Sunday, April 19, 2009

Doji Candlestick Friday in the Dow and Nasdaq

Click on Chart to Enlarge

Friday marked what I think is the first really solid candlestick reversal pattern since the March lows. The Dow ($INDU) and Nasdaq ($COMPQ) showed doji candlesticks when it was all said and done. Regular blog readers may recall the March 8th post I made about doji patterns as the market formed a bottoming doji the previous trading day. A classic reversal pattern in the context of an overbought and overly optimistic market will typically make for good trade. For confirmation, we would want to see a down day tomorrow (Monday), with a secondary scenario as another very small range day (like another doji) tomorrow followed by a downer Tuesday.

Click on the chart above to read the other notes on the chart. But the take home message is that Friday was a very narrow range day compared to recent ranges over the last few months. From a historical perspective, this type of set-up has led to a negative return over the next 2 days about 60% of the time. Also, these narrow range days have shown up with relative frequency at important tops in recent months.

Also, last week I mentioned the Smart Money and Dumb Money confidence indicators from and how it was showing that the Dumb Money was showing an extreme confidence reading that has typically occured within a couple days of major down turns in this bear market. As of Friday's close the Dumb Money confidence reading was the same, but the Smart Money confidence dropped to a lower level than any other in this bear market. This has caused the spread between the Dumb and Smart money to widen to a level that has been very good at identifying market turns.

This past week the ratio of puts to calls that were bought to open by small traders (1 to 10 contracts -- and typically good to bet against) dropped to its lowest level in months. The current levels were last seen in late September 2008 and in June 2008.

While my hammering home of the bearish case may be monotonous by now, it is important to know that the current sentiment environment has consistently led to declines in this bear market, so if we don't see that begin to happen this week, then we better be more cautious with bearish trades because things will be out of the ordinary.

On the trade management front, my hope is to get immediate downside this week and move in a stop on the BGZ trade corresponding to last week's highs which would make any potential loss a small one. Then when the next oversold signal comes, I will evaluate whether to continue to hold or not.


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