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 | Quote | Chart | News | PowerRating) 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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