Technical Analysis Education
Here, we briefly explain the two main analysis methods we employ: Elliott Wave Theory and Japanese Candlestick Analysis.
TECHFX TRADERS will shortly launch an ongoing interactive education series of webinars and e-books, available exclusively to members.
Elliott Wave Analysis
In the 1930s, Ralph Nelson Elliott posited his theory that investor mood swings create specific, recognisable price patterns. The basic premise is that market movements take the form of five specific waves, which are now known as Elliott Waves.
Three of these – waves 1, 3 and 5 – are called impulsive waves and always move in the same direction as the next largest trend. Waves 2 and 4 are called corrective waves and, as the name implies, move against the trend of the larger scale.
Elliott Wave rules and guidelines
- Wave 2 never retraces more than 100% of wave 1.
- Of the three impulsive waves – 1, 3 and 5 – wave 3 cannot be the shortest.
- Wave 4 should not overlap with the price territory of wave 1.
- Corrective waves 2 and 4 often take alternate forms; a simple corrective move in wave 2, for instance, suggests wave 4 will be a complex corrective move.
- A simple corrective pattern is a three-wave structure labeled ABC. It is one of the most common corrective patterns and one of the most tradable.
- Trends are fractal, meaning each impulsive wave can be broken down into five smaller waves and each correction can be broken into three smaller segments of a counter-trend move. However, it’s often not necessary to label every single aspect of the wave.
Trading Elliott Wave
These guidelines help provide a probability framework as to the future direction of market moves, and when to enter and exit trades. In practice:
- Given waves 1 and 2 are the least easily identifiable, the focus is on catching wave 3’s moves (given wave 3 is often the largest and most dynamic wave of a trend) and to a lesser degree waves 4 and 5’s.
- A wave 4 correction offers the opportunity to enter a trade before the trend resumes in wave 5.
- Wave 5 is the final leg in the direction of the dominant trend. As it can last for an extended period it is still worth trading for, however, it is also the one that catches the most investors. Sentiment is at extremes while the underlying health of the market is deteriorating according to momentum and divergence indicators – often a good sign to exit a trade.
The main objective of technical analysis is to extract tradable set-ups from charts so our preference is to focus on the markets where the wave counts are clearest. We do not attempt to label every wave and subwave once a pattern has lost clarity. Instead, we prefer to look for markets that are clearly displaying the impulse or corrective characteristics outlined above.
Japanese Candlestick Analysis.
Candlestick Analysis is believed to have originated in Japan in the 18th century, where it was thought to have been used for trading rice. Tony discovered Candlesticks early in his career at Goldman Sachs and later attended several seminars on Japanese Candlestick Analysis with renowned trading and financial market educator, Dan Gramza.
Having started his career on the Sydney Futures Exchange trading floor, an environment flush with trading noise, emotion and excitement, Tony realised that Candlestick Analysis portrayed those same characteristics in a visual sense.
Tony continues to use Candlestick Analysis to highlight exhaustion and potential reversals within an Elliott Wave framework. This ensures analysis and trade signals are often confirmed by two or more analysis techniques, thereby producing stronger signals and analysis.
The body of a candle is created by the difference between the open and close (also referred to as “the real body”), while the thin “shadows” on either end of the candle mark the high and low over that period (also referred to as “wicks” or “tails”).
A dark or red candle means the close was below the open, while a white, green or blue candle shows the price closed higher than it opened.
Candle Stick Examples
A black or a white candlestick that has a small body, a long upper shadow and a little or no lower tail. Considered a bearish pattern in an uptrend.
A black or a white candlestick with a small body. The size of shadows can vary. Interpreted as a neutral pattern but gains importance when it is part of other formations.
A black or a white candlestick that consists of a small body near the high with a little or no upper shadow and a long lower tail. Considered a bullish pattern during a downtrend.
A black or white candlestick in an upside-down hammer position.
Inverted Black Hammer
A black body in an upside-down hammer position. Usually considered a bottom reversal signal.
Long Lower Shadow
A black or a white candlestick is formed with a lower tail that has a length of two-thirds or more of the total range of the candlestick. Normally considered a bullish signal when it appears around price support levels.
Formed when opening and closing prices are virtually the same. The lengths of shadows can vary.
Formed when the opening and the closing prices are at the highest of the day. If it has a longer lower shadow it signals a more bullish trend. When appearing at market bottoms it is considered to be a reversal signal.
Formed when the opening and closing prices are at the lowest of the day. If it has a longer upper shadow it signals a bearish trend. When it appears at market top it is considered a reversal signal.
Consists of a doji with very long upper and lower shadows. Indicates strong forces balanced in opposition.
Consists of two or more candlesticks with matching bottoms. The candlesticks may or may not be consecutive and the sizes or the colours can vary. It is considered as a minor reversal signal that becomes more important when the candlesticks form another pattern.
Consists of a black or a white candlestick followed by a doji that gaps above above or below these. It is considered as a reversal signal with confirmation during the next trading day.
Difference Between Black & White Candlesticks
Marubozu Black Candlestick
A black marubozu candle has a long black body and is formed when the open equals the high and the close equals the low. A black marubozu indicates that sellers controlled the price from the opening bell to the close of the day, and is considered very bearish.
Marubozu White Candlestick
The white marubozu candle indicates that buyers controlled the price of the stock from the opening bell to the close of the day, and is considered very bullish.