Refining the Rules

Take a look at this chart. BITO seems to be “at the starting gate”. But is it, really?… I’d argue not. The candle on 5/12 is a Doji, which is often a reliable sign that the direction of the trend will change. Furthermore, BarChart marked the day as the ‘lookback low’, and next day’s price action seems to confirm that by closing higher and by crossing above the green MA line.

However, take a closer look at the candle. Yeah, it’s green. But it’s a solid candle, not a hollow one, meaning, prices closed down on the day. Therefore --as Bill Maher would say-- a NEW RULE is required. For a lookback low to be confirmed, next day’s price direction must be ‘up’ (and not merely higher). So here’s an example that qualifies.… Yeah, the day following the confirmation day another Doji happens, and --just as before-- the trend reverses the following day. So here’s the next New Rule: Candle patterns shouldn’t be ignored.

Yeah, OHLC bars are mathematically equivalent to candlesticks, and --if you know how to interpret them-- can offer the same info about the psychology of traders. But OHLC are graphically inferior to candlesticks, and they don’t come with 300 years of commentary on their use. Therefore, a third rule. Use OHLC bars if you really, really prefer them. But you’ll be able to do your analysis faster --and your forecasts will be more accurate-- if you use hollow candlesticks instead provided you take the time to learn how to interpret the 1-day, 2-day, 3-day, and N-day patterns they form, of which there’s about 100. Of those, about 60 are ‘reversal patterns’ (as opposed to 'continuation patterns). And of the reversal patterns, less than a half dozen occur often enough and are reliable enough to be worth learning. So the learning task isn’t onerous, and there are dozens of websites that offer tutorials, with this being as good as any.


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