Day Trading With Canlestick and Moving Averages - Stephen Bigalow

TECHNIQUES The centuries-old technical analysis patterns knov^n to candlestick traders are finding new avenues for profitable trading ^hen combined ^ith more recent analysis tools.

Day-trading with candlesticks and moving averages BY STEPHEN W. BIGALOW AND DAVID ELLIOT

C

andlestick signals, a trading

method rhar has worked successfully for the past few centuries, is now being augment' ed by the apphcation of techniques that could not have been considered just 15 years ago. Correct trade ratios can be greatly increased by combining the historically tested candlestick signals with statis' tically enhancing trend reversal data of today. Just a mere decade ago, most investors had to depend heavily on the Wall Street "professionals" for when to huy and sell. Research and technical investment information was difficult to access other than through the brokerage firms. Fortunately, the advent of Internet investing has eliminated

4 0 FUTURES I November 2004

the limitations that most investors had to overcome, getting the information they need to do their own analysis. The past decade has witnessed tremendous advances in the application of computer-generated technical analysis. The average investor now has

the capability to create any investment trading program that they can imagine. The abilities of computers have been able to greatly enhance the performance ai' successful investment methods. The candlestick trading method has been a great benefactor of computer programming. The basis of candlestick signals is that they are formed using "common sense" investment processes. That the signals are around today is affirmation that they work. A given in investing is that if something doesn't work, it does not stay around very long. Learning how to use the signals profitably has been considerably simplified over the past few years. Of the 50 or 60 candlestick signals, only 10 signals have been

identified as signals worth spending the mental time and energy learning. These 10 signals will produce more successful trades than most investors require. Learning the major signals, whether day-trading the E-minis or investing for the long term, will greatly magnify your profit potential. Using the signals on their own produces high prohahility, high profit results. The main function of the signals is that they put the prohahilities of being in the correct trade grearly in the candlestick investor's favor. They work a high percentage of the time when observed in the proper positions of a trend. The reason for their success is simple. These signals are the result of hundreds of years of rice-traders' ohservations and actual trading results — the most hasic form of statistical analysis. The success ratio of candlestick signals now is heing further improved. Through many years of statistical research, it has heen shown that applying important moving averages to price trends has revealed some important results. This research has altered the application of the moving averages. The common use of moving averages has heen huying and selling positions when specific moving averages cross over each other, such as when the 10day crosses the 20-day, or the 50-day moves through the 100-day, etc. A more profitahle application has heen developed using moving averages. There are many moving averages that technical analysts consider important, ranging from the three-day simple moving average to the 1,000-day simple moving average. However, the 50day and the 200-day provide the most reliable signals. The application of them is different than how most traders approach them, though. The idea is not to wair for the averages to cross

FINDING CONFIRMATION Note how the trading becomes indecisive in the moving average area on the Dow chart. These periods reveal numerous candlestick signals while ttie stochastics are in the oversold or overbought conditions.

each other, but to use them as support and resistance levels. These moving averages reveal impressive results that indicate that trends bounce off the 50day and 200-day moving average with considerably more regularity than any of the other moving averages. When statistical analysis discloses a pattem that exhibits consistent regularity, it is usually a function of repeated human nature. As seen with stochastics, Elliott waves, Fibonacci numbers and trendlines, etc., human nature repeats the same sentiment patterns. Otherwise, these technical systems would not have ever heen identified. Candlestick signals work very effectively if they generate a buy signal while stochastics are in the oversold area. The effectiveness becomes more enhanced when the moving averages are added to the analysis. A candlestick

buy signal, with stochastics in the oversold area, and occurring at the 50- or 200-day moving average makes for a reliable buy point. For the swing trader, the signals in comhination with the moving averages create highly accurate trades lasting three to 15 trading days. Eor the longer-term investor, the analysis can he applied to the indexes. Having a platform for establishing long and short p{isitioning greatly enhances the profit probabilities. Common sense portfolio strategies can be put in place by evaluating the direction of the market indexes and then scanning for the signals in individual sectors or stocks that correlate with the index trends. The moving averages provide the support and resistance levels while the candlestick signals confirm what is happening to investor sentiment at those levels (see "Finding confirmation," above). A major advantage of combining candlestick signal confirmation with moving averages is intraday trading. When fast

Understanding where a TREND has a high probability of REVERSING...provides a high degree of ACCURACY to trading programs.

www .futures mag .com \ November 2004

41

Trading Techniques decisive trade decisions are required to maximize trade potentials, the comhination of the signals at the movinf^ averages performs very well on the one-minute, five-minute and

15-minute charts. An inordinate numher of successful trades can he executed every day when all the parameters align. As illustrated in the S&tP one-minute chart, candle-

ON MY if you're looking for a strategy that provides numerous reliable intraday signals, a :^ candlestick/moving average combination approach might fit the bill. §

CRITICAL RESISTANCE In the longer-term intraday chart, we can see how the 50-period moving average became a key resistance point. This is critical knowledge for the day-trader.

14:J0

42

J-ffl:JO

09:00

09:M 10:00 10.30

FUTURES I November 2OO4

11:00

1 30

12:00

12.30 15:00

JIJ30

Stick signals often will he seen in the close proximity of the moving averages ("On my minute," left). Point A illustrates a bullish engulfing signal followed three minutes later hy a piercing signal, occurring in the oversold area of the stochastics, and at the 50-minute moving average. Point B demonstrates a bullish engulfing signal as the price pulls hack to the 200m i n u t e moving average. Point C reveals a spinning top followed by a hullish engulfing signal, again bouncing up from the 200-minute moving average. Having this visual trading format allows the day-trader, whether trading futures or commodities, to pinpoint the high prohability turns in an intraday trend. As portrayed in t h e S & P fiveminute chart, the 50-period SMA hecomes an obvious resistance level (see "Critical resistance," left). T h e candlestick signals at that level also indicate the selling at the 50-period SMA. Whether using a combination of the 1-, five-, 10-, 15-, 30- ot 60minute charts, the moving averages and the signals will provide bigh probability formats. Putting t h e probabilities in your favor is the hasic premise for trading. Understanding where a trend has a high prohability of reversing, then heing able to see signals that confirm that the reversal is occurring at that level, provides a high degree of accuracy to trading programs. Becoming educated in these easy-to-see visual techniques does not take a great amount of effort. Understanding the investment psychology behind the formation of the 10 major candlestick signals will create the insights to successful evaluation of price reversals. i FM

Stephen W. Bigalow is the author of Profitable Candlestick Trading and is the operator of www.candlestickforum.com. Dave Elliott, Author of Everyone's Guide To Making A Million In The Year 2000 Crash, successfully projecting the correction of 2000, and operates www.wallstreetteachers.com, which provides research on computer-generated, high probability indicators.