What did the Candlesticks say when Nasdaq peaked in March 2000 ?
Traders new to candlestick charting often ask this question at the first opportunity they have - Did candlesticks predict the dot-com bubble bursting in the Nasdaq index? Could one have known the index would lose around 80% of its value beginning March 2000?
The answer to the first question is a YES and to the second question is a NO.
Let us focus first on the question of predicting an uptrend reversal around March 2000. The following is a chart of the composite index beginning December 1999 through May 2000. As with our other charts we are using the 50 sma (blue line) and the 200 sma (red line) as points of interest. As one can notice, the index had two peaks in March. The first peak shows a Shooting Star candlestick signal. This should have alerted the candlestick trader to watch out. Not sell, but watch out. The selling confirmation came the next day with a gap down Doji. This was followed by a Bearish Engulfing signal. This should have definitely got traders out. The market is trying to tell you that the bulls are in trouble.
Let us say, you got out of the market at this point. What should be the thought process now? Remember, the uptrend is still the dominant factor. A strong uptrend, like the one the index was in, needs a massive change in investor sentiment. That was not yet witnessed. So you get in again after the Hammer or the Piercing signal on the 50 sma. What happens then? The index witnesses a Spinning Top right at the previous high. The indecision is resolved with more selling the following couple of days. At this point, it is clear the chart is showing a Double Top formation. Demand is overwhelmed by supply at around 5100. This was the time the candlestick trader would have gotten out.
Now the traders should be watching to see if the index supports again on the 50 sma, creating more buy opportunities in the uptrend. This time, however, the index broke the 50 sma. Clearly the strong bullish sentiment had reversed. What was the target at this point? The 200 sma. Good entry for short positions or buying puts.
Candlesticks depict the scenario as it is. The signals, which have been studied for centuries, have solid fundamental foundations beneath them. The human nature. That never changes. It will keep repeating until there exists Fear and Greed.
Now the second question of predicting the horrendous downfall of around 80% in the index. Candlesticks do not give price targets. Western technical indicators should be used in conjunction with candlestick to provide a highly probable target. Just like we described above the scenario where the 200 sma became a likely target, traders can come up with previous major lows, or gaps or Fibonnacci retracement levels as price targets. But the main use of candlesticks is to tell you what is the trend direction. Once you have the high probability trend direction, let the candles show you how long you have to be in that position. It is not that difficult once you practice and keep at it. It is repetitive and sometimes mechanical. But remember, knowledge is the key!
Chart courtesy stockcharts.com