This morning’s upside confirmation to Friday’s intraday reversal is a promising start for bulls, but just a start indeed. Further improvements in breadth and price action are required in the next week or two, as well. Nonetheless, unlike previous times in this correction since September, the hammers are not proving to be bull traps, at least initially.
Here is the technical discussion (in just one portion of a sub-section, to give you an idea of how comprehensive of a service it is) I wrote up for chessNwine Weekly Strategy Session subscribers this weekend:
After printing fresh correction lows on the major indices, Friday’s intraday upside reversal created quite a few “hammer” candles on a vast array or major index, sector, and daily stock charts. To be clear, we have been here before with potentially bottoming candles and failed to see upside follow-through during this correction. It is not uncommon to see several false signals of potential bottoms during the course of a correction. As such, concepts such as position sizing, stop-loss management, and resisting the urge to add to losing positions all keep swing traders’ capital bases from sustaining fatal wounds.
Regarding the actual technicals of the hammer, in Japanese candlestick terminology a bullish hammer often signals a trend reversal. Above all else, the hammer (on a daily chart) shows that the price drops significantly from where it was at the opening bell, yet rallies back towards the end of the session up near the opening price level. Some key elements are: a prior bearish trend, little or no upper “wick” or shadow to the candle, and a relatively small “body” at the top end of the hammer. The psychology behind the hammer is that early on during the trading session it appears the bears are once again in clear control of the action, and the holdout bulls capitulate and sell their longs. Once the “weak hands” are out on the long side, the “strong hands” of patient bulls arrive and punish latecomer bears who are shorting too aggressively.
Of course, it is worth repeating that no one candlestick is the holy grail of technical analysis. In other words, upside confirmation is critical to advancing the reversal thesis here. Just because some prior potential bottoms have failed during this correction, though, does not mean that this hammer should be dismissed out of hand as a signal of an imminent reversal. In terms of what constitutes confirmation, in addition to upside strength generally speaking you are looking to see the bottom third-to-lower half of Friday’s price range not be probed for any noticeable amount of time next week. Even if the market does not immediately gap higher with broad participation early next week, the hammer thesis remains intact if bears are unable to come close to testing Friday’s lows.
To drive a point home, even a valid hammer bottom is characterized by far more wild, random price swings than the bread and butter of momentum swing traders–Buying stocks in sustained uptrends and riding them higher (or shorting stocks in established bear markets and riding them lower). As a result, confirmation of Friday’s hammer is likely not, at least initially on a stand-alone basis, a green light to go all-in long, but rather to methodically increase long exposure.