What is GDP and why is it so important?

The gross domestic product (GDP) is one the primary indicators used to gauge the health of a country’s economy. It represents the total dollar value of all goods and services produced over a specific time period – you can think of it as the size of the economy. Usually, GDP is expressed as a comparison to the previous quarter or year. For example, if the year-to-year GDP is up 3%, this is thought to mean that the economy has grown by 3% over the last year.

Measuring GDP is complicated (which is why we leave it to the economists), but at its most basic, the calculation can be done in one of two ways: either by adding up what everyone earned in a year (income approach), or by adding up what everyone spent (expenditure method). Logically, both measures should arrive at roughly the same total.

The income approach, which is sometimes referred to as GDP(I), is calculated by adding up total compensation to employees, gross profits for incorporated and non incorporated firms, and taxes less any subsidies. The expenditure method is the more common approach and is calculated by adding total consumption, investment, government spending and net exports.

As one can imagine, economic production and growth, what GDP represents, has a large impact on nearly everyone within that economy. For example, when the economy is healthy, you will typically see low unemployment and wage increases as businesses demand labor to meet the growing economy. A significant change in GDP, whether up or down, usually has a significant effect on the stock market. It’s not hard to understand why: a bad economy usually means lower profits for companies, which in turn means lower stock prices. Investors really worry about negative GDP growth, which is one of the factors economists use to determine whether an economy is in a recession.

bse-bombaystockexchange

Bombay Stock Exchange

The Bombay Stock Exchange or BSE as it is most popularly known is the oldest stock exchange in Asia. In terms of listed companies (4, 800 by August 2007), the Bombay Stock Exchange is the biggest in the world. Being located at the Dalal Street in Mumbai, the stock exchange enjoys the benefits of the financial capital of India. The stock exchange was established in the year 1875 as “The Native Share & Stock Brokers Association.” Bombay Stock Exchange is the first stock exchange in India to obtain permanent recognition from the Government of India under the Securities Contracts (Regulation) Act, 1956. The earlier the exchange was operated as the Association of Persons, it is now incorporated under the Companies Act, 1956. In October 2007 the market capitalization of the companies listed on the BSE was US$ 1.61 trillion that have made it the largest market in the South East Asia in terms of market capitalization.

The exchange is managed professionally under the direction of its Board of Directors that is made of eminent people from the industries and commerce and headed by the Managing director and CEO. The Board formulates all the strategies and keeps an over all control on the functioning of the exchange. The policy of the exchange has been formed to ensure optimum integrality and transparency in the processes. The Bombay stock exchange has nation presence in around 417 cities and towns in India. The exchange has been providing the investors an efficient market for trading in equity, debt instruments and derivatives.

The BSE SENSEX that is also called the “BSE 30” is made of thirty scripts. The index is followed extensively in Indian capital market and it is regarded as the index of the Indian capital market. The Bombay Stock Exchange is the eminent stock exchange in India and the SENSEX of this exchange is recognized and followed all over the world. The exchange has played a pivotal role in shaping the capital market in India. The companies that are listed in the BSE index have been changed only a few times and they account for about one-fifth of the total market capitalization of the Bombay Stock Exchange. Though the SENSEX is the primary and the most widely accept index of BSE there are few indices as well, including BSE 500, BSE 100, BSE 200, BSE PSU, BSE MIDCAP, BSE SMLCAP, BSE BANKEX, BSE Tech, BSE Auto, BSE Pharma, BSE FMCG, BSE Consumer Durables and BSE Metal.

 

Profit Trading

Kicker Signals 

 

The Kicker Signal is one of the most powerful Candlestick signals. This is due to the

signal having a gap built into it. In some cases the gap is very obvious. In other cases the

gap is not always recognized by investors.

 

As described in Mr. Bigalow’s book “Profitable Candlestick Trading”, the Kicker Signal

dramatically illustrates investor sentiment has changed. This is usually the result of a

major news announcement occurring overnight. The result of this signal is highly

predictable. The trend is now going to go in the opposite direction. And with enough

force to make it always a worthwhile trade.

