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.

India F & O Market Weekly Review

In my previous post we discussed about the possibility of a rally in the Nifty and its likely upside target of 3435. I had also mentioned that a confirmation is necessary in the daily/weekly charts for bullish reversal.

Nifty made a high of 3241 on November 5 but a bearish "three outside down" candlestick pattern (bearish engulfing pattern followed by a redcandle and lower close) was also formed. This indicated a bearish reversal in daily chart. Nifty closed higher for the next two days but for the last 3 sessions it has closed negative. MACD and Wilder's DMI both favour bearishness on weekly chart.

External factors like falling crude prices (from $147 per barrel to $57 per barrel) have not made any impact on Nifty. Readers may be aware that while Nifty went up from 1000 in 2003 to 6300 in January 2008, crude prices were also going up, from approximately $30 per barrel to $100 per barrel. So it is only the demand/supply forces determine the Nifty and its trend.

Let us now discuss the futures contracts of Nifty, Bank Nifty, Bharti Airtel, Infosys and Reliance. It is to be noted here that the charts are based on data for November contracts. The Open Interest is shown as green line.

Nifty:

The October 2008 contracts for Nifty expired on 29/10/2008. Few days prior to this, selling was witnessed in the November contracts as prices declined. This indicates a sell off. On 28th October Muhurat trading was conducted and hence the volume was low. We can see a healthy uptrend in futures since rising prices were accompanied by rising volumes. However, similar to Nifty (Spot), a three outside down candlestick pattern was formed, confirming the bearish reversal. When prices rose afterwards, volumes declined; this was followed by falling prices and rising volumes. After the 'healthy' uptrend, volumes should have ideally fallen when prices fell. This would have meant bullishness. Now that the volumes are rising with falling prices, we may conclude that the Nifty future is likely to test its lower support of 2207.

Bank Nifty:

We can observe a similar pattern in Bank Nifty too. However, no candlestick formation could be observed at the top of the uptrend.

Bharti Airtel:

Two huge "falling windows" or "downward gaps" were observed prior to the uptrend. In this case too, a bearish three outside down candlestick pattern was formed with a downward gap on the third day and increased volume. There is some sell off occurring over the last few trading sessions.

Infosys:

The most recent high of 1414 remains a strong resistance. The contract is now moving on a sideways pattern. The volumes are also inconsistent. This means that the market is currently undecided over the direction. Interesting to note that the sideways movement started on October 10, well before the expiry of Nifty October contracts.

Reliance:

The "falling window" formed on October 16 is acting as a strong resistance for the stock futures. Similar to Bharti Airtel, a three outside down pattern with a downward gap on the third day was formed. Rising volumes and falling prices over the last 3 sessions indicate sell off.

Conclusion:

Current technical scenario suggests that Nifty's bearish trend is likely to continue for the medium term.

Weekly Review of India Stock Market

First, the GOOD news:

On Friday, the National Stock Exchange revised the price bands (also known as the operating range) for 214 stocks. Out of these, price bands were increased for 209 stocks. For 90 stocks, 10% price band is applicable instead of current 5%; For 10 stocks, 20% price band will come into existence replacing 5%; The remaining 109 stocks’ price band has been increased to 20% from 10%. This means that the liquidity for these stocks will increase. Surely a good news for the market.

Next, the not so good news:

The Nifty has failed to close above 4530, an important resistance level.

In last month’s review, I had mentioned that the index needs to form a higher high and higher low to resume uptrend for achieving the next target of 4935.

Date	Points Gained	% Gain
03-Sep-07	10.75	0.24
04-Sep-07	4.50	0.10
05-Sep-07	-3.40	-0.08
06-Sep-07	42.75	0.96
07-Sep-07	-9.10	-0.20

Except on Thursday, the Nifty gained or lost very marginally. The overall gain during the week for Nifty is 45.50 points or 1.02%.

It can be seen from the daily chart that as resistance level is approached, the volatility increases. Once the Nifty went past 4530, a minor sell off occurred on Friday. This has resulted in a long upper shadow. A ‘doji’ was formed on Tuesday, indicating that market is not sure which way to go.

