Candlesticks as Weapons of Defense
A gracious hostess will decorate her dining table with finery, the best in the house. If she is fortunate enough to have good chinaware and sterling silver tableware, they will be set in place for her guests. There will be candles, of course; and the candle holders may well be of silver. Even the candles themselves may be of silver.
How docile, sumptuous, and elegant the scene: it could be straight out of a 1930’s Hollywood movie. Perhaps the candlesticks are the ultimate expression of refinement.
Have you ever heard of Japanese Candlesticks? You can’t put them on your dining room table, because they exist only on paper or on your computer screen. They’re a method of displaying stock prices which was invented centuries ago by a Japanese rice trader, who found them to be very useful in revealing the trading psychology of his competitors, thereby giving him an advantage. The use of the Candlesticks carries over today to trading in all financial markets, and their particular ability to forecast major reversals of price trend is becoming more generally recognized and appreciated. They are especially powerful when used in combination with the so-called “Western” indicators to which investors and traders have become accustomed.
The Candlesticks can serve as weapons of financial defense when they are used in combination with the indicators and also with Inverse Mutual Funds and Inverse Exchange-Traded Funds. Many investors are fixated on the idea that money can be made in the stock market only when prices rise. Brokers’ mindsets, in particular, are geared to that concept. Nothing could be further from the truth.
Inverse funds enjoy wide acceptance and are traded in large volume. The basic premise which underlies them is that they gain in value when the stock market declines. A direct-ratio inverse fund which is tied to the S&P 500 Index, for example, will seek to gain one dollar in value for every dollar of decline in the S&P 500. A “geared,” or “leveraged,” fund of the same type will seek to gain two dollars in value for every dollar of decline in the S&P 500.
I would like to show you these two concepts, but apparently it overburdens the system so that I’m not able to demonstrate it with a chart. Text will have to do.
A pretty fair “Evening Star” Japanese Candlestick pattern arose in the NASDAQ 100 about the middle of August. The Evening Star is a bearish reversal pattern. This formation is identified by a tall (relatively, in this case) white candle, followed by a smaller candle, and then by a tall black candle. The bearish implications of the Evening Star were fulfilled: prices have declined almost without interruption since the pattern formed. If investors who were riding a substantial price rise had heeded that Evening Star warning back in the middle of August and shorted the Index in some way, they would have been able to defend their existing portfolio position or, perhaps even better, they would have reversed course and become positively Short the Index.
The second lesson that I would like to draw has to do with a very tall black candle which represents price action yesterday, September 29, which was the day of the large falloff after the bailout bill failed to pass in the House of Representatives. Prices in the NASDAQ 100 fell 176 points yesterday, a 10.5% decline in one day. However, the share value of the Rydex Inverse NASDAQ 100 Fund rose 9.10% yesterday! (I have no connection with Rydex).
That’s not an exact correlation, to be sure. The differential may be partly due to the present restriction on short sales.
Even so, had an investor bought shares in the Rydex Inverse NASDAQ 100 Fund last Friday, September 26, as of market closing yesterday he or she would have substantially neutralized a loss of his or her own yesterday in the NASDAQ 100 Index, and indirectly in its components. That’s a defensive weapon at work!
Had he or she been invested in the NASDAQ 100 before the close of trading on Friday, he or she could have used the Rydex Inverse NASDAQ 100 Fund as an offensive weapon to garner absolute profits.
The moral of the story is that a knowledgeable investor will combine available tools into a powerful trading approach: the Japanese Candlesticks to identify trend reversals as they are happening or about to appear; the Indicators to enhance the accuracy of the Candles; and Inverse Funds in recognition of the fact that portfolio defense – and profit for profit’s sake - are readily available through the use of Inverse Funds.
William Kurtz September 30, 2008 http://www.candlewave.com
