At askslim.com, cycle analysis is our go-to method of technical analysis. This article will refer to various concepts and terms pertaining to cycle analysis, so some background knowledge will prove useful. If you’d like to learn more about Cycle Analysis or just review what you already know, be sure to check out our series on Cycle Analysis Basics.
When analyzing charts, it is necessary to understand how various chart patterns and indicators provide key information. In cycle analysis, such information includes: directional bias, cycle highs and lows, support and resistance levels, momentum, and more. Here we will discuss identifying cycle highs and lows, and how candlesticks in particular aid us in doing that.
A Word Of Caution
Information received from candlestick patterns should not be considered in isolation. Though we may look at the candlesticks on a chart and see a bullish or bearish pattern, there are still many other factors in the market. This is why we always consider what these patterns mean within the broader cycle analysis context. For example:
A bearish pattern may indicate the beginning of a cycle’s declining phase, but it also may project an incoming cycle low.
A bullish pattern may reaffirm the start of a new cycle, and yet it could also indicate an impending cycle high.
As a general (and oversimplified) rule, we look for bullish candlestick patterns to form off of a test of key supports. Conversely, we look for bearish candlestick patterns to form following tests of key resistances.
Once a certain candlestick pattern has given indication of a bullish or bearish reversal, we begin to watch for follow through. We don’t want to link a directional bias change to a particular candlestick pattern unless there is price action to confirm the reversal. This confirmation is identified by powerful tools like the Slim Ribbon Momentum Indicator to assist in confirming directional bias, and we’ll also look to ensure that new found highs or lows are not violated.
In the following examples, we will demonstrate how we interpret candlestick patterns within the greater context of cycle analysis, and what that information tells us.
Reading Candlestick Patterns in Action
On this daily Microsoft chart, we see a bearish kicker pattern occurring in mid June. This occurred during the declining phase of that particular daily cycle, so we’d be watchful for a new cycle low to form. Just after the bear kicker pattern we can see that price, as well as the Slim Ribbon does, in fact, follow upward, confirming the cycle low.
Around the start of September, we see another bearish kicker pattern lead to different behavior. This pattern occurred just after the midpoint of that particular cycle, which gives risk to the downside and tells us we may be in the declining phase of that cycle. If movement were going to continue to the downside, we would expect that new high which formed at the top of the pattern (232.86) to not be surpassed. We would also expect the Slim Ribbon to turn down, confirming the reversal. As you can see on the chart, a new high did not occur, the slim ribbon turned downward, and price action followed.
Above we saw the same candlestick pattern lead to two completely different kinds of price action; a prime example of the importance of considering candlestick patterns in the broader context of cycle analysis.
Here we are looking at the same Microsoft chart, but zoomed in. You’ll notice two hammer candlesticks (bullish patterns) that exhibit similar behavior. They both occur at cycle lows, so we project that price will follow upward. For this to be confirmed, the new low set by each candlestick would have to hold and not be violated, which occurred in each scenario.
In early November, you’ll notice a bearish gap reverse. This occurs rather early in the cycle, so we’d theorize that a left-hand translation (a bearish indicator) had occurred. If this theory were true and the high of that candlestick constitutes the daily cycle high, we would expect price action to continue continue downward. For this to be confirmed, that new high would not be broken for the rest of the cycle. Also, we would watch for the slim ribbon to turn down, which is beginning to happen at the very end of this chart.
These are powerful techniques which can reveal invaluable information to traders who put in the time to learn them. What we’ve examined so far are only a few examples of how one can use candlesticks patterns in conjunction with cycle analysis to gain a real edge. In part 2, we will look at more examples of how to implement this practice.