Saturday, January 30, 2010

Trend Changer: Has Nifty Hammered A Near-term Bottom?

Firstly, to inform the readers over here that this post and the discussion of the chart pattern herein pertains only to the 'Near term' trend of the market. The Candle stick chart pattern as depicted in the below attached chart relates to a 'Trend Reversal' Pattern which could signify either a reversal in the prevailing down trend or simply a trend bottom/changer.

Nifty has been in a short-term down trend after witnessing stiff Resistance around 5280 level. The 5 day short term RSI has climbed down from 70 to 15 during the downward journey of markets, yet another hint of market in over-sold zone in near term horizon.

Charts Courtesy:

Hammering Out A Bottom defines a Hammer as, "A price pattern in candlestick charting that occurs when a security trades significantly lower than its opening, but rallies later in the day to close either above or close to its opening price. This pattern forms a hammer-shaped candlestick."

It further adds, "A hammer occurs after a security has been declining, possibly suggesting the market is attempting to determine a bottom.The signal does not mean bullish investors have taken full control of a security, it simply indicates that the bulls are strengthening."

A Hammer is a Bottom Reversal Pattern. The rationale behind the analysis and logic of this pattern formulation is explained as under:

1) The market is in a pronounced downtrend.
2) A candle stick with small real body but a large lower shadow appears at the end of the downtrend indicating some sort of reversal in prevailing downtrend.
3) The bulls took charge of the situation after bears tested the lower waters but could not sustain/hold their short positions with conviction.
4) Taking note of the situation, the bulls took the lead from the front and closed near the day's high with little or no shadow at all.
5) The primary idea from here is that further downward slide could come for a halt atleast for very near term & at best- a trend reversal towards up side could be seen.
6) In very near term, bears can recoup the control over markets only if the lows tested on the hammer forming day is breached.

The pattern is typically characterized by a long lower shadow with a small real body on the top. The color of the real body (white or red) is not of greater significance while studying the pattern. However, a white body gets a first preference as it signifies that markets sold off as a last leg of the near term down trend and bulls were good enough to bounce back to ensure that markets closed near to the highs of the session. The waters at the lower levels were tested and found good enough for a reversal. The pattern signifies that bulls are eager to gain some lost ground in days to come.

Another study that goes into the Hammer pattern is that the lower shadow should be at least twice the size of the small real body on the top. It signifies that bulls attempted a significant come back from the lows to prove it's dominance. However, even without the fulfillment of above condition a Hammer is a hammer, but its effectiveness could be questionable and uncertain. A smaller real body coupled with longer lower shadow will give the hammer a more complete look and meaning. After all, the chart patterns are nothing but the mirror image of a trader/investor's psychology and their collective action put on paper.

Further, it is desirable for traders who want to bet on this reversal chart pattern to confirm the effectiveness of this bullish hammer pattern by checking the follow-up chart signals (of next 2-3 sessions) in look-out for bullish White Candles or even bullish Continuation patterns.

Nifty & Hammer

On January 29, 2009, Nifty established a low at 4765 and from there on bounced back to close at 4880, a little above the day's opening at 4825. This led to emergence of a small real body with a long lower shadow and a very minute upper shadow. Add to it, on the preceding day of witnessing the hammer pattern, the Nifty witnessed a 'Doji' day which is also a trend reversal signal indicating an equal tug-of-war between the bulls and the bears. A Doji followed by a Hammer could be hinting towards a dissipation of prior (short term down trend) trend's force possibly with a last attempt to test lower waters on a Hammering day. Hence, a doji followed by a hammer pattern is a stronger clue of trend change, in direction of the original bullish trend.

Further, if Nifty closes below the low hammered by Nifty at 4765 on January 29, the analysis and prediction of the bullish reversal pattern can be termed as failed/void and could act as a significant stop loss level for Traders.

Note: Quite often, it may also happen that the reversal patterns may play out well in the near term, but the effectiveness of the trend fizzles out eventually over medium term horizon. So, it is necessary to check and update the view in light of changing market times and environment periodically. Like, for example, a bullish reversal pattern in 'Hammer' ensures that markets move up. But, over a period of time, markets may develop yet another reversal pattern but this time in bearish bias in form of a 'Hanging-Man' pattern which signifies a Top, eventually pulling the markets down. So, it is necessary to review chart patterns in the light of passage of time and development of various chart patterns.

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