“Profitable Candlestick Entry And Exit Strategies”

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“Profitable CandlestickEntry and Exit Strategies”How To Recognize The Exact Right Time To Buy Or SellA Candlestick Forum publication – Years of Candlestick Analysis madeavailable in concise formats. Information that when learned andunderstood will revolutionize and discipline your investment thinking.Copyright @ by Stephen W. Bigalow 2002Published by The Candlestick Forum LLC

Profitable Candlestick Entry and ExitStrategiesTable of ContentsIntroduction . . 3Common Sense 4“Buy stocks that are going up. If they don’t go up, don’t buy them” 5How Stocks Open Reveals Huge Knowledge . . 7BUY on a Strong Open . 13Use Pre-Open Indicators to Improve Profits . . 14Play The Probabilities . . 17When Is It Time To Get Out?. . 22Simple Rules . . 25The Trend Has Started. . 26Use Today’s Investing Strategies for Today! 282

IntroductionThe Candlestick signals are in existence today because of their statistical probabilities. Ascan be imagined, the signals would not be in existence today if they did not produceprofits. Profits noticeable through history, significantly more than random luck or normalmarket returns. The purpose for utilizing the Candlestick signals is to put as manyprobabilities in your favor as possible.The fact that the signals are still around is due to results over centuries of observations.Assuming that the probabilities of making a profit from a signal is above 50%, maybe60%, 70% or even 80%, those percentages can be enhanced by an additional factor. (Todate, statistical performance has been difficult to obtain. The fact that there have beensevere misunderstandings by most investors of when a signal is truly a signal has beena deterrent. That lack of knowledge and the multitude of parameters needed to dostatistical analysis makes programming for statistical results an overwhelming task.The Candlestick Forum is currently directing local university projects to accumulatethose statistics. They will be made available to Candlestick Forum members as resultsare obtained. Because of the magnitude of this project, information will probably bereleased in bits and pieces as they are completed.)How the position is acting once the signal has appeared is an immediate filtering element.Being that we all eternal optimists, we want every position to go up as soon as we buy it.But keep in mind, even with phenomenal results of 80% positive trades, that still leaves20% that will not work. The more steps that can be taken to reduce the bad trades, thebetter the results of your placed investment funds.The information revealed in this book and on the Candlestick Forum website is not thetelling of ancient “secrets” or the new development of sophisticated computer generatedformulas. It is the assembling of common sense observations from centuries of actualprofitable experience. As you may have noticed yourself, Candlestick information hasbeen around for several decades. Everybody knows about them, they use the graphics forbetter viewing of charts, but they just don’t know how to use the signals themselves. You,by taking the time and effort to research the Candlestick method, are still in a smallminority of the investment community. All the concepts conveyed in this book and therest of Candlestick analysis is just common sense. Remember, the Japanese rice tradersmade huge profits from the Candlestick method. They used rice paper to draw charts andbacklit them in candle boxes. The concepts applied to Candlestick analysis eventuallybecame the backdrop of the Japanese investment culture.3

Common SenseAs you learn about the Candlestick method, keep in mind that the common senseapproach is what distinguishes this investment technique from most other tradingpractices, with those practices being heavily weighted by emotional decision-makingprocesses. The information you are receiving is knowledge available to everyone.However, you have the benefit of getting the correct interpretation, which means youget the desired results. Take advantage of this knowledge. It will create confidence ininvesting that most people never experience.Just as the signals produce valuable information as to when to buy a position, they arejust as valuable for demonstrating when to sell. This sometimes is much sooner than isexpected. Simple logic tells us that if a Candlestick “buy” signal appears in the rightplace with the right confirming indicators, that the trade should be ready to go.Unfortunately, reality may show a different outcome. How a price opens the next day isalso a very important indicator as to how aggressive the buyers are. (The sameparameters can be applied to sell / short transactions, but for illustration purposes, the buyside will be used to represent all trades.) Utilizing that information can be instrumental inweeding out less favorable trades.The logic behind the results of an open the next day after a signal is simple. Is thereevidence that the buyers are still around? That information is readily available throughinexpensive live-feed services. We recommend the TCNet program (see moreinformation about all the investment benefits that TCNet provides for investors on oursite, www.candlestickforum.com). Being able to view how a stock is going to openbefore the market opens improves an investor’s positioning dramatically. Watch yourreturns multiply by eliminating the bad trades.The shorter the trading period, the more critical the opening placement. Options aretrading vehicles that require the most exact timing possible. Longer-term investors havemore leeway when putting on a position. A six-month trade or a one-year trade is usuallybeing bought when the monthly, weekly and daily candlestick charts all coordinate, eachchart showing it is time to buy. (The monthly and daily charts are the pivotal charts forlong-term investors; the weekly chart is often out of sync with the other two, which doesnot affect the results).4