 

The description of a Kicker Signal is that the first day of the signal opens and then

proceeds to trade in a specific direction for the rest of the day. The second day opens at

the same level as the open of the previous day. It then proceeds to trade in the opposite

direction of the previous day. On charts other that Candlesticks, it is difficult to see that

there was a definite change of investor sentiment. The two different-colored bodies of the

Candles make it clear the opposite camp has taken over between the bulls and the bears.

The gap when the candles open at the same level is not always recognized in this chart

pattern. The fact that the open on the second day is back at the open of the previous day

means it has already moved from where the price closed that day back up to the open.

 

The bullish signal is very clear in the Cigna Corporation chart, Figure 29. Not only is the

direction completely reversed, it gapped up with enough strength so that there should be

no doubt that the trend is not going to go higher.

 

This will also elicit the “chasing a stock” response from most investors. If you know what

this type of move represents, you should have no fear of buying at those higher prices.

 

Figure 29 – Cigna Corporation 

 

The visual interpretation of the chart is clear. The trend was definitely down. The news

announcement was apparently completely unexpected and very favorable for the

company. Will prices go straight up after a Kicker Signal? Not necessarily, but it is

advisable to sit through whatever waffling may occur after the signal. The signal itself

depicts a strong change in investor sentiment. Sometimes that change of trend may have

to sop up the opposite stock before the trend gets to proceed.

 

Figure 30 – Gemstar TV Guide Intl. Inc. 

 

 

The observant investor can easily locate the Kicker Signal. TC2000 has very easy search

programs that can be formulated and implemented. (See how to subscribe to TCNet on

our website, www.candlestickforum.com ) The trader would be well-advised to search

for  Kicker Signal formations every day.

 

As seen in the Gemstar TV Guide Intl. Inc. chart, Figure 31, the Kicker Signal, although

small, did change the trend direction. As professed by the Japanese about the Doji,

always pay attention when you see it.  The same should be said for the Kicker Signal,

always take notice of this formation.

 

Note in Figure 32 – ISIL, Intersil Corporation, had a close semblance to a Kicker Signal.

Despite the open not being at the exact identical open, the fact that the price gapped back

up to almost the same opening price was warranted by the strong buying through the

remainder of the day.

 

Figure 33 – Coca-Cola Corporation 

 

The Kicker Signal is as effective to show inordinate selling as it does buying. Note in

Figure 33, Coca-Cola, the signal is formed by the gap down from the previous close to

open at that candle’s open and go the other way. Again, this would not be as clearly

defined on a Western Bar chart. The opposite colors and the opposite direction are better

seen on the Candlestick chart.

 

Kicker Signals do not occur very often. But when they do, they will add great value to

your portfolio. Having the faith that a gap in the opposite direction is not something to be

afraid of but something to be exploited will multiply your earnings many fold. The fact

that a price has already moved 5%, 10%, 15% in the other direction should not be a

reason to refuse to get into a position. The move should be the impetus for getting into

the position. The trend changed and moved dramatically in the other direction for a

reason. Buy the stock. Get rid of the investment psychology that you want to buy the

position if it pulls back to let you in. That is the exact opposite of why you want to get

into a position. Buy the position because you saw that the buyers are in with full force.

You want to be in that run.

 

Summary    

 

Gaps have always played an important part in technical analysis. The movement away

from the previous trading range signifies an extraordinary shift in investor sentiment.

This shift can be more in the same direction as well as a complete reversal of the existing

trend. Most important is that a gap has many ramifications. As illustrated in the book,

gaps identify the force that can start a strong rally, or it can signify that final gasp of

enthusiasm. The Japanese observed these movements over hundreds of years and

accurately identified the results when combined with the signals.

 

With today’s computer capabilities, it is easy to do searches that specifically track

gapping situations. Investing in these situations alone can make for a high-profit trading

program. Putting the probabilities heavily in our favor, using Candlestick signals to

identify a direction and a gap demonstrating inordinate force, will provide a source of

profitable trades that no investment advisor is capable of doing. Most investors search

years for an advisor, broker, newsletter, or guru that will lead them to consistently

profitable trades. The well-versed Candlestick investor has a constant treasure trove for

generating big profits. These are not hidden secrets. Yet, the combination of these

investment tools have not been utilized by most investors. Having the backup of centuries

of actual participation in this profitable combination takes the guesswork out of

investment decisions.

