Tuesday, January 24, 2012

More on Spirit

No, this is not another of my now famous rants against the airlines and Spirit Air an particular. No, this is about the spirit of the analysis of charts. You can check out an old blog post on this topic here. This is how it began:

I often look at charts with my right brain to try to understand what they are really telling us. This is different from the left brain approach we all take as we mark up the price action with circles and arrows and a paragraph on the back of each one explaining what each one was (Alice's Restaurant fans, anyone?). Seriously, we look at a handful of indicators, draw trendlines as if they really mean something and then come to logical conclusions about the odds of the market going this way or that.

It's good to see I was a song lyric fanatic back in 2009. But here is something I wrote this morning in Quick Takes Pro (when are you going to take your free trial?) 

Q - How complete does the closing of the gap (or the window) need to be? Especially when the "stem(s)" (for lack of a better word) appear close to closing the gap, but the rectangular boxes (candlesticks) are separated?

A - First, we have to reiterate that we see no reason why any gap or window needs to be closed before a trend can progress. How else can breakaway and continuation gaps be explained? But that was not the question.

If you are a stickler, then gaps/windows are not closed - period - unless they are closed completely. Bar charts measure it with highs and lows but candles have more leeway. Some patterns require shadows (wicks, stems) to overlap or not overlap, depending on the pattern. Others ignore shadows and only deal with real bodies (the fat part of the candle).

Our view is that we need to respect the spirit of any pattern and not worry too much about the letter of the law, so to speak. Opens and closes on doji candles need not be exactly the same. Island gaps reversals (abandoned babies) need not have actual gaps. Why? Because 24-hour trading, decimalization, derivatives, etc… have changed the landscape and what constitutes an open and a close is now a very fuzzy proposition.

The financial markets are radically different than they were last century, last decade and even last year. The spirit of the tools still works because humans do the same old dumb (and occasionally) smart things over and over. It is the actual rules of the analysis that are questionable so keep it simple and you should be fine.

No comments: