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. :-)

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. :-)

Discussion 4 (Part 1) : My Broker Says... No Guts, No Glory!

End of February 2008, one of my buddies, Gary, rang me up and yelled the following at me,

Illustration (i) : Gary Enters!

"MK, my broker spotted me an opportunity of a lifetime! Look at BJCORP right now! The trend is reversing. You can consider buying that now."

After I did a little researching, I called him back later that day, and advised him to not rush the decision. I asked him to be patient and wait to see how it turns out for the next few days before doing anything.

Ignoring my advice, he went into the stock.

Come end of April 2008, he called me up again, and he said,

"The stock doesn't seem to be perfoming right now. Regretted entering that time, should've listened to you earlier."


Illustration (ii) : No Guts, No Glory!

After looking at the chart again, I said:

"Look, Gary. You should make an exit now. It's dangerous to linger around any longer."
"But I haven't made any profits yet. Besides, I am sure that the stock would give me returns. My broker said so."
"I'm now asking you to ignore what your broker says. The Malaysian economy is free-falling right now. What makes you think the stock would perform?"
"My broker says he has insider information which is extremely reliable. I don't want to miss the boat!"
"Are you willing to take such risks?"
"No Guts, No Glory!"

Illustration (iii) : With Guts, Still No Glory...

Illustration (iii) shows what happened after 1 year. I need not to tell my readers that Gary is still holding the stock at that time.

Somewhere around in early April 2009, I met up with Gary in a classmate gathering, and I asked him how is it going with his stocks. He told me that he had sold the stock, when the price rallied up a few days earlier.

I was shocked hearing that. I said,

"Are you nuts? The global economy is recovering. You are patient enough to have waited through the downturn. Why are you so impatient when things just seem to be getting better?"
"Come on, my broker says the economy is still cloudy. If I escape now, I could've salvage a little from an even further potential drop. My broker says the wave has not ended yet."

I lie defeated. I couldn't believe that there is actually someone who could've worshipped a broker to such extent. If only had he invested in himself, things won't turn out like this. When I say invested in himself, it means spending more time to read up materials that would improve his Financial Intelligence.

Illustration (iv) : MK Enters!

I took a look at the chart immediately after the evening gathering ended. I was very surprised to have found that the stock price was in a nice setup. So I queued to buy the stock the following day.

In illustration (iii), I zoomed the period in to show only prices from end of July 2008 to April 2009. My readers may try to spot the setup that made me queue to enter at this price.

Initially, I wished to exit at RM0.59 for quick profit (note that my entry price is RM0.55). But later, the chart turns out that I could profit even more, that I decided to change my profit target to approximately RM0.80.

My readers may begin to ask, "How do you do that?"

It is a matter of simple knowledge to spot these signals. In this example, I profitted 45.5% in 6 days.

Illustration (v) : MK Exits

My readers, compared to a staggering loss of 57.9% in a year, do you now think that investing in yourself pays off? If Gary was a little less ignorant and learned up how to play along the market, he would not have followed the broker's advice with a blindfold around his eyes.

I will share with you how a Sophisticated Investor would have analyzed this stock in the second and third instalments of this discussion. Now, you may try to review the charts above and seek for any indications for the decisions I have advised, or taken.

Let's make the "Thinking Cap" as part of our uniform beginning from this New Year!!