts old prices using a factor which intends to reduce the previous day's EMA over an infinite period of time, which its value will never be reduced to zero.

By far, the most popular MAs that are used in stock analysis are SMA and EMA. EMA definitely addresses the lagging shortage of SMA. However, using EMA, there are higher chances of it giving False Signals. In a sudden price surge or decline, the EMA will show a drastic change in the EMA line, thereby,

1) Distorting the actual trend of the stock price.
2) The drastic change might cross the faster EMA with a slower EMA, or vice versa, thereby creating a False Signal.

Using SMA, on the other hand, would also generate a lagging buying or selling signal during a crossover. In illustrations (iv) and (v), sell and buy signals are generated only AFTER the price begin to drop or rise. In that case, more losses are absorbed, and less profits are taken, due to the late entry and exit signalled by the SMA.

Therefore, if you are trading based on SMA, you can then forget about the Triple Moving Average strategy. You can dream about buying at the lowest and selling at the highest using that strategy. It won't happen. It will never happen because SMA lags.

One more thing about SMAs is that they should only be relied on in a trending stock price, such as an uptrend, or downtrend. When the stock price moves sideways (sometimes it is called consolidation or in the United States, it is more commonly referred to as Channel Market), due to the lagging nature of the SMAs, they will give out plenty of False Signals.

Relying on them to make a decision in a Channel Market is extremely risky and in most of the times, even if it turns out fine, it won't give investors/traders good returns.


WHICH MOVING AVERAGES SHOULD I USE?

Depends on you. Usually, I take MA20d as my favourite MA line. It is due to the belief that I am willing to hold this share out for 20 days before I liquidate my position. Sometimes, when the price doesn't turn out, and it doesn't fall below the support I've set to cut loss, I will hold it for a maximum of 20 days. If it still doesn't turn out the way I wanted it to be, I'll proceed with liquidating my position (be it a loss or gain).

Some long term investors would find MA200d or MA250d more useful. It means, any price fluctuations above this MA line would not trouble the investors at all, because they are holding the position for long term. As long as the price does not fall below the MA line, it means the stock is still uptrending.

Some day traders and swing traders would like a shorter MA, such as MA5d, MA10d, or MA14d. Recent prices are more useful to them compared to historical prices. Therefore, it is all down to your trading/investment preferences. :-)


CONCLUSION
In many situations, MAs have helped me to determine the trend of a stock price, as well as clearly pointing its related support and resistance levels.

For many technicians, MA is an invaluable tool to determine the right entry and exit points in order to execute a profitable trade. However, as elaborated above, MAs are lethal weapons that could help you profit, but at the same time they also have a tendency of giving off a number of False Signals that would hand you a number of grave losses. So, use MAs carefully!

As the saying goes, "In battles, don't use weapons that you don't feel like they are part of your body". Therefore, if you are not familiar with the nature of MAs, DO NOT base a decision on it, until you 'paper trade' enough to know them

Also, don't forget to use other indicators to complement the entry or exit signals generated by MAs, particulary when determining support or resistance levels. And, don't forget to cut losses when things get worse. Always trade with insurance. If you don't know how to swim, you won't jump into an ocean without wearing a life jacket, will you? :p

Once again, thank you for your attention and have a profitable charting week ahead! :-)

Tuesday, January 4, 2011

Discussion 4 (Part 3) : My Broker Says... Look at the Chart!

I remembered when I started investing in stocks, I was a devout Fundamentalist. I worshipped ratios, cashflows, net worth, etc to look for a stock quoted at bargain prices. It was a great experience to practice what I've learned in school, but it was my curiosity that ventured me into Technical Analysis (TA).

The main difference between the two schools, most notably, is that TA specializes mainly in short term entry and exit strategies, while FA concentrates more on spotting stocks with decent growth potential over a period of time. Both are necessary schools to learn in order to become a Sophisticated Investor (SI), but in my opinion, no SI could've lived without either one of them.

Having said so, during my early days, I have learnt a handful of harsh, difficult lessons for buying stocks based on brokers' recommendations. I am not saying that brokers don't give handsome advice. I only mean that you must choose your brokers wisely, and educate yourself to the extent that you are competent enough to evaluate your brokers' recommendations.

It's not as difficult as it sounded. As the saying goes, "It's never difficult for a businessman to differentiate what is a deal and what is a rubbish". Similarly, it shouldn't be difficult for an investor to have done the same to investment opportunities.

Learning the chart has led me to spot many short term opportunities for quick capital gains, such as BJCORP, in this case. In the previous two instalments, I have made four decisions :
  1. Asking Gary to wait and see before he enters into position in end February 2008.
  2. Asking Gary to exit in end April 2008.
  3. Entering (myself) in early April 2009.
  4. Exiting the position 6 days later, making a 45.5% gain.

