Alter Your Investment Perceptions Forever!
In addition to his popular books on “Profitable Candlestick Trading” and “High Profit Candlestick Patterns”, Stephen Bigalow has many articles featured in “Future’s Magazine”, “Stocks & Commodities”, “Trader’s World”, London’s “Morning Star”, and other investment publications.
Refer to this page often to enhance your education on the art and science of using Japanese Candlesticks to trade effectively.
The ability to analyze factors affecting stock market movement provides an additional advantage for being able to evaluate the direction of the markets. Those factors are not hard to find. They are usually what are being reported on the financial news stations. Recently, Crude Oil has been an influence. Also, the decline of the US dollar has become a factor.
The Candlestick signals provide the insights on how the outside influences will affect the Dow and the NASDAQ. The US dollar has formed a few Doji’s when the stochastics were in the oversold condition. There may be an opportunity for a rally in the dollar over the next few days. There appears to be some strength being shown after the Doji’s. If this is one of the factors that is affecting the stock market, having a better visual concept of what one of the influences is doing makes for a better evaluation.
Crude Oil prices, after their decline from the $57 range down to the $46 range, provided strength to the stock market indexes. As anticipated, with the stochastics in the oversold condition, Crude Oil prices bounced back up to the 50-day moving average after it had broken down through that level. Currently, the January futures contract of Crude Oil has been hugging the 50-day moving average. It formed a Doji on Monday, right at the 50-day moving average. This now becomes an easy evaluation. A bullish day after the Doji would send prices up through the 50-day moving average, indicating that the 50-day moving average is not acting as resistance. On the other hand, seeing the Crude Oil prices heading lower after the Doji would reveal that the 50-day moving average was now acting as resistance and it would be feasible to see new recent contract lows in the near future.
Crude Oil
Taking these outside factors into account, it becomes easier to analyze which way the market might go based upon the factors affecting stock market movement. Use the candlestick signals to your advantage no matter which market you are analyzing.
Rising Three Method
Description
The Rising Three Method is an easy pattern to see during uptrends. A long white candle forms. It is then followed by a series of small candles, each consecutively getting lower. The optimal number of pull-back days should be three. Two or four or five pull-back days can also be observed. The important factor is that they do not close below the open of the big white candle. It is also preferred that the shadows do not go below the white candle. The final day of the formation should open up int he body of the last pull-back day and close higher than the first big white candle.
Criteria
Pattern Psychology
The Rising Three Method is considered a rest in the trend or, in Japanese terms, a rest from battle. The concept is that the first black candle day brings some doubt into the bull camp. The next day does the same. By the thrid day, the bulls ar now convinced that the bears do not have the strength to push prices down anymore. The bulls get their courage back and start stepping in. The pattern resembles the Western bull flag or pennant formation, however, the concept was originally developed in the 1700s. In modern terms, the market was just ‘taking a breather”.
Growth stocks are those companies with shares whose earnings are expected to grow at an above average rate in comparison to the market. These stocks typically do not pay dividends because the companies opt to reinvest any retained earnings back into capital projects.
There are common characteristics among growth stocks as well as indicators that the stock investor can look for. These indicators can include the following:
1) Strong growth rate – This includes not only historic growth rates but also the projected growth rate when investing in stocks of this nature. The growth rate will vary between small and large companies but typically smaller companies need to have a 10% growth rate for the past five years to qualify whereas the larger companies need to have about 5% – 7% growth rate to qualify.
2) Strong return on equity (ROE) – You must compare a company’s ROE with the industry in which is presides as well as its five-year average when stock investing.
3) Earnings per share (EPS) – The earnings per share is very important as well when investing in growth stocks. Investors must be sure the company is translating its sales into earnings, and management must be controlling costs. Investors must take a look at pre-tax profit margins and they should exceed the past five-year average as well as the industry average.
4) Analysts also take a look at the business model for a company as well as its market position to be sure that this stock price can double in five years.
Growth Stocks vs. Value Stocks
Growth investors look for companies with fast growing revenues and earnings as well as rising stock prices. Growth investing focuses on stocks that are growing and that have the potential for continued growth. Value investors look for bargains. Bargains are stocks that are trading at low prices relative to earnings, or stocks that have low price to earnings ratios. Value investing looks for stocks that the market has under priced and it looks for stocks that have the potential to increase as the market corrects itself.
