Signs of a confused market

A peek at the charts shows there may be a reversal in sentiment coming soon.

By Stock Traders Daily Feb 2, 2012 12:50PM

Image: Arrow Up (© Photodisc/SuperStock)Everyone is embracing a Golden Cross pattern in the moving average of the market, and bullish prognosticators say that when this has happened in the past, the market sees an average 4.6% increase in the following six months 75% of the time (What happened in the other 25%?). 

A Golden Cross occurs when a security's 50-day moving average crosses above its 200-day moving average. In this case, we're talking about the Golden Cross in the Standard & Poor's 500 Index ($INX).


Although the market increases most of the time anyway -- and there were surely periods of setback in between those 4.6% increases -- this technical indicator should not be ignored by investors using moving averages to guide their decisions.


Moving averages are not exact. They do not offer exact entry levels and exit points for trading strategies, but instead they pinpoint general sentiment. I have found that only straight-line technical analysis offers the exact turning points necessary to profitably manage risk and beat the market. Furthermore, combining straight-line analysis with candlestick patterns is much more accurate than using moving averages.

In the following video, one technical analyst discusses whether the S&P 500 will make a run at new highs.

Post continues below.

A candlestick chart (as seen below) shows the opening and closing price in a vertical bar, or body. The highest and lowest prices for the time period protrude out from that bar like a wick in a candle.


Other unique indicators within candlestick patterns can more reliably gauge sentiment and direction. One of those appeared last week in the longer-term chart of the S&P 500 that I offer to my clients regularly. The candles that I use in that chart are one week candles, meaning that it takes an entire week for the candle body and legs to develop. Of course, I overlap these weekly candles with straight-line technical analysis, but the standout technical observation I am referencing here would have come without my addition.


Last week, the S&P 500 was confused. It lacked direction and closed almost exactly where it began. The market attempted to increase at one point, but failed. When the market threatened to decline, it was countered with buyers. At the end -- near a relative peak -- the market was directionless and looked confused.


The candlestick chart pattern that developed last week is also known as a Doji. A Doji is in the shape of a cross, since the opening and closing prices were nearly the same. It is a candlestick pattern without a body, basically, and it typically appears when the market is confused.  Furthermore, when it happens at relative peaks or valleys it often marks a reversal in sentiment, so these are commonly referred to as Reversal Dojis.


A complete explanation of this technical pattern is difficult given the limited space allotted to me in this venue so I have created a short video to help explain what this pattern is and what it could say about the future. Here it is: explanation of Reversal Doji.


In addition to the Doji pattern that appeared in the longer term chart of the S&P 500, weekly Dojis also appear in the chart patterns of Broadcom (BRCM), Walmart (WMT), JPMorgan (JPM) and Norfolk Southern (NSC). Uniquely, the Doji for Norfolk Southern appeared the week before last, and it was followed by a negatively engulfing red candle (The engulfing red candle is a sign that sellers outnumber buyers). That made it a bearish reversal Doji and a bearish indicator. 


Related reading:

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