Decision 1:


Illustration (i) : Decision 1
Looking at illustration (i), we see that the stock was moving on a downtrend. The pullback seen on 26/02 did not show a strong indication that the bear has ended.

A roughly estimated support of RM0.985 (recorded at the low of 25/02), and a resistance of RM1.31 (recorded at the high of 25/01) can be seen.

Rather easily, you can see that the support and resistance levels here weren't convincing. There are two reasons for that statement:

1) Untested Support & Resistance.
2) No Higher Low, Higher High.

In a stock downtrend, it is unlikely to see a resistance even being tested, and support withstanding a breach. This is due to the nature of a stock downtrend that the stock would record a lower low, and lower high. I'm not convinced that a trend reversal is happening right now. A signal of bullish reversal would normally be a record of higher high and higher low, accompanied by the support level tested on at least one occassion.

Moreover, I would be pretty cautious at this moment when a Shooting Star was formed on the 27/02. It could have been a false signal for all you knew, but knowing its formation at the top of an uptrend usually gives a bearish signal. Those were the reasons why I did not encourage Gary in entering the stock at that moment.


Decision 2:


Illustration (ii) : Decision 2
As suspected, the price did not even linger anywhere near RM1.31, and continued to downtrend when it hit RM1.15 on 03/03. This formed a new resistance. A new support was then formed at RM0.89 on 10/03.

The stock then moved sideways for a number of weeks, testing the resistance of RM1.15 a couple of times. Although the price has managed to make a higher low, but at the same time, it failed to make a higher high. Again, it did not justify a signal of bullish reversal.

Technically, I advised Gary to escape when a Bearish Engulfing was formed around the strong (tested multiple times) resistance level.


Decision 3:


Illustration (iii) : Decision 3
Looking at the chart, you can see that the downtrend made a support of RM0.445 in late October 2008. In the subsequent pullback, it formed a resistance of RM0.60.

In the later plunge, the stock surprisingly made a higher low, forming another support of RM0.50. Both resistance and support were then tested. Just as a new resistance was formed at RM0.52, the support was then broken in mid February 2009.

After the stock rebounded off the previous support of RM0.445, the stock then moved up strongly to break the resistance of RM0.52, and then retraced down. The once resistance would then turn support. However, at this point of time, the support was untested (weak).

Later on 07/04, a Hammer was formed. Being the support was weak, it could have been a false signal, so I waited for a confirmation. On the next day, a white candle was formed with its base resting on the support, accompanied with good volume. This was the confirmation I needed. Also notice that the white candle formed on 08/04, being read together with the Hammer on 07/04, formed a Bullish Engulfing.

I then queued to enter at RM0.55, which was the opening price on the next day, anticipating that the stock would pull back to its resistance of RM0.60.

(Note : We will discuss more on Volume Analysis when the time comes. For now, just keep in mind that in TA, volume is king. No matter how good the technical setup for a stock is, without good volume, the price would probably just won't break up!)


Decision 4:


Illustration (iv) : Decision 4
In illustration (iv), you would be able to see what happened to the stock price after the Bullish Engulfing. A large white candle is formed, breaking the resistance levels of RM0.60 and RM0.64 on 09/04.

Now, I would ask my readers. Should I sell at this price?

The answer is NO. In TA, we always wait for confirmations prior to making a move. Just as I waited for a confirmation to buy the stock, I would also wait for a confirmation to sell the stock. The confirmation that I would be looking out for is a black candlestick to show the beginning of a bearish trend.

On 10/04, the price continued to go up, without showing any bearish signal. On 11/04, it showed a Doji. A doji is usually formed at the top or the bottom of a trend, hinting a reversal is imminent. Then again, to be on the safe side, we have to wait for a confirmation of such signal. If a black candlestick is formed on the next day, then it is confirmed that the stock price is going on a downtrend.

On 12/04, no black candlestick was formed still, as it continued to rocket up and break the next resistance of RM0.74. The following resistance would be the preceding high of RM0.80. On 13/04, the price broke RM0.80. However, the trend came to an end, when the bears came back on 14/04, and a black candlestick finally emerged.

I exitted on the noon of 14/04 (noticing the intra-day trend and volume) after the price came down and touched RM0.80, thus making a profit of 45.5%.


My readers, it is not difficult to spot all these opportunities and plan (sometimes, you time) your trading strategies and at the same time, manage the risks associated in a long (buy) or short (sell) position. In fact, I have made thousands in this particular stock after April 2009, when it continued its uptrend, using the exact same strategy - candlestick patterns and support & resistance.

