Candlestick Charting Book

CANDLESTICK CHARTING FOR MAXIMUM PROFITS B.M. DAVIS COPYRIGHT © 2009 ALL RIGHTS RESERVED

1

EARNINGS DISCLAIMER EVERY EFFORT HAS BEEN MADE TO ACCURATELY REPRESENT THIS PRODUCT AND IT'S POTENTIAL. EVEN THOUGH THIS INDUSTRY IS ONE OF THE FEW WHERE ONE CAN WRITE THEIR OWN CHECK IN TERMS OF EARNINGS, THERE IS NO GUARANTEE THAT YOU WILL EARN ANY MONEY USING THE TECHNIQUES AND IDEAS IN THESE MATERIALS. EXAMPLES IN THESE MATERIALS ARE NOT TO BE INTERPRETED AS A PROMISE OR GUARANTEE OF EARNINGS. EARNING POTENTIAL IS ENTIRELY DEPENDENT ON THE PERSON USING OUR PRODUCT, THEIR IDEAS AND TECHNIQUES. WE DO NOT PURPORT THIS AS A "GET RICH SCHEME." ANY CLAIMS MADE OF ACTUAL EARNINGS OR EXAMPLES OF ACTUAL RESULTS ARE NOT TYPICAL. YOUR LEVEL OF SUCCESS IN ATTAINING THE RESULTS CLAIMED IN OUR MATERIALS DEPENDS ON THE TIME YOU DEVOTE TO THE PROGRAM, IDEAS AND TECHNIQUES MENTIONED, YOUR FINANCES, KNOWLEDGE AND VARIOUS SKILLS. SINCE THESE FACTORS DIFFER ACCORDING TO INDIVIDUALS, WE CANNOT GUARANTEE YOUR SUCCESS OR INCOME LEVEL. NOR ARE WE RESPONSIBLE FOR ANY OF YOUR ACTIONS. MATERIALS IN OUR PRODUCT AND OUR WEBSITE MAY CONTAIN INFORMATION THAT INCLUDES OR IS BASED UPON FORWARDLOOKING STATEMENTS WITHIN THE MEANING OF THE SECURITIES LITIGATION REFORM ACT OF 1995. FORWARD-LOOKING STATEMENTS GIVE OUR EXPECTATIONS OR FORECASTS OF FUTURE EVENTS. YOU CAN IDENTIFY THESE STATEMENTS BY THE FACT THAT THEY DO NOT RELATE STRICTLY TO HISTORICAL OR CURRENT FACTS. THEY USE WORDS SUCH AS "ANTICIPATE," "ESTIMATE," "EXPECT," "PROJECT," "INTEND," "PLAN," "BELIEVE," AND OTHER WORDS AND TERMS OF SIMILAR MEANING IN CONNECTION WITH A DESCRIPTION OF POTENTIAL EARNINGS OR FINANCIAL PERFORMANCE. ANY AND ALL FORWARD LOOKING STATEMENTS HERE OR ON ANY OF OUR SALES MATERIAL ARE INTENDED TO EXPRESS OUR OPINION OF EARNINGS POTENTIAL. MANY FACTORS WILL BE IMPORTANT IN DETERMINING YOUR ACTUAL RESULTS AND NO GUARANTEES ARE MADE THAT YOU WILL ACHIEVE RESULTS SIMILAR TO OURS OR ANYBODY ELSE'S, IN FACT NO GUARANTEES ARE MADE THAT YOU WILL ACHIEVE ANY RESULTS FROM OUR IDEAS AND TECHNIQUES IN OUR MATERIAL.

2

Candlestick Charting Candlestick charting was developed by Japanese rice traders over four centuries ago and could quite possibly be the oldest form of technical analysis. Since technical analysis is not only predicting probable price moves but also assessing market psychology, candlestick charting is probably the best tool to give the trader these answers in the shortest amount of time. Once a trader becomes familiar with candlestick charting, he or she can get a quick and highly visual signal because of the story candlesticks tell. Strict adherers to candlestick methodology take positions based on very short term patterns given by candlestick tradition. While candlestick charting is relatively unknown, and therefore unpracticed by the common investor, their use among active traders is growing. The greatest benefit candlestick charts provide the technical analyst is the ease of use and interpretation. The same price action, quickly seen using candlestick charts, may go unnoticed while scrolling through bar charts. While analysis of chart patterns takes experience and some practice, so too will candlesticks. However, after learning the basic signals, candlesticks can provide the novice trader a shorter learning curve and also shorten the learning curve to chart reading in general. I like using bar charts to find chart patterns, and then switch to candlesticks for a closer look. Candlestick charts are especially useful when analyzing areas of consolidation such as triangles and flags for signs of reversal or continuation. The major signals in candlestick theory are reversal signals. Some of these signals are considered so strong by serious candlestick practitioners; they will enter a trade based on its signal alone, without the need for conformation. Since our trading style is to confirm everything, we won’t act on the signal alone, although we will pay close attention. Our goal will be to teach you candlestick methods in their purest form, so we will alert you to the signals in which no conformation is said to be necessary. We will also break down each signal, expanding on its psychological implications on the chart. Our objective will be to not only educate you in the proper use of candlesticks, but also give plenty of examples of their improper use within a chart formation or pattern.

3

Figure 1 The chart symbols used in candlestick charts are fairly easy to understand. Candlestick charts get their name from the symbol used to represent the trading range in which you are charting (daily, weekly etc…), which are called candles. The candle has a wide area separating the open price from the closing price, which is called the body, Figure 1. On a trading day where the stocks price closed higher than its open, the candle will have an unfilled or clear body and on a day where the stock closes below the open price, the body will be filled (black in the example above). It’s important to keep in mind that a black candle does not necessarily mean the stock closed lower than the day before, just lower than the close. Conversely, a clear candle doesn’t necessarily mean the stock closed higher than the day before, just higher than the open. On some charting software the unfilled bodies may be changed to green and the filled bodies to red. Many charting software also allow the user to change the colors themselves depending on their preference. The color of the body is not as important as the contrast between the two different candle types. For the illustrations in this article, we will use the traditional black and white bodies. On most candles there will be a thin line extending from the top and bottom of the body. The line extending from the top of the body represents the distance from the open or close (depending on the candle) and the high price of the day. Conversely, the line extending from the bottom of the body represents the distance to the low price. These lines are called the wicks, along with a variety of other commonly used names, such as whiskers 4

or hairs. Since candlestick theory puts its emphasis on the relationship of the open price, as compared to the closing price, the wicks rarely carry any technical significance. However, there are a few candles and patterns you will want to pay close attention to not only the wick, but also to the length of the wick.

The Basic Candles To understand candlestick patterns, one first has to familiarize themselves with the basic candle types. In Figure 1, we saw a basic example of a black and white candle and most often these, or variations of the candles will be seen on the chart and will have no significant meaning whatsoever. These candles will be nothing more than random price movements without any clear signal for trading. However, there are some other variations of daily candles that you should familiarize yourself with before we go on to patterns. Some of these candles may carry important reversal implications when seen at the end of a long trend or at points of support and resistance. Many of these candles can give you an insight to the strength of a trend or a weakening trend. As we go through these candles we’ll explain the psychological implications of each and what may be happening as the buyers and sellers (Bulls and Bears) fight it out to move the price of a stock. Remember that all price movement is due to supply and demand. Try and visualize these candles as an indication of the daily battle between the Bulls and Bears so you can look at the larger picture of the price chart and assess who is winning the war. If you find yourself becoming confused between dark and light candle bodies, try to remember to look at each as if we were talking about the weather. A dark body has a stormy or bearish overtone and a clear body has a bright or bullish outlook. Enough analogies, lets move on to the candles.

The Doji The Doji is one of the most important signals in Candlestick analysis. A Doji has the appearance of a cross, with the opening price the same as the close. It signifies indecision in the market (Figure 2).

5

Figure 2 Other variations of the Doji are the Gravestone Doji and the Dragonfly Doji (Figure 3& 4). The Gravestone Doji shows price action that opens and closed at the bottom of its daily range, giving the bears a slight upper hand for the day and can be considered very bearish at a top. The Dragonfly Doji opens and closed at the top of its daily range and can be considered very bullish.

Figure 3 – Gravestone Doji

6

Figure 4 – Dragonfly Doji The psychology behind the Doji shows that buyers and sellers were even for the day, without one side or the other being able to get the upper hand to move the price of the stock. In an oversold market the Doji has very bullish implications and conversely, in an overbought market it has very bearish overtones. All Doji signals are enhanced by a long daily range, and overbought or oversold market conditions. Let’s look at a few charts and observe the Doji in different situations.

In September 2003 MSFT bottomed out with a formation that included two Dojis. Notice the second Doji formed at the end of the first consolidation of the uptrend, just before the 7

broke out and made its biggest gain of the new uptrend. Two months later, the uptrend ended with two more Dojis before gapping down into a new downtrend.

After a fairly good downtrend, NCR ended it with a bottom containing two Dojis. A Doji doesn’t have to be at the exact bottom, as in this chart to have reversal implications. Many times indecision shows itself a week or more before a bottom formation is complete.

Hammers The Hammer, which is similar to the Doji, is a single candle that represents a possible change in trend direction. Also similar to the Doji, the Hammer has a few different variations. A hammer has a long daily range compared to the difference between the closing and opening price. Unlike the Doji, The Hammer will have either a white or black body, with the white body being somewhat more bullish or a dark body being slightly more bearish. Below are two variations of the Hammer candle (Figures 5 & 6)

8

Figure 5 – Hammer

Figure 6 – Inverted Hammer

The significance of a Hammer is its long wick compared to its open and close. It depicts either buyers or sellers started the day off moving prices their desired direction. Once the price went up or down a significant amount, depending whether the initial pressure was selling or buying, the opposite side got the upper hand and were able to push prices the other direction showing the 9

pressure of the trend was lessoning. On the day of a hammer, the signal will be improved by higher volume and the length of the prior trend. A Hammer can have either bullish or bearish overtones depending were it forms. If the trend was an up trend, the length of the wick warns of selling pressure. Even though the bulls were able to push prices back to the top of the daily range, the fact that they had to tells us the trend may be weakening.

Figure 7 On the Dow chart in Figure 7 we can see an example of both a clear and dark bodied hammer at two different minor bottoms in an uptrend. Also we have an example of an inverted Hammer during the last week of October, 2003. At this minor bottom the wick of an inverted hammer shows us that buyers were starting to step in and with some strength. The clear body tells us that they were able to hold off the sellers and close the day above its close, even though a dark bodied inverted Hammer would still have been bullish in this position.

Long and Short Days Long days are simply candles with a long body that represents a large price move from open to close. Long days can be found in many places on a candlestick chart. To determine if a candle is a long day it has to be compared to the average daily move in the stock chart you are studying. Some stocks have a normal daily range of $2 – $4, while other stocks move much less. To determine if a candle is a long day it has to be compared with the average size of the other candles on the chart. A long day is most useful in determining the strength of a 10

move and confirming trend direction. Factors that enhance the signals of the long day would be small wicks and high trading volume for the day. Figure 8 & 9 illustrates an example of a long white candle and a long dark candle.

Figure 8

Figure 9 Figure 10 shows us three examples of long days, two bearish (dark body) and one bullish (clear body). Notice on each of the days illustrated the volume was higher than average. The two bearish long days would be considered confirmation of the established bearish down trend. Conversely, the clear bodied candle was a big confirmation of a new uptrend.

11

Figure 10

Short Days Short days can obviously be considered the exact opposite of the long day. Usually a short day is found in an area of price consolidation on the chart. Short days are typically days with little trading activity, which is sometimes useful in determining if a consolidation is setting up for a move. Consolidations are covered more in depth in the chart patterns section of the site. Briefly, when analyzing consolidation periods on a chart, we look for volume to taper off in a period of consolidation before a price move. We won’t spend much more time on this page discussing short days except the example in the chart below in Figure 11.

12

Figure 11

Spinning Tops

Figure 12 13

Spinning tops a re candles that have a small body compared to the size of the wicks. For a candle to be defined as a spinning top it must not only have long wicks, but must have wicks at both ends of the body. Spinning tops may or may not offer information depending on their place on a stock chart. In a market that is trending sideways a spinning top can usually be considered neutral. However, after a big move in price in either direction a spinning top can have the same reversal implications as the doji, especially if it is accompanied by a spike in volume or forms within a few days of a doji.

Figure 13 In Figure 13 you can see spinning tops at reversal points in the price of BORL. Examining this chart will reveal more spinning top candles assuming a more neutral roll.

Marubozu Variations

14

Another candle that separates itself from the pack is the Marubozu and variations of the Marubozu. While rare, the true Marubozu has a full body with no wicks and has a markedly longer body than the average daily price range of the stock being studied. Figure 14 shows an illustration of the Black and White Marubozu. Notice the lack of wicks; the Black Marubozu opens on its high for the day and closes on the low. Conversely, the White Marubozu opens on its low for the day and closes on the high.

Figure 14 The Black Marubozu can be both a very bearish candle when found in a topping pattern, and a bullish warning candle when found at the end of a long down trend, cautioning us that selling may be peaking. The White Marubozu on the other hand rarely proves to be anything other than very bullish, with buying starting right at the open and continuing throughout the day until the closing bell.

15

Figure 15 Above we have an illustration of a Black and White Closing Marubozu (Figure 15), which are more common than the true Marubozu. A Closing Marubozu will close with no wick; meaning that a White Closing Marubozu will close on its high and the Black Closing Marubozu will close on its low. The opening end of both the White and Black Marubozu can have wicks of variously lengths but the shorter the better.

Figure 16 16

The Opening Marubozu, as seen in the Illustration above (Figure 16) is also more common than the true Marubozu. The Opening Marubozu is defined exactly opposite of the Closing Marubozu. The White Opening Marubozu will have its low price for the day at the open and will close with a wick on the top showing some selling into the close. The Black Opening Marubozu opens on its high and will close with a wick showing a little buying into the close.

Figure 17 In Figure 17, I’ve illustrated a Black Marubozu. While the price of VPI continued to climb a bit after forming this candle, a clear topping pattern emerged soon afterward as VPI ended its uptrend. In this example, the Black Marubozu was the first high volume selling day since a new uptrend started in early December, which would also seen as a warning sign to holders of this stock.

17

Figure 18 Figure 18 shows a Black Opening Marubozu that formed after a healthy downtrend. This candle is interpreted as somewhat bullish for a couple of reasons: · The length of the wick and large volume show us that buyers were certainly starting to step in after the stock sold off heavy. The psychology here is any sellers that were left in ICST at this point were selling today. · The stock price deviated from its normal or orderly down trend by violating its lower trend line by quite a bit when the price was at its low of the day (bottom of wick). The stock rallied better than %10 before heading back down again in January.

18

Figure 19 In Figure 19 we have and example of a White Marubozu and a White Closing Marubozu. The White Marubozu formed at the bottom of a sideways channeling pattern signaling a buy at the support of the channel. The White Closing Marubozu that formed two months later gave us a strong signal that became the flagship of a new uptrend that would extend beyond the former sideways channel for a gain of better than 50% before peaking the first part of December.

Candlestick Reversal Patterns

Reversal Patterns

Now that we have covered the major one day candles, let's look at reversal patterns and their implications on market psychology. One of the most powerful aspects of any type of technical analysis is its ability to gauge the psychology of any tradable stock or index. Major Candlestick reversal patterns are no different 19

and can tell us the psychology in as little as two days, or at least warn the investor of an impending change. It’s important to remember that a well established trend will usually not turn on a dime and reverse itself in the opposite direction. Candlestick reversal signals tell us when the trend is losing steam. The prices may go higher, but not with the same vigor as they had before. With so many tradable stocks, the investor can decide to put his funds elsewhere or ride it out and wait for the next sell signal. The major reversal patterns are as follows: • • • • • • • • • • •

Bearish Engulfing Bullish Engulfing Hanging Man Bullish Piercing Dark Cloud Harami Pattern Shooting Star Morning Star Evening Star Bullish Kicker Bearish Kicker

Bearish Engulfing Figure 1 illustrates the Bearish Engulfing reversal pattern, a major reversal pattern that is made up of a clear body the first day and a dark body on the second. On the first day a white body forms and the price on the second day gaps up and opens higher than the close of the first day, the price on the second day then drops and closes lower than the open of the first day, completely engulfing the body of the first day’s candle. We look for this formation in an oversold market to signal us of a major change in investor psychology. After a good strong uptrend, the engulfing candle of the second day shows heavy selling in a larger proportion to the buying of the first day. To make this signal stronger we would look for: • • • • •

Heavy Volume on the second day. A large body engulfing a small body. A large body engulfing the body and the wicks of the first day. A temporary run-up in price that was greater than the angle of the uptrend that proceeded it. Either candle hitting a point of price resistance, such as an upper trend line, major moving average, or other technical resistance. 20

Figure 1

Figure 2 21

Figure 2 illustrates a nice Bearish Engulfing formation in HANS. This candle engulfed two of the previous days making the signal that much stronger. Notice also that the second day had a strong increase in volume and the pattern formed near the resistance of the previous high a few weeks earlier. While the price of HANS tried to rally during the next week, the Bearish Engulfing signal forewarned the impending downtrend.

Figure 3 In Figure 3, EAGL formed a Bearish Engulfing pattern that began a topping formation that lasted a month, with a second Bearish Engulfing pattern three weeks later that finished off the uptrend. Notice the price action for about a week before the first Bearish Engulfing signal deviating from the normal ascent of its prior uptrend.

22

Bullish Engulfing

Figure 4

The Bullish Engulfing formation (Figure 4) is a very strong two day reversal signal consisting of a black candle on the first day, with the price gapping down on the second day and opening lower than the close of the first day. The price then rallies and the clear candle of the second day closes higher than the first days opening price, completely engulfing the first days body. A look at the psychology behind this formation reveals the sellers, or the supply of stock, dwindling as prices move lower. When the price gaps down on the second day and buyers start to step in with force, the pattern reveals a change in investor sentiment from distribution to accumulation. There are a few things we look for to strengthen the signal: • • •

· High volume on the second day with low volume on the first. · A large body engulfing a small body. · Prices heavily oversold, with prices falling faster than the angle of the trend preceding the formation.

23

• •

· The body of the second day engulfing the body and the wicks of the first day. · The pattern forms on any technical price support area such as, a trend line, major moving average, or horizontal support.

Figure 5

Figure 5 shows a nice Bullish Engulfing formation starting a rally in BORL that gained better than %50. Notice the heavy volume on the second day of the formation and low volume on the first day. Also, the oversold MACD indicator crossed over its trigger line to validate the new uptrend.

24

Figure 6 Figure 6 shows a Bullish Engulfing formation after a gap down in price on the first day indicating panic selling was beginning to peak. Notice the nice gap down on the second day and the short wick below the body indicating the last of the panic selling ended soon after the opening bell and buyers came into the stock and moved prices higher throughout the day.

Hanging Man

Figure 7

25

The Hanging Man formation (Figure 7) gets its name from the patterns unique appearance it gives on a stock chart of a man hanging at the peak of an uptrend. The pattern is made up of three candles with the second candle being a hammer that has gapped up above the preceding candle. On the third day, prices start to decline below the wick of the hammer of the previous day completing the formation. When we see this formation we can observe selling coming in on the day that the hammer forms. After an uptrend, selling comes in after prices gap up and push prices lower. The buyers are able to regain control and push prices back up towards the opening price or beyond forming the lower wick and small body of the hammer. Even though the buyers were still around on the second day, the initial selling is seen as a warning the trend may be slowing. The third day’s dark candle is seen as conformation of this warning. There are a few things we can look for that will make this pattern more significant: A long wick at the bottom of the hammer candle indicating how much selling pressure was present. • High volume on the second and third day. • The pattern forms at a point of technical resistance such as a major moving average, upper trend line, or horizontal resistance. •

Figure 8 26

In Figure 8 we have an illustration of a Hanging Man formation in TACT that gave the first warning of an impending downtrend. Notice the overbought MACD indicator and declining histogram as the pattern formed which also helped validate the signal.

Figure 9 Figure 9 illustrates a Hanging Man in QCOM that became the flagship of a healthy price decline. The pattern revealed itself with a declining MACD histogram at overextended levels.

27

Bullish Piercing

Figure 10

Figure 10 Illustrates a Bullish Piercing pattern, sometimes called a piercing line. The Bullish Piercing pattern is a two day formation that consists of a longer than average black candle on the first day, followed by a white candle that has a significant gap down at its open and rebounds to close into the body of the first candle. This pattern forms in a very bearish climate after a significant downtrend with the long black candle of the first day demonstrating heavy selling and fear. The gap down on the second day indicates fear is still present, but throughout the second day selling dries up and buyers come in with vigor sending prices back into the body of the first day’s candle. There are some factors that we can look for to strengthen the signal: • • • •

Higher than normal volume on both days. A large gap down on the second day. The distance the first candle is penetrated by the second day’s candle. The pattern is formed at an area of technical support such as a major moving average, trend line, or horizontal support.

28

Figure 11

Figure 11 shows a Bullish Piercing formation in the price of FON. Notice the dramatic change in trend that followed this pattern. Conformation of the Bullish Piercing pattern is recommended and this chart illustrates a confirmed signal on the long white candle following the pattern.