Which Type of Stock Is Better?
This depends on what is occurring in the stock market. During periods such as the late 1990’s, growth stocks did very well, however there were time periods when value stocks did better. Investors should just be sure to aim for portfolio diversification and shouldn’t only invest in one type of stock.
Simple candlestick rules makes investing very easy. It also makes investing very relaxed. As illustrated in the previous newsletter, maintaining short positions during February and March was not a high anxiety process. What fears creep into investor sentiment as profits continued to grow? Where should I take profits? Should I take it now so I lock in some profits? These questions constantly nag an investor as their short position profits keep growing as a downtrend persists. Too often, positions are closed because of the fear of giving back some of the profits that have built up. This anxiety can be greatly diminished when using simple candlestick rules.
A downtrend will persist as long as there is not a candlestick buy signal and a close above the T. line. This rule works so well, an investor should be comfortable and relaxed with short positions until that combination occurs. The same is true in an uptrend. The Dow has moved up after the first week of March. What occurs in most humans as a trend continues? The anxiety level increases. They become more fearful of losing the profits they have made. This usually changes the investment strategy. The rational decision-making involved with analyzing the charts gives way to emotional factors. The sage investment advice, “Cut you loses short and let your profits run. ” Is a very viable investment process if investors would allow the discipline to work. Unfortunately, because of emotions, the opposite is usually true. The losses become greater while the gains get nipped in the bud because of the fear factor.
Candlestick analysis operates off very simple principles. Buy when the candlestick signals tell you to buy, and sell when the signals tell you it’s time to sell. Many investors have a difficult time when it comes time to sell. They either sell too early, in fear of giving back profits or they sell too late, afraid they might not get all of the price move. Candlestick analysis makes those problems very easy to overcome. The common sense rules the Japanese rice traders utilized for centuries allowed them to maximize profits and minimize losses. The signals and corroborating indicators take the subjectivity out of taking profits.
DOW
Another aspect of investing benefited by recognizing the continuation of trends involves pattern analysis. Having the knowledge that current conditions of a market trend has not changed allows for the participation in candlestick patterns. These patterns may take much longer to set up. The end result of a pattern has a much better chance of creating huge profits if nothing dramatic is occurring in the current overall trends. The Jayhook patterns, the Fry pan bottom pattern, the Cradle pattern and the Scoop pattern have better probabilities of success when the markets are gradually trending versus oscillating dramatically.
As illustrated in our recent recommendation on ARB, the dramatic buy signal escalated the result of a Fry pan bottom pattern. Since witnessing the Bullish Engulfing Booster signal, the upward trajectory of the trend has been very dramatic. The continuation of this price move as been benefited by the slow gradual uptrend of the markets in general. This trend may have had a much different result had the market indexes been producing a bearish trend.
ARB
The persistence of a trend also allows for the establishment of high profit option trading strategies. A general trending market diminishes the whip sawing actions in option trades that might been found in more choppy conditions. Being able to analyze the market trend is greatly important for establishing the right investment strategies for the right times of the market. The information incorporated into each individual candlestick signal allows an investor to make much more accurate trend analysis than other technical methods. The clarity produced by the signal bodies helps determine how heavily long or short a portfolio is positioned.
Chat session tonight 8 PM ET – open to everybody. With these market conditions, what option strategies should be used? Click here for instructions.
Good investing,
The Candlestick Forum Team
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Steve’s Trading Diary
The information in this section contains the unedited thoughts and musings of a professional Candlestick trading expert, Steve Bigalow, as he goes about his daily Candlestick analysis in search of great trades.
The follow-ups on the daily stock picks displayed here are limited to only the closed or unexecuted trades for previous months. To see the current follow-ups on the open trades, you must be a member of the Candlestick Trading Forum’s paid subscription service.
