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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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  • Candlesticks - great tool, but you need more 3 comments
    Feb 25, 2012 7:39 AM
    Candlestick indicators come in many shapes in sizes, from single sessions up to multiples of three or more. They are great signals of reversal, but you should not act on an indicator until you are able to confirm it independently.

    Some of the best confirmations are going to be found in:

    1. Other candlestick formations. One of the strongest reversal confirmations is a second candlestick formation. As long as both formations tell you the same thing, the indicator is exceptionally strong. For example, an engulfing pattern pointing in a particular direction, followed by a long candlestick heading in the same direction is very strong. Reversal will occur most of the time after this double whammy of candlestick reversals.

    2. Momentum oscillators. Momentum tells you not only the trend direction, but also the changing strength and speed of movement. So indicators like RSI and MACD are exceptional confirming technical signals. When coupled with a reliable candlestick reversal, your confidence should be high.

    3. Price gaps. Among strong trend signals is the price gap, notably when gaps show up as part of a series in the same direction. This runaway pattern is troubling, however, because it may also represent over-trending and will be followed by reversal and filling. This is why the gap pattern works best in confirmation with other signals. When the price turns and gaps in the opposite direction and at the same time, you see the candlestick reversal forming, that's a good sign. And some of the strongest candlestick reversals consist of gapping patterns.

    4. Failed tests of support or resistance. Technicians know that when the borders of the trading range are tested unsuccessfully, it usually means price is about to turn and move strongly in the opposite direction -- but not always. This is why failed tests of support or resistance are confirmed when other signals are found at the same time. One of the strongest reversal indicators is a failed test of the border accompanied by a candlestick reversal indicator.

    5. Volume spikes. What does it mean when volume spikes higher than average? Usually, it means something is going on among buyers, sellers, or both. This is especially true when you also see a narrow-range day (NRD), a day with a very small distance between opening and closing, which in candlestick parlance is called a doji, a word meaning "mistake" in Japanese. It looks like a cross because there is little or no real body. The doji and volume spike appearing together is a big red flag pointing to reversal.

    Remember, no signal is 100% guaranteed to accurately predict price, even when it is confirmed. The practice of confirmation as part of a candlestick charting system will improve your timing averages, but, unfortunately, there are no sure-fire ways to know what is going to happen next. Learn how to master the topic quickly and easily at candlesticks

    Michael C. Thomsett is an instructor with the New York Institute of Finance, where he teaches five courses. He is also an investing and options and technical analysis author. He wrote the best-selling Getting Starting in Options (Wiley, http://tinyurl.com/22nmkf2), now in its 8th edition. Thomsett's latest book is Trading with Candlesticks. (FT Press)

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  • Thomsett
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    Author’s reply » Candlesticks as a starting point in your analytical program
    24 Feb 2012, 12:51 PM Reply Like
  • Thomsett
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    Author’s reply » 5 great confirmation tools for candlesticks
    24 Feb 2012, 01:54 PM Reply Like
  • Thomsett
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    Author’s reply » Candlesticks give you a great starting point in timing your moves.
    1 Mar 2012, 12:41 PM Reply Like
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