Markets tend to move sideways most of the time
Most of the time markets are not in a trending mode but rather moving sideways. On such occasions, the market is in a relative state of harmony; neither the bulls nor the bears are in charge. Markets are estimated to be in a non-trending mode as much as 70% of the time. In such environments, the technical analysis tools to use are called upthrusts and springs.
Upthrusts and Springs form trading opportunities in a sideways market
According to Japanese Technical Analysis, the markets are in a state of “wa“, meaning they will trade in a quiet, horizontal range. However, sometimes the bears or bulls may assault a prior high or low level. And these constitute the moments when trading opportunities can arise. More specific, if there is a sudden breakout from either a support or resistance level, this can introduce an attractive trading opportunity; there could be a strong probability there will be a return to the opposite side of the congestion band.
There is an unsustained penetration of resistance in the first example below. Prices then return back under the old highs which had been pierced. In such case, one could short and place a stop above the new high. The price objective would be a retest of the lower end of the congestion band. This kind of false upside breakout is called an upthrust. If an upthrust is joined by a bearish candlestick indicator, it is an appealing opportunity to short.
The opposite of an upthrust is the spring. Springs form when prices pierce a prior low. Then prices move back above the broken support area (see example above). This means new lows could not hold. One should buy if prices push back above the old lows. The price objective would be for a retest of the congestion zone’s upper band. The stops should be placed under the lows made on the day of the spring.
Combining Upthrusts and Springs with Japanese candlesticks make strong trading signals
A good example of upthrusts with Japanese candlesticks is shown in the example below. Day A marked the high of a move and a resistance level (note the hanging-man line the prior day warning of the end of the uptrend). The dual lows at Lx and L2 marked the lower end of the trading band.
There was an upthrust on day B. That is, the prior high at point A was breached, but the new high did not sustain. The failure of the bulls to hold the new high at point B was a bearish signal. Another negative indication was that day B also had a shooting star. Sometimes shooting stars are part of an upthrust, and as such, they form a powerful incentive to sell. As if a bearish upthrust and a shooting star were not clear enough trading signals, the day after B a hanging man appeared.
Example of Upthrust with Japanese Candlesticks
The next example shows that the early January lows were perforated in late February. This failure to hold the lows meant that this was a bullish spring. And the day of the spring was also a hammer. This combination of bullish signals gave plenty of warnings to the technical analyst to foresee a return move to the upper end of the January/February band near $78. Noteworthy, the rally stopped in mid-March near $78 with an evening doji star formation.
Example of Spring with Japanese Candlesticks
The Change of Polarity Principle
Old support becomes new resistance; old resistance becomes support. This is named the change of polarity principle.
Support Converting to Resistance
Resistance Converting to Support
The strength of this change of polarity is proportional to:
- the number of times the old support/resistance levels have been tested; and
- the volume and/or open interest on each test
The following example displays how the lows from late 1987 and mid-1988 became an important resistance zone for all of 1989.
Example of Change of Polarity
The Change of Polarity Principle is based on trading psychology
The reason why the change of polarity principle is so successful is that it is based on solid trading psychology. What are the principles? This is due to how people react when the market goes against their position or when they believe they may miss a market move. On any chart, the price at which you entered the HitBTC market is the most important price. People become emotionally committed to the price at which they bought or sold. As a consequence, the more trading that transpires at a certain price area, the more people are emotionally attached to that level.
Candlestick indicators assist in determining the switch between support and resistance
As illustrated in the next example (showing how support becomes resistance), those who decided not to liquidate their losing long positions on the minor rallies in early March had to go through the pain of watching the market fall to $5. So at the next rally, in early April (Area E), they chose to exit.
The reverse rationale is the reason why resistance becomes support so often. The simplicity of this rule really works, especially when combined with candlestick indicators. Have a closer look at area E, where the doji after a tall white real body meant trouble. This Japanese candlestick signal coincided with the resistance line. At Area F the same scenario manifests.
Example of Change of Polarity – Support Becomes Resistance
In our next article, we will continue our course on the combination of multiple technical techniques. We will provide more information on Japanese candlesticks with Moving Averages, with Oscillators, and more.
Source: Japanese Candlestick Charting Techniques (by Steve Nison)