Editor’s Note:

Each night we feature a different lesson from

TM University. I hope you enjoy and profit from these.
E-mail me if you have any
questions.

Brice

Tails Seldom Fail — Thoughts On One Of My Favorite Patterns

By Goran Yordanoff

TradingMarkets.com

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.

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