As of now, there are no significant reversal signs in the daily chart. A “bullish engulfing” pattern has been formed on Wednesday and Thursday. This formation, when occurs near support levels at the end of a downtrend is a reversal sign (it of course needs a confirmation on the third day). Whereas, if it is formed on the top of an uptrend, it is referred to as “double lovers’ suicide’ by the Japanese, meaning more people will jump into the rally thinking it would continue further. But profit booking may start, keeping all those who entered the stock (near the top of the trend) at bay.

Forecast for the next week:

Now we have only a clue; there is no confirmation. But on Friday, the long upper shadow indicates some sell off. So, a corrective decline next week cannot be ruled out. In such a case, one has to watch out for 4340 and 4211 which are 38.2% and 61.8% retracements in daily chart. Since Nifty is on first wave, a new support level should occur as trading goes on.

Nifty future traders may enter long positions only after confirmation of the trend reversal. Short sellers on the other hand, may see some profit initially, but in bull markets they are the ones who suffer most.

Nifty continues to be bullish in medium term and long term charts.

Sensex:

In the sensex also, a “bullish engulfing” pattern has been formed on Wednesday and Thursday. A bullish “three inside up” pattern has been formed at the bottom of the downtrend (compare this with the bullish “three outside up” pattern in Nifty). The sensex too, is poised to witness a correction. The support levels for the sensex are 14979 and 14521.

The weekly charts of Nifty and Sensex are given below. Note the formation of candlestick patterns in both the charts.

In case of Sensex, a bullish “Homing Pigeon” pattern formation occurred while the Nifty encountered a bullish “Three inside up” formation. It is quite possible to analyze both indices simultaneously, but for the sake of simplicity it is good enough to analyze one.

The India Street selected some stocks as short term picks. The following table shows their status.

Scrip	Close 29-Aug	Highest Close	% Gain
BOMDYEING	542.45	611.10	12.66
GTLINFRA	34.30	36.85	7.43
KOTAKBANK	699.35	732.50	4.74
SCI	178.85	202.00	12.94
SUNILHITEC	204.70	250.75	22.50

Our medium term pick XL Telecom Limited closed at 180.65 (on June 29 its close price was 134.25) gaining 34.6% in just over two months time.

Advance / Decline Ratio:

Date	Adv.	Dec.	Unch.
03-Sep-07	849	276	25
04-Sep-07	699	422	30
05-Sep-07	557	572	21
06-Sep-07	712	405	31
07-Sep-07	502	636	15

Top Gainers / Losers among Index stocks:

Scrip	% Gain	Scrip	% Loss
REL	9.11	BHARTIARTL	3.61
SUNPHARMA	8.76	GLAXO	3.01
CIPLA	8.34	BPCL	2.20
GRASIM	7.87	ZEEL	1.18
HDFC	7.56	ONGC	1.03

Top Gainers / Losers in overall market:

Scrip	% Gain	Scrip	% Loss
AMBICAAGAR	46.64	PATNI	12.01
DECOLIGHT	45.19	JAYAGROGN	10.63
AKSHOPTFBR	39.78	USHAMART	7.09
SAREGAMA	34.70	TELEDATAIN	7.02
SAMTEL	34.63	WELGUJ	6.93

India Stock Market – Weekly Review Indices appear to have bottomed out!

Indices appear to have bottomed out!

In the last week’s review I had written that 3972 is a critical level and the index needs to be watched for a close below it.

This week, many people seemed to have been confused by the movement of Nifty. Over the last 6 days, we have been seeing selling followed by buying; this has happened for three times in a row. What does this have to do with futures traders? Apparently, they are not sure whether to go long or short.

Last Friday the index lost 70.55 points. But this Monday, it gained 101 points. On Tuesday and Thursday we saw index losing 134.15 points and 38.20 points respectively. On Wednesday and Friday, the index gained 78.25 and 75.20 points respectively. The total gain for Nifty this week is 82.10 points or 2%.

We had also indicated that worst for the index is possibly over. This appears to be so, even though we may see some more volatility next week.

We will now examine the daily chart of Nifty and see what supporting evidence we have to conclude that the market may have bottomed out.

The possible market ‘bottoms’ have been shown in boxes above. It may be noted that ‘red’ candles have been followed by ‘green’ candles or buying immediately followed selling. This indicates lot of buying support at these levels. In the last six days of trading we have seen alternate selling and buying. So we may conclude that the index is in the process of bottoming out.

The stochastics indicator (middle chart) indicates that it has attained a double bottom. The falling –DI in the lower chart indicates that Nifty is headed towards a possible reversal.

Forecast for next week:

In the weekly chart displayed above, we can see the bullish “harami” candlestick pattern. The real body of the green candle lies within the real body of the red candle and also the shadows of green candle are within the shadows of the red candle. This gives medium reliability for the pattern. Ideally, the entire greencandle within the real body of the red candle would be highly reliable. This harami pattern, when followed by a green candle and higher close either next week or next two weeks would confirm the reversal pattern. This means that the index needs to close above 4325 in the next two weeks.

Since the index has still not closed yet below 50% retracement level in the weekly chart, there is every possibility that it may close above 4325 either next week or the week after next.

Futures & Options Market:

The following chart shows the status of underlying open interest in the August futures contracts for Nifty.

“Open interest” means the number of total contracts which have not been exercised (outstanding in the market). It can be seen from the above chart that open interest is declining while prices are also declining. This implies that the long positions are being liquidated. In other words, the bull market is still intact. Since open interest is not increasing no fresh short positions are being added to the market.

Advance/Decline Ratio:

Date	Adv.	Dec.	Unch.
20-Aug	857	263	14
21- Aug	82	1046	8
22-Aug	490	634	15
23-Aug	349	759	31
24-Aug	778	323	30

Top Gainers / Losers among Index stocks:

Scrip	% Gain	Scrip	% Loss
BHEL	12.37	HCLTECH	7.98
STER	11.45	CIPLA	7.55
BHARTIARTL	8.61	PNB	6.37
AMBUJACEM	7.11	SUNPHARMA	4.03
TATASTEEL	7.07	WIPRO	3.58

Top Gainers / Losers in overall market:

Scrip	% Gain	Scrip	% Loss
SELMCL	51.05	ATLANTA	17.57
CHAMBALFERT	25.40	OMNITECH	17.03
PATNI	22.37	IILTD	16.26
PAVCI	15.77	WALCHANNAG	14.85
EUROCERA	15.36	TFL	14.77

SEL Manufacturing Company (SELMCL) is a new issue.

Feeling Bullish - India Stock Market Weekly Review

Bulls make merry as Indices continue to rally!

In the last weekly review I had mentioned, “This week was an interesting one and now we have the confirmation that the bulls are back on track”.

This view was found correct as the indices were on a roll this week. The Nifty gained 61.50 points (1.37%) on weekly basis. Except for a minor correction of 15.40 points on Tuesday the index closed positive on all four remaining days. But the major rally was witnessed on Thursday as the index soared by 62.55 points. On Monday, Wednesday and Friday Nifty remained almost flat with gains of 7.60, 2.80 and 3.95 points respectively. The Nifty closed at 4566.

On Tuesday and Wednesday there were two candlesticks with ‘doji’ bodies. In my earlier article “Candlestick patterns in Indian stock markets” we discussed about single and multiple candlestick patterns and their use. A doji represents indecision among traders. ‘Doji’ candle’s open and close prices are same (or nearly the same). But the real body should be almost in the middle of the candlestick range. Tuesday’s and Wednesday’s candlesticks though, had a “doji” body meaning open and close were almost the same. But on Tuesday the real body was found below the middle of the candlestick range. On Wednesday it was above the midpoint. The long upper shadow on Tuesday indicated a sell off; it was reflected in Wednesday’s trade for the first 4 hours. During the last hour of trade the bulls had managed to close positive, though the gain was a meagre one. This is seen from the long lower shadow of the candlestick on Wednesday. In other words the bears tried to push the market down on Wednesday; but the bulls managed to push the index up. As a result we saw a rally on Thursday.

But that was a short lived one. Today Nifty has once again formed a ‘doji’ body with a long upper shadow similar to that of Tuesday, signifying selling pressure. Both daily and intra day chart of nifty are shown below. Today’s trading session has been a weak one, though with a small gain. The day, though opening higher, formed lower highs and lower lows continuously. The last hour of trade witnessed sell off as indicated on the chart. This means that the market is witnessing profit booking at higher levels. Going by this chart, we may see further corrections next week. But those corrections will be good for the index and the overall market.