“Buy stocks that are going up. If they don’t go up, don’t buythem.” Will RogersEach formation is not necessarily a signal. A Candlestick “buy” signal in the overboughtarea does not mean the same as a Candlestick “buy” signal in the oversold area.Conversely, a Candlestick “sell” signal does not mean the same in the oversold area as itdoes in the overbought area. Many investors confuse the formations as signals, but do nottake into consideration where the stochastics are.As you learn more about the signals, you will become acquainted with where the realsignals occur. The majority of the time, that will be in the overbought or oversold ranges.Occasionally it will be in a midrange area, as in the J-Hook pattern. But there should beone simple, basic parameter for entering a position after the appearance of a buy signal.Are the buyers still present?When do most investors want to buy into a stock? Usually after the price has gone upconsistently for the past number of days or weeks. Finally they become convinced thatthe stock is going to go up forever. That is the reason inordinate amount of volume isusually seen at the tops. Everybody has gained enough confidence to get in. There hasbeen broadcast after broadcast on the T.V. financial stations about how great thecompany or the industry is doing. To not get in means you are going to be left behind. Ofcourse that is just about the top of the run. It starts to pull back because of profit taking.You hang on because after the profit taking, the up trend should continue. However, thepullback lasts a few weeks longer than you expect. Then it moves slowly up to the areathat you bought, bumps into resistance, and pulls back again. Pretty soon you are sittingin a stock that you’ve owned for three months and it still isn’t back to where you boughtit. Not a good return on your invested dollars!Or consider the investor who has a little more thinking in his approach. He is going tobuy a stock he has followed because it has pulled back a hefty percentage. This is at leastmore logical than buying a stock because it has gone up a great deal. But this also has itsflaws if done without using any buying parameters or signals. Enron is a prime exampleof not buying a stock just because it has backed off a good percentage from its high. Theperson buying a stock because it has gone down, without any buying signals, is justgrabbing for the falling knife. One of three things can happen from that point, and two ofthem do not make you money. The price could easily continue its downward trek. Buyingbecause you think that the sellers have sold enough may not be a viable approach. Or thestock price could level out and trade flat for the next six months, not a profitableendeavor.Finally, because you have a wonderful sixth sense, you happened to buy the stock at thebottom and it turned up reasonably quick. If that is the case, you do not want to read thisbook or any book that would screw up that talent.The best investment strategy is to buy a stock that has bottomed and the buying isbecoming more prevalent. Tall order? Not really, when you can visually see the buy5

signs. The probabilities are much greater in finding stocks that are just starting to makean up move. It is better to buy a stock where fresh buying is recently coming into thestock and getting in on strength. Participating with other buyers at least indicates thatthere are other buyers, logical. As in the famous investment strategy of Will Rogers,“Buy stocks that are going up. If they don’t go up, don’t buy them”. As backward as thatphilosophy appears in the real world, the Candlestick signals get investors close to thatconcept.6

