Posted by: Livy | February 12, 2009

Charts: The Next Step

More price bars, gaps, islands, and changing trends

In the article, Chart Fundamentals, we covered the basic form and shape of the line chart Open, High, Low, Close price bar and chart, and the candlestick price bar and chart.  This article will take it a step further and identify potential trend reversals, confirmations, and price behaviors identified by the shape, size, and placement of an OHLC price bar. An OHLC chart is a big step past a line chart that can create patterns and provide indicators to can give a trader an idea of what is to come.  While not quite as extensively used as the candlestick chart, a thorough knowledge of the OHLC chart will create a strong foundation for increasing potential profits and moving onto the candlestick chart.  Many, if not all, of the basic indicators in an OHLC chart apply in a candlestick chart as well.  It is strongly suggested that you begin with a thorough knowledge of the concepts applied in this article and the OHLC chart before tackling the candlestick chart.

High and Low
The high and the low has significance within the other factors of the OHLC price bar, and the bars that precede it.  A wide spread between the high and the low shows a strong struggle between bull and bear, a small spread a weak struggle.

  • A high is bullish if it comes at the end of the day and/or it is above yesterday’s high.
  • A high is bearish if it comes at the beginning of the day or is below yesterday high, and even more so if below yesterday’s open, or worse still, yesterday’s low.
  • The low is bullish if it occurs early in the day and/or opens higher than yesterday’s close.
  • The low is bearish if it occurs at the end of the day or is below yesterday’s close.

Trends

Both the high and the low, in comparison to the open and close can be affected by market sentiment. For instance the market indexes have a poor day overall, but the high occurs at midday.  More than likely some piece of news related to that stock, or it’s sector, buoyed the price temporarily.  Other factors, some as simple as the cyclical nature of stocks, may increase buying or selling pressure and raise or lower the price accordingly. Highs and lows point to market sentiment and may create confidence in a trend reversal or continuation, but alone they don’t indicate one.

Open and Close
The open and close have more significance, but still correlate directly to the other factors within a price bar and the previous price bar.  In addition to these other internal factors, outside factors can play a stronger role than they did on the high and the low, specifically due to after-hours-trading and the effects it can have on the open price, and subsequently the closing price.  Many companies report  quarterly earnings either before or after the bell, or outside of normal trading hours. Needless to say this can have a profound effect on not only specific securities, but the market as a whole.

  • Be cautious with an opening bounce. Mutual funds and large securities such as an ETF may allocate funds accumulated overnight at the open, instilling false confidence that a security will go up. It may also be due to market sentiment anticipating good news that may or may not materialize.
  • When buying at the open research the specific security and determine how susceptible it is to after-hours-trading and market sentiment or anticipation.
  • It has been my personal experience that buying at the opening is a bad idea. After-hours-trading often times falsely inflates the price. It’s easy to get a sense of confidence based off this upturn, and watch the price quickly liquidate to a more appropriate (and lower) level.

The closing price is considered to be the most important part of a price bar by many. It indicates what the market feels about the price of a security. Lows and highs have often been tested and debunked.  The close is the final say. After-hours-trading that occurs even two minutes after the bell gets absorbed into the new open the next day.  The line chart is based solely off the closing price. Bids and asks are based are weighted on it in after-hours-trading.

  • Sellers, especially day traders, often sell at the close to reduce risk from any potentially negative news overnight.  Margin calls are also made in the afternoon and many options become due in the afternoon. The close can be a dangerous place if you are unfamiliar with it. Securities can defy trends just to start them anew first thing the next morning. If the high of the day is the end of the day, HOLD ON SALLY!
  • Day after day closes higher than yesterday’s close indicate buyers are willing to pay higher and higher prices. This is a bullish trend.
  • Day after day closes lower than yesterday close indicate sellers are willing to get less in return to dump the security.
  • Be careful to pay attention to both the open and the close. If you only pay attention to say the close getting higher, you may miss that the open is also getting lower and vice versa. It’s called an OHLC chart and not a OH chart for a reason.

Gaps of all kinds
A gap is when there is a significant (how significant is open to debate) gap between the open and close of a security price bar. There are two kinds of gaps. I call them cool gaps and uncool gaps. Uncool gaps, also known as common or normal gaps simply occur because. No other reason than that. Maybe after a long trend a group decided to take profits and sold out, or maybe a mutual fund decided to buy in and it created a gap. It just happens, especially in lower volume securities. An intraday chart may show a couple gaps on a low volume security. A cool gap is the kind we like, driven by market forces internal and external, it signifies a change in the trend or confirms a continuation of the current trend. Really, who doesn’t like positive constant reinforcement?

Breakaway Gaps:

  • Common sense dictates. If there is good news and a huge gap occurs, there you go. Volume should be up as well. Same way with bad news.
  • The price should be sliding, meaning in no significant trend already before the gap.
  • The gap is large. If the stock trades in the $1.50 range and the gap is $4.00, something mammoth occurred.
  • Look for confirmations afterward such as bullish or bearish trends in open and close. Runaway gaps or island reversals indicate more of the same or something new. So can doji (same shape as candlestick) at midday.

Runaway Gaps:

  • Simply further enforce the existing bull or bear trend.

Exhaustion Gaps:

  • Trend reversal indicator. Usually has lower volume as in the case of many false indicators. Will show a trend continuation in the same direction, but with below average volume.
  • Time to sell if in a bullish pattern, buy if in a bearish pattern

Island Reversals:

  • Long bar, again with low volume. Usually has gaps on both sides of it. This is the last hurrah of a trend. If it appears it’s the end of an era, whether that era was a few minutes or a month.
  • Don’t misinterpret a spike as an island reversal. Spikes may indicate reversals or confirmations of a trend, but shouldn’t be acted upon until the next price bar confirms it. Spikes are very “iffy”.

Gaps etc

Market indecision:

  • Can also indicate a change in trend. The market isn’t sure whether it wants to continue it’s current course. May stick with it, may change.
  • Inside days, an OHLC form of Harami, it points to indecision. In the illustration above the price bars before both of the breakaway gaps are an inside day. All factors are inside of the previous price bar
  • Outside days rely on information stated earlier. They are large bars that encompass the previous price bar, or the opposite of an inside day. The open and close dictate bullish and bearish, and how it relates to the current trend informs you of a continued trend or potential reversal
    • Low open high close is bullish
    • High open low close is bearish

Finally, remember these can occur in both OHLC charts and candlestick charts. Also remember the market is a beast of mob mentality. It could be a fluke. Use the indicators and channels described in the next few articles to help determine the validity.  Every trader is going to get burned from time to time by indicators and patterns that don’t follow the rules. If all indicators followed the rules all the time then trading stocks would be easy. Where’s the fun in that?!?

Livy

1/27/09

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Categories

%d bloggers like this: