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Hanging on for gains

First of all, I can well understand why some of you may be nervous right now. As Christopher points out, the FTSE has again reached the 6870 region, where it has twice topped and then plunged over the last nine months. It is only natural to wonder whether it will be third time unlucky. "I am taking the necessary precautions," he writes.

FTSE's critical level


Neil, meanwhile, is unsettled by the appearance of a 'hanging man' Japanese candlestick pattern on the FTSE's daily chart. A hanging man warns of a reversal of an uptrend. It is a result of a market opening near its highs for the day, dropping sharply during the session, and then recovering to close near its opening level, whether above or below it.

FTSE's hanging man


I do not personally look very much at candlestick patterns. But I have no objection to them, so long as they are picked out objectively, that is, according to rules and preferably by a computer. This is exactly what Neil has done, using ShareScope’s candlestick pattern-finding tool.

"The 'Hanging Man' has been pretty successful at indicating a downturn in the last eight years," he writes. "Prior to that, all the way back to 1984, there was only one other such signal which failed, in 2005."

Hanging men past

Using the same package, I count five previous occurrences of the hanging man going back to 2000. As far as I know, one cannot go back before this on ShareScope, as it only contains daily closing prices between 1984 and mid-2000. To calculate daily candlesticks, one also needs the day’s open, high and low prices.

Two of these five FTSE hanging men (January 2009 and April 2010) led to bear-market drops of more than 20 per cent. Another two (February 2007 and January 2010) led to sharp pullbacks of 7 and 11 per cent respectively. On none of these occasions did the market rally more than 1.6 per cent after the signal before starting its decline.


Nikkei rally choked

I would certainly acknowledge that these results are impressive. And the hanging man has also worked outside of the FTSE 100. It foretold the Nikkei 225 and S&P 500's recent sell-offs nicely, and also helped spot two decent corrections in the DAX in the last decade. By contrast, it has been hit-and-miss in the Dow Transports and the Nasdaq 100.


Botched hangings in Nasdaq

As persuasive as the evidence may seem for the FTSE, the very limited sample makes me cautious. The record in some other markets is even scantier. For a 14-year period, ShareScope identifies just two hanging men in the DAX, one in the Nikkei and none in the CAC 40 or Dow Industrials.


Mid-cap hanging man

For the record, the FTSE 250 - about which I am even more bullish than the FTSE 100 - has also given one of these signals lately. I don't rule out a decline in either index in the near future. But I certainly won't be bailing out of the rally on the strength of this pattern, either. And, if we do get a dip, I think it will be a buying opportunity, and probably sooner rather than later.