How Stocks Open Reveals Huge KnowledgeAfter that wordy dissertation, we now get to the meat of the subject - being aware of howto get into trades properly. What is the message of a “buy” signal? As expressed in the“Profitable Candlestick Trading” book, a signal is the cumulative knowledge of allinvestors participating in that stock that day. If this is the only statement that youremember about Candlestick analysis, you will easily comprehend the ramificationsbehind the signals. A “buy” signal is formed by the reversal of the psychology of adownward trend. That is the formation that becomes visually evident to the Candlestickinvestor.Simply stated, the signal is showing the evidence of buyers coming into a stock, reversingthe previous downtrend. Those signals, 10 major signals and approximately 40 secondarysignals and continuation patterns, can be identified by the Candlestick trader. Asdiscussed earlier, the signals each provide a positive percentage of profitable trades, andbad trades. The best test for determining placing a position from that signal is based uponone simple question. On the open of the next day, are the buyers still there?This may appear to be elementary, but it is the basis for getting into the position in thefirst place. The Candlestick signal represents a change of direction. The magnitude of thepresence of buyers has an important factor on how strong that reversal will be.Figure 1, Pinnacle Entertainment opens near the previous close. This clearly indicatesthat the buyers have not backed away. Witnessing the price advance from the openingtrades reveals that buyers are stepping in without hesitation. Buy immediately. You haveall the parameters evaluated. The probabilities are in your favor. There should be noreason not to get into the position.7

Figure 1, Pinnacle EntertainmentOpening near theprevious close andimmediately headinghigher is considered astrong openNote in Figure 2, Province Healthcare Co. the buyers were still present. The open, byremaining in the area of where the buyers closed the price the day before, indicates thatthere was not a change of heart overnight. “In the area” can mean a slightly loweropening price. Consider the action of the price the day before. It had a big up day. As theclose was getting near, the shorts may have realized that selling was not coming into thisstock. They may have covered, pushing the price up further on the close. Profit taking orsellers still wanting to get out of the stock could lower the price on the open. The nextmorning, prices opening slightly lower and immediately heading higher indicates that thebuyers have not disappeared. As soon as the first few minutes of trading transpire afterthe open, an investor should be able to ascertain how the stock and markets areperforming.If the market is not falling out of bed and the stock price doesn’t appear to want to headlower, it is time to start putting on the position. A prudent method would be to buy halfthe position at the slightly lower level and putting a buy stop at the previous day’s closefor the other half. The rationale being that if the price comes up through yesterday’sprice, the buyers are still present.8

Figure 2, Province Healthcare Co.An open very nearthe previous close isa strong openThe most promising form of evidence that the price is getting strong buyers’ attention isthe gap up. Note in Figure 3, Meritage Corp., a gap up formed. As defined by the gap,(see “Big Profit Patterns Using Candlesticks Signals and Gaps”) the strength from thebuyers is very strong. A gap at the bottom of a downtrend and after a reversal signal isone of the best signs of buying strength possible. One should be committing fundsimmediately.The gap up at a beginning of a trend bodes very well for an extended rally. Whether theindexes are opening up weak or strong, a gap up in a stock requires immediate attention.There is buying going on in this stock that is not concerned about the status of themarkets. Try to get into the stock as fast as possible. The advantage of being able to viewthe bid and ask prices prior to the open is that it prepares you for your entry strategy.Seeing a stock price being bid up before the open, and knowing what a gap up indicatesafter a Candlestick signal, allows you to place a market order on the open.Use that buying force to your advantage. Get in as early as possible. Again, theprobabilities are in your favor and this time the gap is adding to the force of the move.9