Daily chart of Nifty

Intraday chart of Nifty on 20-Jul-07

(Courtesy: NSE)

However, we still maintain our bullish view on medium and long term trends on the index.

Several index stocks are at a life time high. These include Bharti Airtel, Gas Authority of India, Grasim, Indian Petrochemicals Corporation, Larsen & Toubro, Reliance Communications and Reliance Industries. Bharat Petroleum and Hindustan Petroleum are bearish in short term charts.

The India Street analyzed Omaxe IPO. Today the issue got closed at 1700 IST. Following details are available now.

Total Issue Size	17796520
Total Bids Received	1197281780
Total Bids Received at Cut-off Price	51889820
No. of times issue is subscribed	67.28

As of yesterday, the qualified institutional buyers had oversubscribed by 8.59 times, non institutional investors by 3.26 times, retail investors 1.17 times and employees of the company by 0.95 times. These figures will change today.

Top gainers and losers among index stocks:

Scrip	% Gain	Scrip	% Loss
RELIANCE	6.72	SIEMENS	9.08
BAJAJAUTO	6.45	CIPLA	5.15
IPCL	6.15	ABB	4.72
GUJAMBCEM	5.70	BPCL	3.82
RCOM	5.22	SUNPHARMA	3.54

Top gainers and losers in overall market:

Scrip	% Gain	Scrip	% Loss
ZEENEWS	61.82	BSL	17.26
PTC	33.52	COLORCHIPS	16.73
KOTHARIPRO	30.23	NDTV	15.86
CELEBRITY	25.49	HEXAWARE	15.13
NIPPOBATRY	24.96	INFOTECENT	14.76

We discussed about Celebrity Fashions in my earlier article, “The Top 5 Bullish Stocks for this Week”.

We have analyzed 20 stocks for short term, 10 stocks for medium term and 5 stocks for long term investment. The following tables show the status of these stocks as of today. (Please note that ‘Initial’ refers to close price on date of analysis, Highest refers to the highest close price after the analysis date, % gain is calculated based on these two prices.)

Short term picks

Analysis date: 29-Jun-07

Scrip	Initial	Highest	% gain
GOKEX	242.60	259.20	6.84
HCC	123.20	132.00	7.14
OPTOCIRCUI	385.10	469.85	22.01
ORBITCORP	272.70	355.65	30.42
SOUTHBANK	127.50	152.55	19.65

Analysis date: 05-Jul-07

Scrip	Initial	Highest	% gain
EVERESTIND	123.95	123.95	0.00
INDIANB	141.05	163.70	16.06
POLYPLEX	144.60	154.20	6.64
SINTEX	259.65	289.75	11.59
SRF	175.75	176.10	0.20

Analysis date: 12-Jul-07

Scrip	Initial	Highest	% gain
ARVINDMILL	48.50	51.30	5.77
GNFC	124.90	137.30	9.93
PARSVNATH	394.00	394.00	0.00
PFC	169.30	195.65	15.56
TATAMETALI	147.95	147.95	0.00

Analysis date: 18-Jul-07

Scrip	Initial	Highest	% gain
CELEBRITY	76.80	89.00	15.89
GALLANTT	13.10	13.10	0.00
INDIAGLYCO	164.20	164.45	0.15
KTKBANK	196.05	196.05	0.00
USHAMART	280.00	289.90	3.54

Medium term picks:

Analysis Date: 02-Jul-07

Scrip	Initial	Highest	% gain
ADANIENT	270.70	320.75	18.49
GODREJIND	214.65	220.55	2.75
HIKAL	491.75	566.95	15.29
TINPLATE	60.80	60.80	0.00
XLTL	138.75	140.05	0.94

Analysis Date: 16-Jul-07

Scrip	Initial	Highest	% gain
COSMOFILMS	99.85	102.70	2.85
HEG	224.65	237.90	5.90
KIRLOSOIL	347.65	357.40	2.80
ROHITFERRO	39.50	39.50	0.00
ZEEL	335.80	335.80	0.00

Long term picks:

Analysis Date: 02-Jul-07

Scrip	Initial	Highest	% gain
DENABANK	49.75	56.95	14.47
GTL	222.60	231.75	4.11
GVKPIL	496.95	579.35	16.58
RPL	114.35	117.90	3.10
SREINTFIN	92.20	107.45	16.54