A savvy, experienced investor has a money making plan for any condition in the stock market. Whether the market is stable or volatile, whether it is bullish or bearish, there is a method for finding a profit. Such is the case with a Sell Strangle. This technique requires the investor to sell a Call Option that is out-of-the-money as well as a Put Option that is also out-of-the-money; both the Call Option and the Put Option need to be on the same stock with the same expiration date. This strategy is very similar to a Sell Straddle but with a Sell Strangle, the strike prices are not the same.
A Sell Strangle is made when the market has experienced a substantial upward move and your expectation is for consolidation. In this case, the possible results are a known, limited gain or unlimited risk. A Sell Strangle isn’t a move for the beginner investing in the stock market since the risk to reward ratio is not positive and extreme care with this maneuver is required.
The gain in a Sell Strangle is only the premium that is received for selling the call option and the put option. Remember, as with any stock transaction, your profit is reduced by any commissions. Done as a response to a dramatic upward move that has occurred, the investor is expecting the market to experience a consolidation and absorb its gains before moving again. Since the market is filled with extreme stock volatility, the cost of the Call and Put Options will tend to be very high. When the market does consolidate, volatility will decrease and lower the price of the options, allowing the investor to buy back the options at a lower price to close the position. With a Sell Strangle, the concept of time decay also works to the advantage of the investor. While this is a somewhat complex transaction, a Sell Strangle is an excellent stock option trading strategy for an experienced trader.
A Sell Strangle requires that the investor monitor the position for unfavorable movement and, if necessary, buy back one of the options if there is any indication that the market will resume its trend or reverse direction. If there is an indication that the market will resume its upward trend, the trader should buy back the call; if the market appears to be heading down, the trader should buy back the put.
It is important that the trader do stock market technical analysis prior to implementing this strategy. The powerful charting capabilities of this stock investing system will offer insight into movements in the market before attempting to enter a Sell Strangle. By using a stock market trading system like Japanese Candlesticks, a trader can not only identify the mood of the market, but identify a stock that is a candidate for a trade like a Sell Strangle.
While a Sell Strangle isn’t advisable for everyone, it is one of several investment options that can create profits for a skilled trader. Using a tested stock trading plan, good technical analysis tools, and a system such as Japanese Candlesticks, a trader will find this method to be something that not only creates a profit, but adds another weapon to the arsenal of successful traders.
Stock market advice is plentiful over the internet. There is sage stock market advice like; Don’t try to time the market, use cost averaging, diversify, and limitless tid-bits but they do not teach you anything about trading. What good is stock market advice if you still don’t know how to read a stock chart? The Candlestick Forum provides practical stock market advice by continued “How To Trade” articles for identifying specific candlestick charts. This article will help you to identify The Morning Star signal and the trading criteria used for successful implementation. We hope these articles are helping you along your way to successful stock market trading. Be sure to join Stephen Bigalow live over the internet for his free Thursday evening Chat Sessions.
MORNING STAR
Description
The Morning Star is a bottom reversal signal. Like the planet Mercury, the morning star, it foretells that brighter things – sunrise, is about to occur, or that prices are going to go higher. It is formed after an obvious downtrend. It is made by a long black body, usually one of the fear-induces days at the bottom of a long decline. The following day gaps down. However, the magnitude of the trading range remains small for the day. This is the star of the formation. The third day is a white candle day. And represents the fact that the bulls have now stepped in and seized control. The optimal Morning Star signal would have a gap before and after the star day.
The make up of the star, an indecision formation, can consist of a number of candle formations. The important factor is to witness the confirmation of the bulls taking over the next day. That candle should consist of a closing that is at least halfway up the black candle of two days prior.
Criteria
Signal Enhancements
Pattern Psychology
A strong downtrend has been in effect. The sellers start getting panicky. There is a large sell-off day. The next day as the selling continues, bulls are stepping in at the low prices. If there is big volume during these days, it shows that the ownership has dramatically changed hands. The second day does not have a large trading range. The third day the bears start to lose conviction as the bull increase their buying. When the price starts moving back into the trading range of the first day, the sellers diminish and the buyers seize control.
Training Tutorial
The Morning Star & Evening Star Signals This 56 minute video provides a clear understanding for trading and maximizing your profits.
