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Deliberation Pattern in S&P 500

Candlestick charts can offer a unique perspective for charting market direction and sentiment. Developed in Japan, these charts represent price action with a figure that looks like a candle. That is, the price depiction has a body and one or two wicks. The body of a candle can either be open or closed representing either a higher or lower close for the specified time period, respectively. Open candles are represented with a light color and closed candles are displayed with a darker color. The extremes of the body represent the open and the close which can sometimes coincide with the high or low for the time period being analyzed. In such a case, there would be no wick, or straight line extension, from the candlestick. Otherwise, the wicks represent the high or low for the specified time period.

Candlestick charting offers an easy way to quickly assess the market trend. Thomas Bulkowski identified one particular pattern that can be used to identify a possible end of a trend and reversal underway which he refers to as “Deliberation.”

The Deliberation candle pattern begins in an uptrend where the bulls are in control. It can be identified by spotting “three white candlesticks in an upward price trend. The first two are tall bodied candles but the third has a small body that opens near the second day’s close” (The Encyclopedia of Candlestick Charts, Bulkowski). This buying pressure will force each candle to open higher than the previous one. However, the small body candle on the third day indicates confusion and indecision over direction. This can potentially lead to a loss of bullish momentum from the prior two days.

The theoretical implication for Deliberation is a bearish reversal. However, it actually led to bullish continuation 77% of the time during a bull market and 75% of the time during a bear market.  Since the series of lower highs and lower lows began in late 2015, the major market indexes are indicating a bearish tone for the markets currently which would still suggest a high chance of price continuation after the pattern completes. Should price move higher after this Deliberation, bullish continuation will be confirmed after the price closes above the pattern’s high.

Looking at the current formation in the S&P 500 (SPX) there are two white bars in an uptrend that culminate with a small-bodied white bar. Note how this Deliberation completed in the top third of SPX price action over the past year. Bulkowski mentions that “Deliberations within a third of yearly high act as continuations most often” (The Encyclopedia of Candlestick Charts, Bulkowski, 198). Additionally his research finds that tall candles perform best. The current pattern in SPX qualifies as having tall candles given the relatively large daily range of its recent price action.


For the moment, SPX stopped its uptrend from the February 2016 lows at 2055 which is a noticeable level of resistance dating back to support from 2015. Traders should monitor any further pullback in SPX while also watching for a price move above 2055. Based on Bulkowski’s research, after a likely pullback we could see price advance higher (i.e. a bullish continuation) by +6% on average. He notes that traders should trade with the existing trend when using the Deliberation pattern. A long position could be initiated once SPX closes above 2055, the high from the Deliberation pattern with a stop being placed at the last pivot around 2010.

As always, please feel free to contact me with any comments or questions. Thanks for reading.


John

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