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Two Reversal Candlestick Patterns For The US Paper Index

07/11/07 09:13:12 AM
by Chaitali Mohile

$DJUSPP reflects the effect of two reversal candlestick formations.

Security:   $DJUSPP
Position:   Buy

The hanging man candlestick pattern is a bearish reversal pattern that forms in an uptrend. This pattern indicates the end of the uptrend and the beginning of a new downtrend. In Figure 1, the advance rally of 17 points ended with the formation of a hanging man at the top of the rally. The hanging man candlestick indicates that selling might begin in this index soon. Following the formation, the index opened lower.

The strength of the hanging man can be seen in the index retracing toward its 50-period moving average (MA) support. During this minor correction, the index lost 13 points but rallied further with the 50-day MA support. In addition, the relative strength index (RSI)(14) was overbought and the average directional movement index (ADX) was overheated above 40 at the 167 price level. It is always best to confirm candlestick formations with indicators such as the RSI and the ADX. Both indicators support the hanging man formation, confirming the possibility of a correction in the paper index.

FIGURE 1: US PAPER INDEX, DAILY. The hanging man pattern, a strong bearish reversal pattern, is responsible for the decline in upward rally from the 167 level. And the morning star pattern helped push upward the bullish rally to run strongly with the support of other indicators.
Graphic provided by:
The hanging man brought an intermediate change in an advance rally and the index moved in sync with the 50-day moving average. New highs were followed by a dip, establishing support at the 50-period MA till a bullish reversal pattern was formed. The morning star pattern was formed at the 50-day MA support, indicating the start of a new advance rally. The morning star is a set of three candles, with the first long red candle indicating the existence of a downtrend in the daily chart (Figure 1), followed by a gap down opening, finally forming a doji candle, and a third bullish candle indicating a new uptrend.

The morning star pattern has already confirmed its power by hitting new highs at 179 level. The ADX (14) is at 18, indicating a developing uptrend, and the RSI (14) has reached its previous high so some consolidation is possible at a new high. I would recommend traders and investors to buy above the 180 level.

The bearish reversal pattern made the paper index retrace to its low pivot, and the bullish reversal pattern that was formed recently gave birth to a new advance rally with the 50-day MA acting as a strong support. Again, I would like to remind traders to wait for more confirmation when following candlestick patterns.

Chaitali Mohile

Active trader in the Indian stock markets since 2003 and a full-time writer. Trading is largely based upon technical analysis.

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