The guy in the picture is not Japanese, but he is bald and boy; his eyes are intense!
He is Brett Sayles and you can check out his portfolio here.
With the first week of 2019 done, I hope all of you have started attacking your New Year resolutions.
In the last post, I had introduced the different types of charts that you and I can use for technical trading. We had also established that Candlesticks are the most insightful of the lot.
Today, we will look at one of the most basic candle formations along with the psychology behind it, which is what fascinates me the most.
I cannot reiterate enough on how the stock market is a tug of war between buyers and sellers commonly represented as bulls and bears. The various candlestick formations we are going to discuss now and in future are outcomes of this tug of war.
Please note that these patterns are called some name or other. In today’s case, it is Marubozu, meaning a bald man in Japanese!
However, the fact is that you can call it anything under the sky!
IT DOESN’T MATTER!
What matters is the science
behind the formations!
MARUBOZU – An Introduction
A Marubozu is probably one of the most potent and simplistic candles around! There are two versions to it – bullish and bearish.
Assuming, India represents bulls and USA represents bears, we will discuss using two different sports – Cricket and American Football.
In a Bullish Scenario!
They are playing a game of cricket. Odds are drastically tilted in India’s favor. Indians scored 600 runs and bowl out the USA for a 100 and won by 500 runs.
No inch conceded! An absolute pasting! That is basically what a Bullish Marubozu is. Below is an image of the same:
Notice how the candle opened at 100 and never went below that?
Similarly closed at a top of 600! Moreover, there are no shadows on either side? Bulls have shredded bears down, and the market is in general, optimistic and positive.
In a Bearish Scenario
Indian and American teams still represent the bulls and bears, respectively. The only difference is that they are now playing a game of American Football.
Here, the odds are drastically in favor of the USA.
They would probably win 73-0, which is the most substantial goal difference in the history of the game.
Bearish Marubozu works on the same principle.
Below is an image that illustrates the same:
In this case, the candle opened at 600, which was the high of the day and kept falling till it closed at 100, which was also low for the day. It signifies that the market opened with a high amount of pessimism and fear, which carried throughout the day.
Some things to be kept in mind!
There are three significant pointers to be kept in mind while reading a chart for a Marubozu.
A Marubozu or any other pattern or indicator is never a 100% confirmation. Essentially, it means that a Marubozu has to work with surrounding candles and indicators and never without an apparent entry and exit to manage your risk.
Definitions of a bullish and bearish Marubozu, as mentioned above, are applicable in an ideal scenario. In reality, it may not always pan out with a 100% match to the definition.
For instance, imagine the candle you are using is a weekly or a monthly candle. It is highly unlikely that a stock will keep going up or down through and through the entire five days. Reason being pullbacks, discussed in here!
While browsing through the NIFTY50 chart with daily candles, there wasn’t a single candle in the recent past, which formed a perfect Marubozu.
Hence, it is ok to consider candles with a small shadow as Marubozu, provided the supporting elements like volume, surrounding candles, or other indicators endorse the direction of the candle.
Again, this is not a rule-based black and white subject. It is all about how you interpret what you see!
A Bullish Marubozu is especially potent in two cases:
- If it presents itself in an uptrend, it is most likely that the uptrend will continue
- If it presents itself in a downtrend, it is most likely that the trend will reverse itself
Similarly, a Bearish Marubozu is potent in:
- If it presents itself in a downtrend, it is expected that the trend will continue
- If it presents itself in an uptrend, it is most likely that the trend will reverse
Below are a couple of examples of successful Marubozu’s from Nifty50
Please note that I have used daily candles in the below charts:
In the given figure, you can see that a couple of Bullish Marubozu’s was formed on consecutive days, highlighted using the red ellipse. The first one also came up with an increase in volume, providing further confirmation.
My observation is that there are two possible trades in this setup.
First one is for someone with a bit of risk appetite, Bullish Marubozu with volume increase can give a buy signal.
The risk is in the fact that we are not waiting for the following candle to reconfirm the direction of the move.
Entry for the trade can at the opening price of the next candle, which is point C in the diagram at 8200 points. Stop Loss can be between point D and E, which amounts to the total risk of approximately 100 Points. Profit is between C and B, amounting to a maximum of 433 (8633-8200) points before the trend starts reversing.
In this case, there was a possible ‘upswing’ of approximately four times the risk. It means that for every INR 1 risked by an investor, there was a maximum opportunity of taking INR 4 out as profit.
The second one is for someone with lesser risk appetite, completion of the following candle also triggered a trade signal.
Entry can be at Point A, which is the closing price of the second Marubozu at 8331. The stop loss can be at point C, which is 8200, making the total loss per share in case of a wrong reading 131 points.
There was an upswing of a total of 302 points, which is approximately 2.3 times the risk. Though it is not as good as the first scenario, it is still a decent number to target.
In the case of a bearish market, what one does is something called ‘Short Selling.’ Imagine you realize that a particular script is in free fall from INR 100. Short selling gives the trader an option to sell the specific script at INR 90, and repurchase it at let us say INR 60, through which the trader makes INR 30 profit.
In the Indian Equity market, this is possible only in an intraday trade, which is not in our scope at this point predominantly due to the risk and time demand involved in it. That said below is a chart that showcases a Bearish Marubozu.
In the above situation, a healthy Bearish Marubozu is formed in a weak uptrend.
How can I conclude that?
Well, look at the sizes of the preceding candles and compare it with the Marubozu (encircled). It is much bigger, suggesting a change in sentiments.
Though you can see a small shadow on the Marubozu, it is almost nonexistent when compared to the body itself.
It closes at Point C, which is at 10427 points, which can also act as a stop loss for someone who enters the stock market on the next day.
Total risk if one keeps a stop loss at A would be around 134 points. Total downswing was between points A and B, providing a total possible profit of 287 points.
Like I mentioned earlier, this scenario is relevant for stocks (and for us) only if short selling was possible in a positional trade. So, for an aspiring swing trader like me, a Bullish Marubozu has more meaning than the other.
A Marubozu isn’t the ‘Holy Grail’ of stock trading. It is just another means of evaluating your hypothesis of the market.
In fact, while analyzing NIFTY50 for the above charts, I found more failed Marubozu’s than the successful ones!
So enjoy it when it pops up but don’t get consumed by it. You can never be too confident of any strategy or tool or indicator.
That is what makes technical analysis a delightful subject to learn! Everyone has access to all the tools, patterns, formations, and indicators. The critical factor is the ‘how’ behind its use!
“Don’t blame the pen if your handwriting is bad. Work on your handwriting until the pen doesn’t matter!”
In my chats with people on my interest in trading over the past few months, one of the most common statements I have come across is that “Trading is just gambling”!
Well, I disagree and my next post will dwell on my reasons for the disagreement.
Until Then, Cheers,
N.B – Below are the resources I referred to for this post:
- “How to Make Money Trading with Candle Charts” by Balkrishna Sadekar, is a book I will be referring to a lot when discussing Candlestick charts and patterns.
- This and this are two very detailed links with good visual representations.
- Charts are as usual from www.investing.com