Posted on August 20, 2010 by StockTrading.net | Comments Off
Do you know what the difference between good stock trading and great is? Timing. Finding a great stock to buy isn’t hard, but finding the right time to buy it or the right time to sell it can be a lot more challenging. Fortunately, there are a few candlestick* charting clues that traders can look for to spot short-term highs and short-term lows that make for optimal entry and exit points.
Not that they’re the only candlestick chart patterns worth knowing, but two types of patterns tend to be found at major tops and bottoms for stocks and indices alike. One is called a harami, and the other is called an engulfing bar.
Either can be bullish or bearish, depending on the scenario. In all cases though, the underlying hint is the same…. the market just underwent a major change of heart, for better or worse.
An illustration of each is in order.
A harami is often referred to as in ‘inside day’, where one day’s entire bar – from high to low – spans less than the prior day’s open/close range. And, the two days are pointed in opposite directions, thus the reversal aspect. The two bars in an ideal harami also tend to be much taller than usual, indicating the extreme swing in momentum.
The nearby example of a bullish harami shows us a very tall bearish day for the first day, then a very short bullish bar (completely contained within the prior day’s open-to-close range) on the second day. Clearly something dramatic happened over the span of two days to create such an abrupt change in momentum, and when the reversal is so abrupt, it also tends to last for quite some time.
Conversely, a bearish harami starts out with a very tall bullish bar for the first day, but the second day consists of a short bearish bar that’s pointed lower. As was the case with the bullish harami or bullish outside day, the sudden shift in momentum isn’t a mere coincidence – something significant and long-lasting has likely happened for the worse.
Clearly being able to spot haramis or inside days (and the abrupt reversal of momentum they tend to indicate) is of great benefit when stock trading. They aren’t the only clues that momentum has made a major shift, however. Engulfing bars or ‘outside days’ can indicate the same sudden swing in sentiment.
A bullish engulfing bar or bullish outside day is exactly what it sounds like… just the open-to-close span of the second day is above and below the prior day’s entire high-to-low range. And of course, the second day is bullish (close above the open) while the first day is bearish (open above the close). And as was the case with haramis, the taller the bars, the more meaningful the signal. The nearby image illustrates the idea.
Of course, a bearish engulfing bar or bearish outside day is a mirror image of the bullish one, where the second day’s open-to-close range is above as well as below the prior day’s entire high-to-low range, and the second day is bearish versus the first day being bullish.
While no trading tool is perfect, being able to spot these key reversal clues will make anyone’s stock trading far more productive, even if only used to confirm or dispute other technical indicators.
* Candlestick analysis is the art of spotting the strength of a trend or the likelihood of a reversal based on the pattern of a stock’s open, high, low, and closing price for any given day. The technique even looks at that same information over multiple days to determine what’s in store for the foreseeable future. This approach to stock trading was named so, as the daily bars of the charts often look like candlesticks, with a ‘wick’ at one or both ends of an upright ‘candlestick’ representing the stock’s movement for that day.