29

Figure 12

Figure 11 Illustrates a Bullish Piercing pattern that also led to a profitable uptrend. Notice the pattern formed with MACD in oversold territory while leveling off.

30

Dark Cloud Cover

Figure 13

Figure 13 represents a Dark Cloud Cover formation. This two day reversal formation is made up of a white (or clear) body on the first day, followed by a dark candle on the second day that gaps up and comes back down into the body of the first day’s candle. While the Dark Cloud is a strong reversal signal, conformation is required by the next days candle to determine if it will be used as a reversal signal. The Dark Cloud pattern forms after a substantial uptrend has been in place. On the first day’s white candle buying has peaked. The small number of buyers that are left the next morning cause the price to gap up above the close of the first day and sellers begin to step in, bringing prices back down into the body of the first day’s candle. We can watch for a couple of indications that will help us determine the strength of the Dark Cloud Cover formation: • • • •

High volume on both trading days of the candle formation. The size of the gap up in price on the second day. The distance the second day’s dark candle penetrates the white body of the first day. The bigger the candles on both days, the better. 31

•

The pattern forms at a major technical resistance such as an upper trend line or major moving average.

Figure 14 Figure 14 illustrates an example of a Dark Cloud formation in the price of VLCK. Confirmation of this pattern came two days later with a long dark candle breaking down through the ten dollar share price.

32

Figure 15 In Figure 15, we see an example of a Bearish Dark Cloud pattern in the price of INTV that was confirmed the very next day. Notice the overbought conditions on the MACD indicator also helping to confirm the signal.

33

Harami Figure 16- Bearish Harami

Figure 17- Bullish Harami

34

The Harami pattern can be both bullish and bearish. Figure 16 illustrates a Bearish Harami and a Bullish Harami is seen in Figure 17. Both Harami patterns are two day reversal signals made up of a long candle on the first day with a smaller bodied candle on the second day forming within the body of the first day’s candle. Although the Harami is a strong reversal signal, conformation of the signal is required. The Bearish Harami reversal signal is seen after a significant rise in price. With a white candle forming on the first day, the price gaps down on the second day to open below the close of the first. The price falls throughout the day, closing lower, but still above previous day’s opening price. The Bullish Harami reversal signal occurs after a sizeable downtrend. A large black candle forms on the first day, the price gaps up the next morning as buyers step in. They are able to move prices higher all day, but not high enough to overtake the opening price of the previous day’s candle. There are a couple of things we can watch for to make the Harami pattern stronger: • • • •

High volume on the second day. The longer both days’ candles are the better. The higher the second day’s candle closes up into the body of the first, the more strength the signal shows. The pattern forms at a major technical resistance (Bearish) or support (Bullish).

35

Figure 18 A Bearish Harami pattern, in Figure 18, kicks off a significant reversal in the price of LTD. The signal was confirmed the next day and MACD indicator was in overbought territory.

36

Figure 19

Figure 19 illustrates a Bullish Harami which formed at the support of the previous low six weeks earlier. This signal was confirmed three days later and the price of MACR gained over 90% before beginning to roll over again.

37

Shooting Star

Figure 20 Figure 20 illustrates a Shooting Star reversal pattern. The Shooting Star pattern is a three day pattern consisting of a white (or clear) bodied candle on the first day, followed by a small bodied black or white candle on the third day that gaps up above the first day’s close. The final day of the Shooting Star will complete the pattern with a longer than average black (or filled) candle that gaps down below the body of the second candle, closing well into the body of the first candle of the formation. After a substantial uptrend, buyers carry prices higher as the first day of the formation reveals itself. At the beginning of the second day there are enough buyers left to cause a gap up in price, but demand for the stock decreased as sellers move in to take their profits and cause the formation of a candle with little price movement (small body). The third days dark bodied candle forms as the sellers overtake buyers causing an oversupply in the stock being traded and prices quickly decline throughout the day, eliminating much of the move of the previous two days. There are a few indications you can look for to reinforce the signal: •

High volume on all three days of the Shooting Star formation.

•

Very long candles on the first and third day of the formation.

•

The third day penetrates the first days candle by greater than 50%.

38

•

The pattern forms at a point of technical resistance such as an upper trend line, major moving average, or horizontal price resistance.

