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!! :-)