Our
dear reader, in our article here, we will sail together on a technical
and fundamental analysis boat, trying to find out together the benefits
from catching a technical formation or rather known (a technical
pattern) whether it's positive or negative, bullish or bearish,
attempting to link it with the contemporary economic circumstances.
We all
know that the market itself isn't gambling; so that we always see those
who are playing the coins flipping game with the market, tend to fall
down easily and so quickly.
Of
course, to catch a pattern you need to read the chart technically;
alongside with a good background of fundamental analysis because we do
believe here in ecPulse that both readings are needed as well.
The
pattern is just an indication, which identifies the winner of the
battle between bulls and bears. We also know that, the chart determines
the high, low, open and close.
When
the conflict occurs between buyers and sellers over the time frame we
see what is recognized as the close point, which lots of trader or
maybe all of them are starting to read the battle form their point of
view, resulting in making decisions, which may make profits or losses.
We chose the candlestick patterns to explain the purpose of why many people spend a long time to learn technical analysis.
Before
we start any deep studies about the Japanese candlesticks, we will
focus on the definition and the historical root of these candles.
World of the candlesticks:
The
candlestick chart is another type of chart used by analysts to help
determine the trend of equities or securities in the markets over time.
This chart is derived from the line and bar charts and helps tell the
range of movements within a specific time interval.
History:
It all started in the 17th
century as the legendary Japanese trader, Munehisa Homma, alongside
other traders were using this technique to trade rice. The charting
technique was able to provide them with open, high, low and close
prices for the specified time interval.
Munehisa
was the youngest son of the Homma family yet despite his trading
techniques and expertise, he was able to inherit the family business
and move the trading firm to Tokyo. Continuing his researches and
findings, he was able to develop a new set of rules known as the
"Sakata Rules" through following historic price movements and weather
conditions to later become the framework used by Japanese investors.
Throughout
time and after developing his skills, Homma left the Osaka rice markets
to expand and target Tokyo exchanges. His fortune grew as he was able
to engage in over one hundred consecutive successful trades. As a
result, this became the foundation for what is known as Japanese
Candlestick analysis.
Although this trading method and technique was around for hundreds of years and ever since the 17th
century in Japan, it just recently entered the US approximately 25
years ago as they believed that it was too difficult and too time
consuming to understand. However now, it has become the most popular
trading technique as computer software was able to develop a more
advanced platform. This refined trading technique was then officially
published in the US by Steve Nison in 1991 under a book titled
"Japanese Candlestick Charting Techniques".
However,
it is important to note that candlesticks were also picked up by
Charles Dow during 1900 as his theory of technical analysis followed
the same principles that included:
- Buyers and sellers move markets based on expectations and psychology
- Markets Fluctuate
- All known information is reflected in the price
- Price doesn't necessarily reflect the value of the underlying asset
- The price action is more important than news, earning, etc.
Candlestick Layout:

The
candlestick is composed of a body, black or white; and two shadows
known as wicks and tails. The upper shadow shows the highest trading
price whereas the lower shadow indicates the lowest trading price. As
for the body, as seen in the above image, a black body shows the
opening price at the top of the body followed by the closing price at
the bottom of the body and vise versa for the white body.
Patterns
are single, double and also triple. The pattern defines if we will
continue moving within the same trend or maybe reverse it to the other
direction.
Among all patterns of the Japanese candlesticks, a single pattern has attracted traders just like honey attracts bees. It's the [Hammer].
The hammer is a single candlestick bullish reversal
that looks like a square lollipop and it is always forming at the end
of a downside trend. The price usually moves to the downside before
rallying back to the upside to close below or above the price. The
color of the body is of no significance. It reverses a specific trend,
which should be bearish.
As a
matter of technical fact, the length of the lower shadow and also the
length of the upper shadow which some traders know them as (wick and
tail) do signal the strength of the reversal, as the hammer without an
upper shadow is always able to indicate a stronger reversal, giving a
plus sign as seen on the example below.