Figure 21 Figure 21 illustrates a Shooting Star formation in the price of LTD that formed at horizontal resistance as the price of the stock was channeling sideways.

39

Morning Star

Figure 22 Figure 22 illustrates a Morning Star formation. A Morning Star is a three day reversal pattern that starts off with a dark candle on the first day, followed by a black or white candle that gaps down in price but trades into the range of the first day’s candle (wick). The final day of the formation reveals a white candle gapping up in price and closed well into the range of the candle of the first day. After a substantial downtrend, the first days candle reveals strong selling. On the second day sellers open the day lower but are losing steam as buyers step in and absorb the supply of stock causing a small trading range for the day. The third day reveals buyers taking control as demand for the stock increases dramatically, causing the last candle to trade well into the body of the first day’s candle and wiping out losses for the period. A few things we can look for to help strengthen the signal: •

The length of the downtrend preceding the formation.

•

High volume on all three trading days of the formation.

•

The length of the first and last candle. The longer the better.

•

The distance the third candle trades into or above the candle of the first day. The pattern form at a point of technical support such as a major moving average, trend line, or horizontal support.

•

40

Figure 23 Figure 23 illustrates an example of a Morning Star formation in the price of TWI, leading to gains well above 150%.

41

Figure 24 Figure 24 illustrates a Morning Star formation in the price of LTD that led to substantial gains during the next two months. Notice the over sold MACD and the divergent histogram while prices were falling, also validating the signal.

42

Figure 25 Figure 25 illustrates a stronger, but less common, variation of the Morning Star pattern called an Abandoned Baby bottom formation. The difference between the two reversal patterns is the candle of the second day. An Abandoned Baby’s second day will trade below day one and three including the wicks.

Evening Star

43

Figure 26 Figure 26 illustrates an Evening Star reversal pattern. The Evening Star is a three day pattern that consists of a longer than average white (or clear) bodied candle on the first day, followed by a smaller black or clear candle that gaps up to open above the close of the first day. The third candle is a longer than average black (or filled) bodied candle that gaps down to open below the body of the second candle and trades well into the body of the first candle. While the bodies of all three candles may not be separated from one another, the trading range of all three days will trade into one another which are represented by the wicks. After a substantial uptrend in price, buyers carry prices higher on a very bullish day. The following day buyers are still strong enough to open the stock above the close but sellers come into the stock, supply and demand even out, causing a small bodied candle on the second day. The third and final day of the pattern reveals the demand for the stock at current prices has dried up and sellers step in causing an oversupply of stock. Prices plummet throughout the day well into the body of the first candle, eating up the gains of the last three days. There are a few things we can look for to strengthen the Evening Star reversal signal: •

High volume on all three days.

•

The length of the first and last candle or the formation.

•

The distance in which the third candle penetrates the body of the first day’s candle.

• •

The length of the uptrend preceding the Evening Star formation. The pattern develops at a point of technical resistance such as a major moving average, upper trend line, or horizontal resistance.

44

Figure 27 Figure 27 illustrates an Evening Star formation in SWIR that became the flagship for a healthy downtrend. Notice the overbought conditions in the MACD indicator which also helped verify the reversal signal.

45

Figure 28 Figure 28 illustrates an Evening Star formation in the price of ETN. The MACD also began crossing over at the point of the signal and the histogram was divergent with price.

46

Kicker Signals

Figure 29

Figure 30 Figure 29 & 30 Illustrates the Bullish and Bearish Kicker reversal signal. The Bullish Kicker is a two day reversal pattern consisting of a dark (or filled) bodied candle on the first day that should be longer than average. On the second day a white bodied candle gaps up to open above the close of the first day and also closes higher than the first day’s open. The Bearish Kicker is also a two day reversal pattern made up of a longer than average white bodied candle on the 47

first day. The second day forms a dark bodied candle that gaps down below the close and then closes below the open of the first day’s candle. There are a few criteria we can look for to strengthen the Kicker signal: • • •

The length of the second day’s candle. z High volume on the second day. The distance from the close of the first day to the open of the second day. The pattern forms at a point of technical support or resistance such as a major moving average, trend line, or horizontal support or resistance.

Figure 31 Figure 31 illustrates a huge Bullish Kicker reversal signal in the price of QLGC that kicked off a very large rally that led to gains of over 200%.

48

Figure 32 Figure 32 illustrates a Bearish Kicker in the price of PMCS that led to a 30% decline in price.

49