Editor’s Note:

Each night, we feature a different lesson from

TM University. I hope you enjoy and profit from these. If you need any help,
please e-mail me.

Brice

 

TAILS NEVER FAILS

Tails, or upper and lower
shadows as they are sometimes referred to as, are an extremely useful tool in
assessing areas of potential support and resistance. Not only are the price
levels at which they occur to be considered during our analysis, but their
presence in different time frames provides a bit more insight as to the
underlying strength or weakness of the stock/sector we are investigating. As
Japanese candlestick method puts great significance on the relationship between
opening price and closing price, the tail is an extremely important occurrence
when analyzing charts because it reveals an area of price that was visited
during the time frame under analysis, but was unsustainable. As such, tails can
be viewed as a type of “search party” that ventures into certain price areas. At
times they can be successful, and at other times can signify important failures.
My purpose in this lesson is to discuss the significance that tails hold when
viewed in different time frames and the important early warning signal they
provide to an impending trend reversal.

Observe the following charts:

The chart of AdvancePCS (ADVP)
below reveals how the occurrences of tails on the daily charts would have guided
us in analyzing the underlying strength and ultimate reversal pattern in this
strongly uptrending stock. As you can see, the tails gave us far clearer
information than we would have obtained trying to draw in regression lines.

 

The next chart is a weekly of
the Dow Jones Industrials. Interestingly, a review of the weekly candlestick
bars from November 2000 through March 2001 reveal an inordinate amount of tails
into the 11,000 zone. These “search parties” were sent out to explore price
areas at the 11,000+ level early in the trading week but were sent back lower
due to selling pressures later in the week. This occurrence provided an
important piece to the puzzle that allowed us to forecast an impending drop in
the DJI. When these upper tails occur consistently on weekly charts it should be
considered extremely bearish activity as consistent weakness late in the trading
week is a clear sign of institutional distribution as retail buyers are lured
into buying at higher levels earlier in the week.

 

 

The next chart is a weekly of
Efunds (EFDS). Efunds has been a strongly uptrending stock since October 2000
and had appreciated nearly 450% into last week. As such, I like to stalk these
runaway upside movers for signs of an impending top and trend reversal as
amateur traders continue to pile on the long side. Being able to short stocks
that have made moves of this nature at or near the areas of their tops is highly
profitable — but you need a strong stomach. As you can see, the tails up
created a two-month-long topping process that certainly signals lower prices
ahead. By taking into account what the tails are telling us, we can get early
warning signals of a potential trend reversal without having to wait for
trendlines to be broken or other such conventional analysis to provide the
signal.

The following daily chart of
Juniper Networks (JNPR) displays another type of candle that provides a warning
signal that the previous trend is in jeopardy. This candle possesses long upper
and lower tails and is called a high-wave candle. This type of candle forewarns
that the market may have lost its sense of direction and that the bulls or bears
responsible for the prior trend may be running out of ammunition.

 

As most of us are already
familiar with the chart formations of the hanging man doji (small real body with
long tail down), the gravestone doji (small real body with long tail up), and
the shooting star (long upper tail with a small real body near the lower end of
the trading range), we can use our understanding of the chart formations above
to compliment our arsenal of important reversal indicators. In addition, being
able to review the trading pattern of a stock or index on multiple time frames
and paying close attention to what the tails are revealing allows us an
opportunity to analyze the underlying strength/weakness present and formulate a
prudent plan of attack. As trendline violations, etc. do not always allow you
the most graceful entry into a trade, applying your knowledge of trend-reversal
signals through the analysis of tails and other candlestick formations to other
technical oscillator indicators can oftentimes provide excellent trade entries.