Figure 3, Meritage Corp.A gap reveals extensivebuying, get in as fast aspossibleSometimes you are going to see a gap up, you get in and then watch the price head backthe other way. Don’t worry. The buy signal was the reason to buy. The buyers were stillaround to gap prices up. If profit taking occurs after that, no big deal, the buyers are stillaround. Wait a day or two and the signal should confirm itself.A substantial gap up may require watching to see if there is any immediate profit taking.This position might be better entered by buying half the position on the open, and thesecond half after observing the price move. In some substantial gap ups, the openingprice might be the high for that day, creating a black candle. The fact that it had manybuyers and some immediate profit taking still reveals that there was a strong change insentiment.Note in Figure 4, Meridian Gold Inc. how the large Bullish Engulfing pattern clearlyillustrated that the bulls had stepped in. This shows great buying influence. The next daygaps up. This could be the beginning of a very strong rally. This has all the makings of astrong run up. There would be no reason not to get into the position. However, once theposition was filled, the profit taking set in. Is this time to worry? Remember what theBullish Engulfing pattern told you. The buyers were coming into this stock with greatforce for some reason. It would seem very unusual that the next day they would all of asudden disappear. It should not be so strange to see some profit taking after a 10% to15% run up in two days. The underlining factor remains that the buyers have come intothis position with vigor. Sit comfortably for a day or two to see what happens after the10

profit taking disappears. In this case, the strong buy signal was the prelude to morebuying.Figure 4, Meridian Gold Inc.After the huge BullishEngulfing pattern, pricescould either head throughthe roof or see some profittakingThe appearance of a gap up is a clear indication that the “buy” signal is having the followthrough required to sustain a strong rally. Figure 5, The Exploration Co. has every sign ofstrong buying. A Bullish Engulfing pattern is the first signal. The gap up and the strongbuying afterwards is more evidence. There would be no reason for not getting into theposition on the next show of strength.Once you have gotten into the position, the price rolls back. It could be profit taking, orthe rest of the market starting to get weak. Your peace of mind is still in the strong buysignals. As in this illustration, it took a few days for the trend to start back up. Duringthose few days, note that the sellers could not knock the prices down. It may have testedsome nerves, but after 3 or 4 days, the bulls starting gaining confidence the sellers did nothave enough strength to push the price back down. This led to the continuation of theupward trend. It took a few extra days, but that is reality. Some positions look great whenyou get in, but will lag for a few days. But if the message of the signals is correct, thetrend will be continuing. Sometimes that will take patience but the probabilities will be inyour favor.11

Figure 5, The Exploration Co.A Bullish Engulfing patternfollowed by a gap up and a bigprice/volume day is as confirminga pattern as can be expected.Getting in on the next show ofstrength is logical12

BUY on a Strong Open“Buy on a strong open.” What does that mean? Once a Candlestick “buy” signal hasmade itself present, investors want to see one obvious element in the next day’s openprice; that the buyers are still committing. The signal in itself reveals that buyers havemoved into the stock. Will that buying continue? That is what can be easily identified thenext morning.Establishing an initial position requires a small amount of research. What is the directionof the indexes? What is the direction of the sector index most related to that particularstock? How are the other stocks doing, the ones closely associated to the stock you areready to buy?The entry instruction “Buy on a strong open” has two definable variables. What isconsidered “strong” and what is considered the “open”. First let’s discuss the definitionof the open. Some investment gurus recommend not trading in the first thirty minutes oftrading. The volatility is too great during that time. Most traders know that the bestopportunities are produced in the first and last hour of trading each day. Probably morethan 60% of the total daily volume occurs in the first hour and the final hour of thetrading day. The pent-up research of the night before, since the close of the previous day,is implemented during the opening hour of the next day. This is the time to takeadvantage of Candlestick signals.A new dynamic is put into force during the first hour of trading. All the investmentdecision-making processes are put into action with buy and sell orders in the openinghour. The inordinate volume is crossed and matched in market conditions. Once thisvolume is consumed by the joining of buy volume and sell volume, the price will beginmoving in the direction of the remaining order balances. This inordinate volume makesthe first hour more volatile than the other trading hours during the trading day. It alsoimpacts the direction and the magnitude of the move.13