Of course, there are a lot more indicators and candlestick patterns that I would be sharing with my readers in the upcoming articles, to enhance your chances of success.

I remembered there was once when I chatted with Gary over Instant Messenger, and he made this remark:

"Shares are risky. I won't invest in shares anymore."

It is important not to lose yourself in the stock market. Of course, there are times when we failed to make money and got hit flat. Even I have experienced that before, many times! Therefore, it is important to always stand up from where you fell, and valorously challenge the market again.

For Gary, I feel sorry to him that he has just given up a very useful investment vehicle available to him in his life, that could have made him more wealthy than what he already is.

So, my friends. Do you think that you should invest based on stockbroker's recommendations anymore? Well, of course you do! Brokers always do have the BEST Insider tips that you might just need, and I MEAN it! You might just get hyper rich relying on their information. That's why you get yourself a broker, right? But you will need to be a distinctive investor who knows which are the good deals, and which are the bad ones.

So from today onwards, just before doing what your brokers recommend you to do, always remember to tell your brokers...


"Thanks for your great advice! But, give me some time. I need to first look at my Chart..."


Thank you for reading, and happy Charting. :-)

Saturday, January 1, 2011

Discussion 4 (Part 2) : My Broker Says... Don't Use Candlesticks!

When I talked about Technical Analysis with my friends who scholastically come from Fundamental Analysis, I often hear comments such as,

"Candlesticks don't take latest market news into considerations. It is not useful in the ever fast volatile market."
"It doesn't make sense to predict the market based on Candlesticks."
"You don't 'time' the market in investments. That's not the way to invest!"
"We are investors, not mathematicians or statisticians. Why buy probability? We invest because we are 'certain' of the outcome."

I immediately stopped speaking on TA. Their minds were closed the moment they made such comments, and they wouldn't have made themselves to consider how candlesticks could've impacted on their wealth. They've already gone defensive.

Surprisingly, many stock brokers gave such similar comments as well whenever they hear the word "candlesticks". They'll just go on an auto-pilot, relentlessly going about saying how 'bad' candlesticks are. When I finally asked them, "Wow, you seem to know a great deal about candlesticks, so how much have you read on them?" They replied, "Not much." I then gave them a customary friendly smile.


Illustration (i) : Candlesticks
First, let me introduce to you what a candlestick is. To put it simple, a candlestick is a record (in the form of a bar) of what happened during the day of the market. Please see illustration (i) for more explanations.

A candlestick is made up of 2 components - body and shadow.

The body of the candlestick is the solid bar that is either in white, or in black. In a bullish candlestick, the bottom of the bar would represent the opening price, while the top represents closing price (showing the differences between the opening and closing prices of the day). The reverse applies to the bearish candlestick.

The shadow, on the other hand, are the lines which extends below, or above of either candlesticks. These shadows represent the intraday high and low of the stock (Note: "Intraday" means "within the day of trading").

The candlesticks give a pictorial view of the price movements of a particular stock or index. It clearly shows a pattern, which all Technical Analysts look at to spot short term opportunities. "Short Term", in Technical Analysis' definition, may range from minutes, to hours, days, or even weeks. However, it rarely goes into months.

"How do I make use of candlesticks to spot opportunities?"

Analysts (technicians) usually will see opportunities where there is a signal of reversal of an uptrend or downtrend. "Reversal" means the point of change from an uptrend to downtrend, or from a downtrend to uptrend. Analysts will technically base upon two basic candlestick concepts to spot these opportunities.

Now imagine that you are playing a computer game. The rule of the game is simple. You will need to gain 2,000 points to clear each level. Once you've cleared a level, your game would automatically be saved at the beginning of next level, so that if you fail to achieve 2,000 points in the new level, you could restart the game at the beginning of that level. But there's a catch! If you are unable to gain at least 1,000 points in the new level, you will need to restart your game from the beginning of the previous level!

Say, I'm now in level 5, and I gained 1,700 points. I can restart from the beginning of level 5. However, if I gained only 500 points, the game would think that I cleared the previous level on luck, and will send me back to the beginning of level 4. I would need to climb all the way up to level 5 again!


Illustration (ii) : Support & Resistance Concept
You see, the beginning of each level is known as your support level (you know you'll be back there if you failed), and the ending of each level is known as your resistance level (you need to beat this to proceed). Also know that when you've beaten the level (breaking the resistance), the once resistance level then become your support level, and vice versa. Same goes to share prices.

