Sunday, September 6, 2009

Nifty faces strong resistance for medium term

It has been well established by Ralph N. Elliott in his Elliott Wave Theory that price movements of a security can be predicted by observing and identifying a repetitive pattern of waves. The price movement consists of 5 waves in the direction of the main trend followed by 3 waves in the corrective trend. The duration of these waves can last for centuries (Grand Supercycle), decades (Supercycle), years (Cycle), months (Primary), weeks (Intermediate / Minor), days (Minute), hours (Minuette) and minutes (Sub-Minuette). The 5-3 pattern remains constant although the time span of each may vary.

Technical traders use this theory to identify breakouts for profitable investment opportunities. There are several web sites and books related to this theory; Wikipedia describes the principles in detail. Cyclpro has an exhaustive list of rules and guidelines which need to be observed during the Elliott Wave Analysis.

However, for those with limited resources of time and energy, there are few basic rules that need attention.

  1. Wave 2 cannot retrace beyond low of Wave 1; i.e. not more than 100%
  2. Wave 3 is never the shortest among impulse waves 1, 3 and 5. This means either Wave 1 could be the shortest or Wave 5 could be the shortest.
  3. Wave 4 cannot fall below high of Wave 1.

Using Fibonacci retracements of 38.2% and 61.8%, following relationships between waves can be identified.

Wave 2 = 61.8% of Wave 1

Wave 3 = 161.8% of Wave 1

Wave 4 = 38.2% of Wave 3

Wave 5 = 100% of Wave 1

The above values are approximate and have been found to occur frequently in well trending markets. It is not uncommon for Wave 2 to fall below 61.8%, there are cases in which Wave 2 has retraced only 38.2% of Wave 1. Similarly, Wave 3 has sometimes retraced even 261.8%.

So, what may happen in case these guidelines are violated?

The answer is simple. The move becomes “suspicious.” This is usually considered as a warning sign; a trend reversal may follow soon.

Let us now discuss the long term chart of Nifty.

In the above chart, it can be seen that:

  1. The long term bull market started in April 2003 when Nifty had a low of 920
  2. Wave 1 ended at 2015 during January 2004
  3. Wave 2 retraced 66% and ended during May 2004.
  4. Wave 3 retraced 227% of Wave 1 and ended during May 2006.
  5. Wave 4 retraced 47.4% of Wave 3 and ended during June 2006.
  6. Wave 5 retraced 343% of Wave 1 and ended during January 2008.
  7. Wave a retraced 75.5% of the entire movement from low of Wave 1 (920) to high of Wave 5 (6357) and ended during October 2008 with a low of 2253.
  8. Wave b has retraced 60.7% of Wave a when it touched 4744 in August 2009.

Cyclepro guidelines suggest that Wave b is likely to retrace 38.2%; the next most likely retracements are 50% and 61.8%. It also says that the time taken by Wave b is usually between 61.8% and 161.8% of the time taken by Wave a. Wave a lasted for 9 months; wave b is currently in its 11 th month.

Taking all these facts into account, we may come to the conclusion that Wave b may end anytime and Wave c is likely to start afterwards.

Nifty has not shown any kind of reversal signs so far in daily charts. The support trendline remains unpenetrated yet. We may see some more sideways movement in the near future. Nifty will face strong resistance around 4797.

Bullish stocks for short term:

CMP = Current Market Price BB = Bullish Breakout TT = Technical Target

  1. Binani Cement: CMP 63.55 BB on August 28 TT 83.85
  2. Gitanjali Gems: CMP 117.65 BB on August 25 TT 162.30
  3. ISMT Limited: CMP 37.55 BB on August 27 TT 56.40
  4. Omaxe: CMP 116.45 BB on August 28 TT 170
  5. Tata Sponge: CMP 222.40 BB on September 4 TT 265.80

Sunday, March 1, 2009

How to trade two day candlestick patterns?

Investors and traders use technical analysis to identify trends, breakouts, reversals etc. In a bear market prices keep falling; so an investor who wishes to take long positions will have to wait until the market reverses. The breakout trader may take long or short positons based on bullish or bearish breakouts.

In my previous article "Candlestick Patterns in Indian stock markets" we discussed about engulfing pattern. Candlestick Charting is a complex and interesting subject. Steve Nison has authored a couple of books viz. Candlestick Charting Techniques and Beyond Candlesticks. Both offer excellent insight into various aspects of candlestick charting. Candlesticker is another site which explains reversal and continuation patterns with plenty of illustrations.

Candlesticks offer effective trading signals which are not available with other methods of charting. Several reversal and continuation patterns have been recognized but few of them (like abandoned baby) are very rare. Certain candlestick patterns require 3, 4 or 5 trading sessions to form. Therefore, two day candlestick formations are more common.

Following are the common two day candlestick patterns:

Engulfing (bullish & bearish)
Harami (bullish & bearish)
Harami cross (bullish & bearish)
Piercing line (bullish)
Dark cloud cover (bearish)
Shooting star (bearish)

The available literature suggests that engulfing & harami cross patterns are more powerful than others (of course it depends on where the formation occurs; rarely, a harami pattern has been found to be effective compared to engulfing pattern on a similar chart.)

It is to be remembered that the overall technical picture needs to be studied thoroughly before attempting to experiment on candlestick patterns. This of course comes with practice and patience.

Bullish engulfing pattern is formed when real body of a green candle engulfs (wraps around) real body of a red candle. This is the basic definition; however there are several variations as shown below:

1. The entire black candle, including shadows (this is the computer age; so red candle) is engufed by real body of white candle (green candle).

2. The real body of red candle is engulfed by real body of green candle and shadows of red candle are engulfed by shadows of green candle.

3. Real body of red candle and its lower shadow are engulfed by real body of green candle but upper shadow of red candle is not engulfed by either real body or shadow of green candle.

4. Real body of red candle and its upper shadow are engulfed by real body of green candle but lower shadow of red candle is not engulfed by either real body or shadow of green candle.

5. Real body of red candle is engulfed by real body of green candle but neither upper shadow nor lower shadow of red candle is engulfed by real body or shadows of green candle.

Based on available literature, my own observation and trading experience, I've created a checklist for engulfing and harami patterns (bullish). It is recommended to have checklist for each candlestick pattern.

Bullish engulfing / harami candlestick pattern checklist

  1. Is the stock on a down trend?
  2. Is the downtrend fast, protracted?
  3. Is the green day volume more than red day volume?
  4. Is the green day volume more than 21 day moving average?
  5. Is the entire red candle is engulfed?
  6. Are the shadows of red candle engulfed by shadows of green candle?
  7. Does the entire green candle lies within real body of red candle? (Harami)
  8. Are the shadows of green candle within the shadows of red candle? (Harami)
  9. Does the candlestick formation occur after a critical support is tested?
  10. Is there positive divergence in case the stock makes a new low while candlestick pattern is formed?
  11. Is the red candle a ‘long black’ candle? (Harami)
  12. Is the green candle a ‘long white’ candle? (Engulfing)
  13. Is the first candle doji? (Engulfing)
  14. Is the second candle doji? (Harami)
  15. Does the red candle have minimal upper shadow?
  16. Does the green candle have minimal lower shadow?
  17. Are the candlestick centerlines nearly equal?
  18. Does the green candle engulf more than one real body?
The ideal answer for all 18 questions above is YES; but it may not be always possible to achieve it. Interested investors and traders may start paper trading with these ideas and try to arrive at a conclusion as to what works and what doesn't in real trading.