Use Pre-Open Indicators to Improve ProfitsKnowing that the open consists of a period of inordinate volume, the Candlestick investorcan watch the movement of the stock price. If it is consistent with the other factors of astrong or weak open, the trade can either be executed or withheld until the proper factorsare evident.The other factors are simple indicators of what the market direction should be once themarket opens. Each morning the futures can be observed in many places. CNBC has theDOW, Nasdaq, and S&P 500 futures posted in the lower right hand corner of the T.V.screen. If a position is ready to be implemented, it would not be prudent to place the tradeon the long side if the futures were illustrating heavy selling on the open. The signalsneed continuing confirmation that the buyers are still around. Dramatic selling pressureon the futures before the markets open is an indication that the buyers may not want tofight the selling pressure that morning. The direction of the index may be projected byobserving the formations that appeared prior to the next open. If it is expected to be in anupward direction that day, then the futures should be confirming that sentiment in theiractivity before the open.If the direction of the market is projected to go higher, a small pullback of the futuresshould be tolerable. If the futures leave the “open” as questionable, check the pre-openprice of the stock itself. Having software that shows pre-market bid and ask pricesprovides a clear indication of what is happening in the demand for that stock as it getsnear opening time. That will be the most important illustration of how the buyers andsellers are lining up on the open. That does not mean it is the final indication. Sometimesa buyer or seller will commit their buy or sell order immediately after the market opens,not wanting to show their hand too early.If the level of the bid and ask does not produce any concrete decisions, investigate howsome of the same type of companies are acting on the pre-open. If they are opening aboveor below the previous night’s close, that information should add some insight as to howthe stock in question is going to act.The first thirty minutes after the market opens will swing around a bit. Your generalanalysis should have reduced some of the potential possibilities of what might happen thenext day. Logically, you would not be looking to buy long if there was overwhelmingevidence that the indexes were going lower. That is probably why you picked out thepotential long trade in the first place, because you thought the next day had better bullishprobabilities.Buy on a strong open. Your analysis leans toward an “up” day. The stock you are tryingto buy had a bullish signal the prior day. There are four combinations that can occur onthe open:1. The indexes/futures appear to be opening positive. The pre-market indication on thestock price is that it is opening higher than the close of the night before. The buyers have14

not disappeared. This is the scenario that best fits with your analysis. In this case, there isno reason why you would not want to get into the position as quickly as possible. Buy atthe market on the open.2. The indexes/futures are showing strength but the stock position is opening lower thanthe close of the previous day. Analyze the situation. If the “buy” signal was created byextensive buying, which created the signal, some of that buying may have been fearfulshort covering near the close, causing an extra boost in the price on the close. There maybe some traders taking some quick profits off the table, moving the price slightly downon the open. If this scenario happens, watch how the price acts during the early minutesof trading. If there doesn’t seem to be any sustained selling and the rest of the marketseems to be staying strong, pick up a partial position. The “buy” signal showed a reversalthe day before, the market is staying up, and there isn’t any major selling going on in thestock. Anticipate that the lower open was just some quick profit taking. As soon as younotice buying coming in, fill out the rest of the position. Or if you want to be moreconservative, try this strategy. When the price opens lower, put a buy stop at theprevious day’s close. The rationale being if it opened lower but came back up through theprevious day’s close, then the buyers were still around.3. The indexes/futures appear to be opening weaker and the stock price is opening higher.The signal from the previous day is the overriding factor; the buyers are still around. Butthe indexes are not acting well. The buyers of the stock are witnessing the weaker marketindexes also. In this case, watch what the stock price is doing. If it appears that the buyersare coming into the stock despite the lower market in general, then the buying force is notregarding the market conditions, they want the stock. Buy it. Conversely, if the stockopens higher and the market indexes are heading lower, watch to see if the price doesn’tfizzle and start backing off. Lay back for awhile, and see what the markets are going todo for the day. A safe approach under these conditions would be to put a buy stop at theopen price. Again, the rationale being that if the price came up through the open price,the buyers were back in control.4. The worst scenario in the grid is a weak open on the indexes and the stock openinglower. Not too much of a decision here. The trade shouldn’t be considered. But a buystop at the previous day’s close acts as the same beneficial strategy as before. In thissituation, if the markets and the stock price start coming back up before the end of theday, the buyers should be back.The primary element that should go into every entry decision is simple. Is there evidenceof buying present, continuing the trend as indicated by the reversal signal? Being able torecognize which trends are going to get stronger buy participation will increase yourportfolio returns impressively.The signal has indicated the trend has reversed. It may be a slow reversal, or it may be apower move. The signal revealed a new trend was probable. Our e-book “Finding andLearning Candlestick Signals Fast and Easy” recommends reviewing past charts to seewhat signals occur at the reversal points. The same practice can be applied to the same15

