Using Candlesticks with Indexes
Candlestick signals work just as well with indexes as they do with individual stocks. The psychology inherent in the formation of the candles does not change when applied to market or sector indices. Index movements also follow the same technical analysis parameters and are subject to the same probability theory. Given a candlestick buy signal in an oversold condition for an index, the probabilities are extremely high that the corresponding downtrend will reverse. The probabilities increase even more if the signal occurs at an important technical price level like the 50 sma or 200 sma. Traders can apply any technical parameter they are comfortable using, to corroborate the candlestick signal.
The following chart shows the biotech index $BTK. One can observe how the 50 sma and the 200 sma have been a dominant factor in the chart. The 200 sma supported the index back in March. The bulls finally took off with a Bullish Harami and the index eventually rallied over a 100 points. Now, the index is again testing the moving average after failing the 50 sma. We notice a Morning Star signal forming with stochastics in oversold conditions. What can one analyze from this scenario? The analysis should be that the bulls have taken over the trend. Logical target would be a test of the 50 sma again. Depending on what signal formation is witnessed at that technical level, further analysis should be conducted.
Another way to play this scenario would be to look at individual stock charts of companies forming the index. With the index chart showing trend reversal possibility, it is highly probable that individual charts of those companies in the index would look bullish too. They might offer more percentage gain possibility than the index itself.
Remember, we are still dealing with probabilities. If the bears can close the index below the 200 sma, it would be prudent to look for charts with bearish candlestick signals as the index could then test the recent lows again.
Chart courtesy stockcharts.com