Another
condition, which may be capable of determining the strength of the
reversal, is the ratio of the lower shadow versus the body, as the
typical or ideal pattern always offers 2:1 or 3:1.
As far as the tail is longer, the reversal is stronger.
The low
of the hammer shows that plenty of sellers remain. Further buying
pressure, and preferably on expanding volume, is needed before acting.
The heavy volume can serve to reinforce the validity of the reversal.
Based
on the length of the lower shadow, professional technical analysts and
experienced traders can determine how far the reversal may go, using a
convenient level for defining the end of this reversal according to the
time frame they use.
While this may seem enough to act upon, hammers require further bullish confirmation.
Such
confirmation could come from a gap up or long white candlestick,
commonly forming next to hammers or rarely two candles following it.
The examples below show the difference between the two cases.
The
first example shows a weekly hammer which has been formed on the
USD/CAD pair in the first week of November 2007 and was followed by a
direct confirmation.

On the 23rd
of July 2007 on the daily chart of the Greenback versus Swiss franc,
the hammer has been captured but the confirmation was given later.

Hammers can mark bottoms or support levels.
After a decline, the low of the long lower shadow implies that sellers drove prices lower during the session.
However, the strong finish indicates that buyers regained their strength to end the session on a strong note.
Two
important elements should be put in our consideration before the
indication is confirmed; firstly the historical or the previous
established support level.
What if it met the recorded low of the hammer?
Second,
the angle of the trend as when the trend is closer to 45 degrees, the
reversal gets additional strength and confirmation for starting a new
ascending wave.
Most of traders play the game like this, buy near support and sell near resistance.
Of course the solo indication is always useless.
Therefore
finding a support level will not be useful without being used in
conjunction with other forms of analysis, what could be better than a
hammer candlestick?
Check the following example.

As we
explained above, the solo indication might cause a failure if the
trader depends on it alone, but also there are some rare cases in
which, the reversal of our detected hammer may fail.
These
cases occur when the bears control the movement of the market and this
action is represented on the chart with a bearish engulfing candlestick
pattern, which takes the price below the recorded low of the hammer and
brings downside rally resumption.
Note the following example for a case of failure:

Now
dear reader, after discussing one of the most important technical
reversal candlesticks and were able to pinpoint the exact result from
it, let's combine both technical and fundamental analysis to see how
this may affect growth in the global economy.
We
won't drift off our main topic which remains the hammer, yet we will
attempt to implement this singles candlestick on the current economic
situation in several major economic powers that many believe are on the
verge of crawling back out of a recession that resulted from the worst
financial crisis since the Great Depression in 1930s.
The
Hammer candlestick is simply a candle with specific characteristics
that has the ability to end a downtrend and reverse it to the upside to
reach specific targets depending on several factors discussed earlier.
Ok,
looking back at the end of 2007, the global economy has been gradually
declining from prosperity nearing the end of the completion for the
first two parts: the downside wave and the hammer candlestick. However,
do note that the candle is still forming and we are currently waiting
for the close of the candle to confirm the final part of the cycle.
To
begin with dear reader, let's discuss the two factors that have been
completed before moving on to the result of the pattern; which to us is
more important than the pattern itself, and that is the actual reversal
to the upside to symbolize an economic recovery.
From
the period between 2002 and 2007, the global economy witnessed a new
phenomenon known as globalization which supported world trade to extend
across the entire globe. With all the growth prospects, financial
markets became more active as more and more traders were entering the
markets day after day. The fatal attraction of large amounts of profits
witnessed by some and the diversification of instruments in the markets
was more than enough to lure the players needed.
If we
focus on the world's largest economy, the US, we see that it too shined
to prosperity during this period. However, looking at it at another
point of view, financial markets were able to provide the support
needed to help the economy as billions of dollars were constantly being
pumped into the American markets as investors were targeting
investments in what was known as the most stable market at the time.
The
housing sector had the major role as it attracted the most due to the
different derivatives and investment instruments that were provided
from the sectors alongside the magnificent performance of the sector
compared to others in the economy. House prices continued to surge
which unfortunately mislead investors to believe that this incline will
guarantee them profits.
With
all the capital in the markets and US housing sectors, it wasn't long
before a bubble was formed that would eventually burst similar to the
Dot Com bubble in 2001 and that back in the 30's which ended with the
Great Depression. Due to investors insisting to pump more liquidity in
the markets, stocks were heavily overvalued opposing fundamentals that
were being released and the true performance of different companies.
During
the second half of 2007, European Banks that had invested abroad in the
US realized that they couldn't tell the exact value of their
investments and that the actual volume of investments was much less
than all the securitization which simply meant that if shareholders,
bondholders or any investors bearing any of the commercial
papers/instruments were to ask for liquidity, the amount of cash on
hand won't be enough to satisfy the amount of actual investments.
BNP
Paribas was one of the first victims as it froze three major hedge
funds in the US to trigger the largest credit crisis in the global
market. We can't blame them for the current situation, but this is when
investors realized the truth which resulted in a major sell off in the
market dragging global stock indices to the ground to hit historical
lows. Unfortunately, the crisis wasn't just contained within the US
borders, but it eventually spread across the globe to hit several banks
and financial institutions who were boggled with the true value of
their investments in the US instruments.
Not
long were the economies of the US, Europe, Japan and UK affected by the
crisis as the it was obvious that the foundation that the US laid upon
was no longer fit to support the economy unlike what was seen in China.
From here, the negative effects on growth rates and company performance
in the different sectors started to emerge.
By this
we have safely highlighted the declining wave that dragged growth rates
lower which accelerated after the collapse of Lehman Brothers in
September 2008. The third largest investment bank in the US at the time
failed to receive government aid which resulted in the bankruptcy of
the bank and further deterioration in the economy.
Following
this collapse, the US government stated that it would take over
American International Group (AIG), the largest insurer in the world,
due to the massive losses posted after guaranteeing mortgage backed
securities. Ahead of the government take over, Freddie Mac and Fannie
Mae, the mortgage giants were also threatened of bankruptcy where if
deemed true, this could've been the end for the entire global economy
and not just the US.
All
this pushed banks across the globe were hoarding cash as they froze the
credit markets and hence affect global trade that depends heavily on
credit. In addition to that, waning demand battered emerging markets
and dragged them into a recession as exports were weak after the US,
Europe, UK and Japan all entered a technical recession. These economies
served as the largest markets for many emerging nations that depended
on them, and with them out of the picture, the emerging nations were
soon to sink as well.
Amid
all these developments, central banks and government were to come up
with unorthodox measures that included interest rate cuts to record
lows and pumping trillions of dollars in the markets across the globe
in an attempt to slow the pace of deterioration in the financial
markets. Sadly, this wasn't enough to help the economies as they
continued to contract to post the worst growth rates that extended to
the first half of 2009.
With
the end of the first quarter in 2009, it's safe to say the declining
wave has ended and the lower wick of the hammer reached the lowest
level it could possible hit. The US witnessed a 6.4% contraction during
the first quarter whereas the Euro Zone contracted 2.5%, the UK shrank
2.4% and Japan topping the list posting a 11.7% contraction. However,
all these economies were able to show improvement in growth rates
during the second quarter of the year despite the US, UK and Euro Zone
failing to post positive readings unlike Japan which expanded 3.7%. It
seems like economies are now on the right path to recovery.
Now
with the obvious improvement in economic fundamentals and growth rates
in the second quarter in specific, we can say that there is a battle
between the economies and negative effects that resulted from the
credit crisis which will symbolize the body of the hammer candlestick
after the lower wick has been placed as it attempts to close as far
away as possible from the lowest point seen in the first quarter.
We
can't quite say that the shape of the candle has been constructed and
that the second quarter is the closing of the candle especially as
economies are still facing several challenges. However, we can say that
the end of the year will definitely determine whether the closing is
far enough from the lowest point or not to overcome all the economic
tensions and instability witnessed recently.
Let's
move on to what we referred to earlier as the most important part of
the entire cycle and that is…the reversal. We first need the
confirmation for the completion of the pattern which may emerge during
the first quarter of the upcoming year according to several analysts
across the globe. The first quarter of 2010 will be a clear cut sign
indicating how well the global economy performed to crawl out of the
recession.
In
order to determine the targets for the global economy, there is still
one factor that we need to take into consideration. Despite the recent
developments in most of the sectors during the second quarter, the only
sector that continues to weigh upon the economies is the labor sectors.
The labor market can be seen as the largest prey for the crisis as it
continued to deteriorate alongside the waning demand and frozen credit
markets that resulted in massive losses for many companies, whether
financial or not, and forced them to cut back on expenses by firing
employees.
Such
lay offs took unemployment rates to the highest levels across the globe
where in the US, companies continued to fire workers for 19 straight
months taking the unemployment level to 9.7% marking the highest in 26
years which may possibly reach 10% by the end of the year. In the UK,
unemployment hit 7.8% in June while reaching 9.5% in the Euro Zone and
5.7% in Japan, marking the highest in six years.
The
spike in unemployment rates and the loss of jobs to people crippled the
ability to spend in the economy as income was now limited for
households where consumer spending in the US accounts for 2/3 the
economy and more than half of the economy in Japan. This alone is
enough to highlight the importance of this factor in supporting
economic growth.
Therefore,
if we were to determine where the global economy is to go in the
process of recovery, we need to first pinpoint the expected recovery to
be witnessed in the labor market in general and to what extend will all
the stimulus plans set by governments be able to support consumer
spending so that companies can stand back up on their feet and start
hiring once more. All this depends on the stability of the financial
system and markets in the different nations to encourage businesses and
individuals to invest once again.
There
are two theories for recovery which we should discuss as debates across
the globe have split opinions into two. Some believe that the economy
is to recovery in a (V) shape which supports our outlook on what the
hammer is to do; while others believe that it will take the shape of a
(W) which then may contradict what we expect. Either or, we will
explain both theories to you dear reader, and the choice is yours to
pick…
Concerning
the first theory in which recovery will follow the shape of the letter
(V), this theory depended on trusting the measures taken by governments
and policy makers in the world to support economic growth. Governments
pumped $2.2 trillion in the markets to provide liquidity and ease the
credit market freeze as well as support sectors that needed aid.
Analysts see that these measures alone are enough to put the global
economy back on track disregarding the time factor.
Those
supporting this theory also believe that a lesson has been taught to
policy makers and governments as they implement regulations to monitor
company performances and alter certain developments in the financial
markets in addition to the financial regulatory body in the great
economic powers such as central banks will have a bigger role in
implementing these regulations on financial markets in order to avoid
falling in the same mistake.
Moving
on to the second theory which supporters believe the economy is to take
the form of a (W), they believe that the current improvement in the
economic situation is only temporary and that the global economy is to
deteriorate once again to near the bottom before rebounding and
recovering at a quicker pace.
This
theory shows that reviving from the current recession will take some
time as they believe the negative effect in the long run for all the
liquidity pumped in to the markets will result in higher inflation and
hurt a country's budget.
Do note
dear reader that in order to provide such amounts of liquidity in the
markets, policy makers had to engage in desperate and unorthodox
measures like quantitative easing which depending on buying long term
government debt to provide the government with the liquidity needed to
fund the stimulus plans. In other words, governments printed more money
and issued more treasury bills to cover the excess notes.
The
nation's budget will then carry the burden of such actions which pushed
many analysts to expect another period of sluggish growth and economic
deterioration that may drag currencies lower and affect inflation
rates. And that is what is known as the (W) recovery.
We will
leave it up to you dear reader to choose what best describes the
current developments in the global economy; yet we still have important
questions to address. Do you believe that the time has come to witness
a recovery in the global economy? Or are the negative effects from the
credit crisis still clouding us?
And if
the economic recovery could hope to escape from the clutches of the
crisis; do you think that will take long? Or will the repercussions of
the global crisis be back into effect and take the globe into a deep
economic downturn?

At the
end, don't you think with me that, the global economy is in definite
need for a hammer in order to make sure that the crisis is over and the
market has already placed a real bottom? Or the bears will control the
next movements, resulting in a long period of uncertainty?
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