The ultimate poop trade! Technical analysis of stocks become much easier when able to interpret what investor sentiment is demonstrating. Candlestick analysis incorporates common sense investor concepts into graphic depictions. Understanding how to interpret what investor sentiment is doing after specific market movement will greatly enhance your profit potential.
The technical analysis of stocks present a multitude of price movements. A highly profitable opportunity is usually presented in bad news gap-downs. Consider the following situation. You just recently bought a position because of a very good bullish signal. All confirmation is positive, it moves up nicely the first day. THEN, the dreaded news; the company issues an earning warning, the SEC announces a surprise audit, a contract gets cancelled. Whatever the news, the price drops 20%, 30% or greater. The question is what to do now? Do you sell the stock, take a loss and move on? Do you trade it at the new levels? Do you hold and/or buy more at these levels? What is the best course of action?
Traders and long term investors will have completely different outlooks. The traders bought the stock a few days back due to specific parameters for making that trade. They should consider liquidating the trade immediately and move their money to better probabilities. The reason for putting on the trade, for a short term trade, has completely disappeared after the massive down-move. The longer term investor has a few more analytical options for gap analysis. They may want to hold the position because the Candlestick formations indicate that the price will move back up or liquidate because the Candlestick signal shows further decline. Reading the signals becomes an important element in knowing what to do in a “bad news” situation.
A “bad news” gap-down has a multitude of possibilities after the move. The prior trend gives you valuable information on how to react to the move. Of course, the news is going to be a surprise or there wouldn’t be the gap-down. Analyzing the trend prior to the move gives you a good idea of how much of a surprise the announcement or news bulletin is.
For example, IBM recently reported lower earning expectations. The price gapped down. However, you have to analyze whether this news was a complete surprise or whether the gradual decline in the stock price was the anticipation of the coming news. As can be seen in the IBM chart, the price had been declining for three months before the actual news was announced. The smart money was selling from the very top, months ahead of time. It was the die-hards that held on until the bad news was reported.
As the chart shows, the final gap-down produced a Long Legged Doji, massive indecision. From that point the buyers and the sellers have held the price relatively stable for the next few weeks. This now becomes one of the few times that a technical analysis has to revert back to fundamental input. Unless you believe that the markets in general are ready for a severe downtrend, consider what the chart is telling you. The price of IBM stock was reduced from $125.00 per share down to $87.00 per share. The last down-move produced a Doji. The price has not moved from that level for two weeks.
IBM
Now, the fundamental input. IBM is a major U.S. company, well respected, and known to have excellent management personnel. And like any other quality company, it has made marketing or production mistakes from time to time through the years. The announcement that they made that knocked the price down, whether it was an earnings warning, shutting down a product line, or whatever, the factors that were announced as the result of the problem did not surprise company management. They knew that there were problems well before the news announcement. Being intelligent business people, the management of IBM was aware of the problems and had been working on the solutions months before they had to announce.
When the announcement was made, probably many strides had already been taken to correct whatever problems caused the price to drop. For the long term investor, it would not be unusual to see the price of IBM move back up to at least the level from where it last gapped down, at approximately $100. This still provides a 15% return.
You can chart your own course through common sense technical analysis of stocks. Watching for a Candlestick “buy” signal gives you the edge. IBM is not going out of business. Who was buying at these levels when everybody was selling? The smart money! Are the professional analysts of Wall Street recommending to buy at these levels? Probably not! But watch the price move from $85.00 back up to $95.00, then you will see the brave million dollar analysts say it is time to buy. Practical hands-on analysis, being able to see the “buy” signals for yourself, will keep you ahead of the crowd.
The use of moving averages has become much more predominant with the advance of computer software. Moving averages can now be utilized up to the very minute of a trading chart. The automatic calculations for MA’s have greatly simplified their applications. Their use, along with Candlestick signals, makes understanding the stock market a much easier process. As with all other technical indicators, MA’s have a relevance when correlated to price movement. How the moving averages are utilized can make a big difference between moderate returns and highly profitable returns. When applying Candlestick signals with moving averages, understanding where the stock market indexes are likely to go becomes a higher probability evaluation.