This is the first concept, support and resistance. Candlesticks play as an important component of recognizing support and resistance. The only difference between the real world and the game above is that in the game, you already have known support and resistance levels (level 3, 4, 5, etc), but in the real world, you will have to determine the levels (support and resistance) on your own.


Illustration (iii) : Support & Resistance Candlesticks
So, how do you go about knowing your support and resistance levels?

As a rule of thumb,

Uptrend
Support (in a Retracement) - Previous trend high.
Resistance (in a Break Up) - Preceding higher trend high.

Downtrend
Support (in a Break Down) - Preceding lower trend low.
Resistance (in a Pull Back) - Previous trend low.

Study the example in illustration (iii).

Notice that a stock price, most of the time, would linger around the support and resistance levels. Thus, when a stock price hits support level, it is time for investors to enter the position (buy signal). Similarly, when the price hits resistance level, investors would need to be wary of a potential downturn (sell signal).

Also note that, the more often a resistance or support is tested, the stronger that resistance or support is. Stronger here means that the level would not be broken as easily as those untested ones. However, once such strong level is broken, the price would most likely either skyrocket to another resistance level, or free fall to the next support level.

However, all these show only an indication of what would be happening in the next few days. There are times when the prices reversed when they aren't even near any support or resistance at all. In that case, the new high or new low would be the new resistance or support that investors should look out for.

Always remember that any techniques that you learn from Technical Analysis (TA) should not be used in isolation. It should be used together with other TA techniques, or even crossover with Fundamental Analysis (FA) to bring out its full potential. TA is never conclusive, as it's purpose is only to increase the probability of you making profits in the share market.

The second concept you would need to know about candlesticks is Candlestick Patterns. Sometimes, it is called Candlestick Formation. A pattern is formed when one or more candlesticks appear in a particular sequence.

There are many candlestick patterns, and it'll take days to finish sharing all of them with my readers. However, allow me to first share two sets of the most basic patterns with you today.

Illustration (iv) : Hammer / Hanging Man
The first set of candlestick pattern that I would introduce to you is the hammer set.

Any candlesticks belonging to the hammer set should have a shadow of at least twice the length of the body extending from the bottom of the body.

Hammer set candlesticks play a very important part in identifying the reversal of a price trend. Referring to illustration (iv), these candlesticks are either called a Hammer, or a Hanging Man, depending on where it is found.

If the candlestick (be it white or black candle) is found at the bottom of a downtrend, it is called a Hammer. I usually express this as "The Power of Thor", relating it to the Norse mythology's God of Thunder. This is a very common candlestick pattern that is usually seen prior to a bullish reversal (end of downtrend, beginning of uptrend). I always say, "I've found the power of Thor" whenever I see this pattern. :-)

If the candlestick (be it white or black candle) is found at the top of an uptrend, it is called a Hanging Man. It resembles a man being hanged from a ceiling. It is a signal that the uptrend has almost come to an end, and again, this candlestick pattern is most commonly seen prior to a bearish reversal (end of uptrend, beginning of downtrend).
 
Illustration (v) : Inverted Hammer / Shooting Star
A variation to the Hammer set can be seen in illustration (v). Similar in nature, If the pattern is seen at the bottom of a downtrend, it is called an Inverted Hammer, which shares the same functionality with a Hammer.

Conversely, if the pattern is found at the top of an uptrend, it's called Shooting Star, deriving its name as it resembles stars shooting down to the Earth. It shares the same function as a Hanging Man.

Both of the variations are also commonly found at the end of an uptrend or downtrend.

Take note that strength of the candlestick patterns belonging to the Hammer set, and its variation set, is usually influenced by the length of its shadow. The longer the shadow is, the more affirmed the signal is.

Illustration (vi) : Bullish Engulfing / Bearish Engulfing
The next set of patterns I would like to share with my readers is the Engulfing set.

Engulfing set is built with 2 candlesticks, with one large candlestick eclipses or engulfs the other.

A Bullish Engulfing is found at the bottom of a downtrend, and it usually sends a bullish reversal signal.

A Bearish Engulfing, on the other hand, is found at the top of an uptrend, usually signalling that a bearish reversal is imminent.

Illustration (vii) : Candlestick Reversals
Have a look at illustration (vii) and see how candlestick formations correlate with support and resistance!

It may seem illogical to most who are new to TA. But before you go all defensive, it is good to take a breather, grab yourself a cup of coffee, or maybe workout a few minutes before continuing the following exercise. You need to maintain a clear mind for what is coming.

Having equipped with these two basic TA knowledge (support & resistance and candlestick formation), please make an effort to refer back to Part 1 of this Discussion. Review the charts and see if you have spotted the reason(s) for my suggestions or advise.

I will unveil everything in the third instalment of this discussion. :-)