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!! :-)

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!

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! :-) ]