charts to become acquainted with the formations seen during the first day or two after thesignal. Learning to recognize how a strong uptrend acts in the early stages of itsdevelopment once again puts the probabilities in your favor. The signals are going toreveal plenty of buying opportunities. How to evaluate the follow through of the signalswill allow you to filter the best of those opportunities.16

Play the ProbabilitiesNot every trade is going to shoot straight up after the buy signal appears. There will bemany entry points that fit the perfect buying conditions, yet fade just after you fill yourposition. Mistake? Depends on how the rest of the day finishes. Will every trade you getinto work the way the signals indicate? Definitely not! But go back to the basics. You arelooking for the best possible place for your money to make the best returns withminimized risk. Hopefully the signal itself is representing well above a 50/50 probabilityof making money. This ratio may be 60%, 68%, or 74%. Fine-tuning the entry processmay increase the probabilities another 3%, 4%, 5%. A good evaluation of the entry alsohas the element of limiting the losses. If a trade is placed, and the basis of being in thetrade disappears immediately, i.e. the buyers have disappeared, then the trade should beliquidated immediately. The loss may only be 1%, 3%, maybe as much as 5% if it isliquidated that day or on the next day’s open.The gains have an opportunity to run when the buy signal is not negated. The losses gettrimmed immediately if the signal fizzles. All from a simple premise, “Are the buyersstill in control”?A good rule of thumb for protecting a newly established position is: If the close of theentry day, the day after the formation of the buy signal, is more than one-half way downthe body of the previous day, close the position. Statistically this represents that thesellers still have the upper hand. However, keep in mind that a buy signal did form at thebottom of the trend. Despite having to exit the trade at a small loss, be prepared to seenew buying evidence soon. If so, re-establish the position. The buy signal occurred forsome reason.It is professed in other investment programs that a stop loss should be put 6%, 8%, 10%behind the price as a trailing stop. Due to the fact that Candlestick signals are not createdby numeric thresholds, a numeric stop is not valid. A trend created by the force of thebuyers over the sellers has nothing to do with a percentage move. It is purely based on thedirectional sentiment of investors. A 10% pullback for some stocks may be an everydayoccurrence. For others a 4% pullback would be unheard of. Analyze what the trend isdoing.The most important area is at the reversal point. Is it a reversal or just a jig in the trend?That is where the analysis and monitoring are most important. A buy signal requiresfollow through. The weight of a sustained downtrend needs strong change of sentiment toreverse its course. If the reversal has only two or three days of up move, don’t be hesitantto take quick profits once a weak signal appears. There may be a more opportune time toget into a position if a pullback occurs. The current low may hold. But if it doesn’t holdand goes lower, you are not in the position. This is true whether you are a short-termtrader or a long-term holder.Figure 6, Hovnanian Enterprises Inc. illustrates the Candlestick investor’s minordilemma. All the parameters say to buy this stock. A Hammer is followed by a Bullish17

Engulfing pattern. The stochastics have turned up, volume is picking up. But the next daythe price opens much lower than what would indicate buyers were still active. What is thebest way to enter this position? Are the sellers taking back control for some reason?Maybe the indexes opened much lower. In keeping with the practice of buying a stockthat is going up, the best entry strategy would be to put a buy stop at the close of theprevious day. If the buyers are still participating, it would be evident if they moved theprice from the lower open back