I wanted to show you this candle chart, as again it has some extremely important lessons for us as traders, using technical analysis as our primary trading tool. The first aspect of this chart which I think is a perfect example is the waterfall effect, seen in mid-December 2008. In any down move, increasingly wide spreads indicate that the move is gaining momentum, and as you can see here, the spread of the down bar increases, creating the so called “waterfall”, which describes the pattern perfectly. Now if you have volume on your trading system, then this is an excellent tool to validate the move as we would expect to see increasing volume with the increasing spreads as the market bears take control. So in any move, if you see widening spreads, in either a down move, or an up move, then this is an indication that the move is gaining momentum, and therefore provides us with a trading signal.
The second aspect of this move, is at the bottom of the waterfall, where we see a classic hammer candle, hammering out the bottom which we have discussed before. With such a deep hammer, after such a strong down move, there is only on way for prices to move, and that’s back up, but only temporarily, and this is the key point. As traders we have to be patient and wait for the confirming signal to appear. Whilst we might have made money trading the first hammer, we might have got stopped out in any reversal. The second hammer which appears six days later, is a much stronger signal as it confirms the first, and therefore we can trade with much greater confidence that the reversal is a genuine one, and not a temporary move higher. The lower wick of the candle is re-tests the same level as for the first hammer candle, adding more weight to the signal. Having seen the second signal we would then wait until prices moved up and through the moving averages which then provide us with added confidence as the move develops. I am still in this one and waiting for prices to reach the resistance above before closing out, or alternatively if a reversal occurs then trigger my stop loss below the 1.15 level.