Mailbag: Candle Colors, Inverted Yield Curve, and the Best Indicator Combo
(Posted 09 August 2000)
Q: On my pc when I view a candlestick chart, I notice that some candles on a down day ( close lower than the open ) are shaded in black. My normal color default for down days is red. Does the black candlestick represent something else ? Thank you.
A: Take two! ;-) Traditionally, candlesticks have not been different colors. If the close was less than the open, you get a filled candlestick and if the close was higher than the open, you get a hollow (white) candlestick. You can see this by turning off the "Colored Prices" option in our SharpCharts tool.
Coloring candlesticks is actually more complicated than you might first think and there are several places where people can get confused. One thing that can confuse people is that there is no such thing as a white candlestick - it is hollow, not white. That means that if you are viewing a candlestick chart with volume bars behind it (the default for SharpCharts), you may see a colored volume bar showing through a hollow candle. If you find that confusing, select "Separate" from the "Volume" dropdown just below the chart.
The next thing to keep in mind is that when the market is open, we add another candlestick on the right side of the chart based on the current intraday quote. Because that candle is still in the process of developing, we draw it on top of a yellow background. The yellow background will disappear when the final closing prices are recorded.
Finally, if you do enable the "Colored Prices" option for a SharpChart, here are the rules that we use:
Notice that these rules are subtly different from the rules for determining whether to draw a filled candlestick or a hollow candlestick. Those rules (stated in the first paragraph above) rely on the relationship of the opening price for the current day to the closing price of the current day. These subtle differences can lead to what I call "oxymoronic" candlesticks -- candles that are colored bullishly, but filled bearishly (i.e., a filled, black candle) or vice versa (i.e., a hollow red candle).
For example, in the GE chart above, notice that filled, black candlesticks appear at several important peaks on the chart. They happened because GE opened significantly higher than the previous day's close ("gapped up"), fell during the day, yet managed to still close above the previous day's close. Less obviously, on May 23rd, a hollow red candle appears because GE gapped down on the open, rose during the day, but didn't close above the closing price for May 22nd.
Q: I've read most of the articles on your education center. Really, I really enjoy those articles and I learn a lot! Well, after reading them, I have a question. When we analyze a stock, what is the best combination of indicators we can use?
A: The combination depends on a lot of things: time horizon, risk tolerance, expected return, etc.... I would recommend starting with a momentum oscillator (MACD, PPO), an overbought/oversold oscillator (RSI, Stochastics), and a volume indicator (Chaikin Money Flow, OBV). These should be combined with proper money management and other aspects of technical analysis (patterns, trendlines, support and resistance) to provide a well rounded approach.
Q: Is the recent rise in the short-term bond rates causing the yield curve to become completely inverted a cause for concern or is the inversion in the long-term rates the only thing to watch? Also, does the retirement of bonds by the Treasury have any impact on the behavior of the rates (like driving prices up, thus interest rates down)?
A: The complete inversion of the yield curve is certainly a cause for concern, because historically, inverted yield curves have occurred prior to economic recessions, and recessions are often not positive for the stock market. I discussed this yield curve inversion more thoroughly in my weekly column of 26 May 2000.
The retirement of US Treasury Bonds certainly does have an impact on the behavior of rates, just as you describe. This is one reason why I am uncertain as to how valid the inverted yield curve is at this time. In other words, is the yield curve inverted because rates on the long end are being pushed down due to the retirement of the long bonds, or is the yield curve inverted because the Fed is trying to slow down the economy? My guess is that it is a combination of the two. The question now is whether the Fed's actions will be too strong and push the economy into a recession, or will there be a soft landing. Although most pundits will argue that there has never been a soft landing, I would argue that there have been many soft landings, and I am anticipating that we are experiencing just such a soft landing right now.