There are many trading techniques using moving averages to provide entry and exit decisions. The most common use is when the relevant moving averages cross. The feasibility of using MA crossings apparently has some relevance or it would not be known as one of their useful aspects. However, the benefits of using moving averages become greatly diminished if that is the only application that is utilized. The accuracy of the crossing analysis is moderately successful. But there are many technical evaluations that are moderately successful.
Using Candlestick signals, along with the moving averages in a much different capacity, creates a trading program that produces highly profitable trades. The trades are also provided with a much greater frequency. The point of investing is to find processes for using technical indicators that provide a very high ratio of successful trades. Using the important moving averages as support and resistance areas, in conjunction with Candlestick analysis, advances the probabilities of participating in a correct trade. Fortunately, the use of the moving averages is very simple. Once applied to Candlestick charts, it makes the analysis of where a trend may support or resist a very simple visual process.
The 50-day moving average and the 200-day moving average are the important moving averages. There seems to be a great tendency for prices to support or resist at those averages. The 20-day moving average and the 80-day moving average are also important but would be considered secondary moving averages. Are there other moving averages that work effectively? Probably, but the moving averages mentioned above seem to have a statistical relevance for the past few years and will most likely continue to be relevant for the next few years.
Technical indicators provide important information. An indicator gains importance because of the reoccurring significance of major investment considerations happening at those points. This explanation is put forth so that each investor can become convinced in their own minds that moving averages, especially the ones being recommended in this chapter, have some relevance. Through the following chart evaluations and one’s own chart studying, the relevance of these signals should become apparent. This does not limit an investor from constantly being aware that other moving averages may start gaining importance in the eyes of other technical investors. The point of using these moving averages, along with Candlestick signals, is that historically many investors are watching to see what price movements do at these levels. The advantage of the Candlestick signals is that the signals tell you exactly what investors are doing at those levels.
Moving Averages as Support
When witnessing a downtrend, how do we tell when a bottom is getting near? As described in other chapters of my book, it could be when panic selling is witnessed coming into a price trend as the stochastics are getting toward the oversold area. That is a helpful alert but does not give us a roadmap to where that panic selling might end. Being able to utilize the 50-day moving average and the 200-day moving average as important support areas, those levels can at least be used as a target. Being able to evaluate the potential target that a trend may want to go to now makes the analysis of what is going on in the Candlestick formations that much easier to interpret. For example, if a sustained downtrend is now showing larger candles, the evidence that the panic bottom may be nearing and the price is approaching one of the major moving averages provides extra preparation for seeing what might occur at that moving average level. Panic selling, along with stochastics approaching the oversold area or being in the oversold area, and a major moving average approaching a level where a Candlestick buy signal has a probability of occurring, becomes a trade set up that an investor wants to start preparing for.
Do all charts work well with moving averages? Definitely not! However a large majority appear to. The purpose of Candlestick analysis is to provide an advantage for the investor to see what is happening at important technical levels. The Candlestick signals provide that clarity. If a chart is not providing patterns that make it easy to see what a price movement is going to do, then move on to another chart. There are many from which to choose, especially with the availability of easy-to-use computer scanning programs.
In putting all of the probabilities in favor of the investor, using every technical method can be enhanced when Candlestick signals are applied. How do you discover whether the major moving averages are a positive correlation with anticipating price moves? Easy! Investigate what has happened at those moving averages previously in the price trend. This can be done very quickly. All it takes is a quick visual analysis of what has happened in the past.
Commodity options are a commonly used means of handling investment risk in trading commodity futures. By purchasing options contracts instead of directly purchasing futures contracts traders retain the right to buy or sell futures but have no obligation to do so. In using commodity options the trader will need to pay an option premium. However, the premium is the extent of his or her risk in options trading. In buying calls or buying puts in the commodities markets the trader can profit from a large shift in commodity prices but not suffer a loss if prices move in an unexpected direction. Traders selling puts and selling calls collect premiums in commodity options trading but also accept the risk of a large loss. Commodity and futures training will help the beginning trader get a handle of commodity options.
Commodity options are options on whether to buy or sell commodity futures. Commodity futures trading is contracting to buy or sell a standardized lot of a commodity at a future date. If the price of the commodity goes up or down substantially and in the desired direction the trader makes a handsome profit and if the commodity price moves adversely the loss can be devastating. By using commodity options the trader can buy a call or buy a put on a commodity futures contract. This will give him or her the right, but not the obligation, to buy or sell a commodity futures contract. If the trader believes that a commodity price is and will remain stable he or she may choose to sell puts or calls on the commodity. Providing that the price does remain stable the trader will gain the premium on each trade. Over the long term selling options is typically more profitable than buying. However, the trader needs to be able to withstand an occasional substantial loss.
Whether the trader is dealing directly with commodity futures or chooses to trade commodity options it is important to have a clear sense of the range of possibilities the commodity in question will offer. This starts with the basic fundamentals and then moves on to the technical aspects of the commodity market. Both fundamental and technical analysis come into play as fundamental analysis will help predict the spot price of the commodity at contract expiration and technical analysis will help predict daily price movement of the futures contract. The trader is best served by doing his or her fundamental and technical analysis on the commodity in question well in advance of trading it. When the trader is quite certain in his or her belief that a commodity price will go up or down it may be best to simply buy or sell a futures contract. It is when there is some uncertainty involved that the trader will purchase and options contract. Then, if the desired price move occurs the commodity trader will execute the options contract and buy or sell the commodity futures contract. If the desired price movement does not occur he or she will simply swallow the price of the premium as a cost of doing business and not suffer a loss in direct commodity trading.
What is the market telling us? The Dow has been in the oversold condition and exhibiting candlestick buy signals. Today it had trouble getting up through the 200 day moving average, but an indecisive trading day after a large bullish day as seen on Wednesday is not unexpected. The NASDAQ is giving more bullish tendencies. After coming up through the 200 day moving average, it has used the 200 Ma for support over the past few days. The NASDAQ is trading above the tee line. Although the upward trend may be very lethargic, as long as the indexes remain above the tee line the uptrend has to be considered in progress. This scenario has changed a couple of times over the past two weeks due to the dramatic oscillation of each trading day.
As witnessed at the end of April, when the markets start showing great indecision, that is the time to start watching for a trend reversal. This is time to start watching for bottoming signals in individual stock prices. A bullish candlestick signal needs to be followed by a close above the tee line. Remain nimble, meaning be prepared to get into positions and out of positions relatively quickly if investor sentiment dramatically reverses.
DOW
NASDAQ
Because candlestick analysis is based primarily upon the high probability situations, the analysis of today’s market conditions indicate bottoming action and a high probability that an uptrend should be in progress. The magnitude of the uptrend is what will need to be watched. The next few days will give an indication of whether a strong uptrend is in progress or a sideways slowly moving uptrend is in progress. Fortunately, in either case, candlestick scanning capabilities allows for identifying which sectors/stocks will be performing the best.
LULU
The T-line is a very important confirming indicator. However, it is often asked whether a position should be bought below the tee line. The answer to this question is a function of how far away prices have moved from the T-line. As seen in the August Feeder Cattle chart, a bullish Harami/Hammer signal formed well in the oversold area. Buying on the confirmation of that signal is more important if the price has moved a decent ways away from the tee line. The strategy becomes a little different. The important factor for when to buy or when to sell is based upon witnessing a candlestick reversal signal when stochastics are either in the overbought or oversold condition. The T-line is an excellent additional confirming indicator. However, when the price moves away from the T-line before reversing, the T-line now becomes the first area to watch to confirm whether an uptrend is in progress.
Feeder Cattle
As seen in the August feeder cattle chart, when the trading did come up to the T-line, it was evident there was not going to be resistance at that level. If you have been attending the free chat room training sessions on Thursday nights, you’ll often hear analysis that says, “Wait to see what the price does when it gets to the next moving average.” Waiting to see what it does at a specific moving average means seeing what type of formation forms at that level. Candlestick signals are going to reveal whether investor sentiment was very decisive going through that moving average or whether an indecisive/sell signal formed once it got to the projected target. This information is extremely useful when establishing trades below the T-line.
Chat session tonight 8 PM ET – We will be looking at which sectors should be coming out of this bottoming action with the best strength. Remember, Tina Logan will be presenting next Thursday June 10th.
Good Investing,
The Candlestick Forum Team
July 2010
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