 

The Candlestick Forum, distinguishes itself from other

Candlestick sites by enlightening investors to the actual implementation of profitable

Candlestick trading strategies. Our soon to be published “Formulas for Major Signals

Using TC2000” will describe how to develop your own search programs using the

effective TC2000 search software. When able to do your own searches, the formulation

of gap searches will put you in charts that have a strong move capability.

 

Isn’t that the foremost purpose for your investment plan, finding the best possible places

to put your funds?  Remember, these signals, formations, and philosophy are not the

results of some quick, thrown-together back-tested investment program. The investment

concepts portrayed in this book are the results of hundreds of years of visual observations

confirmed with actual profitable experience. Once you have observed the results of a gap

up discovered by your search, you will lose past thought processes such as “it is not wise

to chase a stock”. A gap up is the indication that a new trend may be starting when it

occurs at the bottom. It also warns the investor when the exhaustion buying is occurring,

showing the end of the trend.

 

You can exploit profits that the common investor will shy away from. You will find

profitable trades that most investors do not fully understand. Your wealth will be

multiplied by common sense placement of funds, the same opportunities that the rest of

the investment community has been advised to avoid. You have this knowledge. Use it. If

you are a member of the Candlestick Forum, utilize the expertise of the staff.

Bottom Trading

An easy-to-see, obvious reversal is the Island Reversal. It provides a dramatic reversal in 

that the enthusiasm that sent a price in a particular direction is countered with the same

enthusiasm going the other way. In the example of Orbital Sciences Corp. ORB,

Figure 29, the up-trend can be easily seen. At the top, after the buying enthusiasm created

a long bullish candle, the price gaps up away from the previous trading. This really

demonstrates that the enthusiasm had reached an apex.

 

But upon inspecting the formation that it made, a long-legged Doji, the Candlestick

investor should have been alerted to the indecision that was illustrated during this gap up.

The following day did not show any evidence that the buyers were still present. This

would have been further warning that the blow off top was in place. Finally the gap back

down illustrates the great enthusiasm to get back out of the stock. This is an Island

Reversal, usually very accurate and powerful.

 

Figure 29 – Orbital Sciences Corp. 

An Island Reversal doesn’t have to be a quick move. Note in the Circuit City chart,

Figure 30, how the gap down was countered with a gap up over six weeks afterwards.

This formation indicates to the long-term investor that a new long-term trend has started.

The gaps on both sides of the bottom trading area make the Island Reversal an easy-to-

see situation.

Figure 30 – Circuit City 

As long as the gaps remain unfilled, the trend should remain up.

 

Bad News Gaps 

 

The ultimate poop trade! 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 earnings 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 trader

bought the stock a few days back, due to specific parameters for making that trade. He

should consider liquidating the trade immediately and move his 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. 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, Figure 30, 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 anticipating the coming news. As

can be seen in the IBM chart, the price had been declining Figure 30 – IBM

 

 

 

 

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 diehards who held on until the bad

news was reported. As the chart shows, the final gap down produced a long legged Doji,

indicating massive indecision. From that point the buyers and the sellers 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.

 

Now let’s look at the fundamental input. IBM, a major U.S. company, well respected,

known to have excellent management. And like any other quality company, it has made

marketing or production mistakes from time to time through the years. The

announcement  made that knocked the price down, whether it was a 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

been already 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 where it last gapped down, approximately $100. This still provides a 15%

return.

 

You can chart your own course through common sense analysis. 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.

 

BKS, Barnes and Noble, Figure 31, has a completely different scenario. Notice it was in

an uptrend, just about ready to break out to new highs when it had bad news reported.

With the trend being up prior to the announcement, it appears that the announcement

came as a complete surprise. This should imply that if you are in the position, get out

immediately. There will be no telling what the reaction will be. In this case, the sellers

continued to sell on the big down day after the announcement.

 

Being out of the position now gives you a better perspective as to what the news will do

to the longer-term trend. It took only the next day to see a Doji to be prepared to get back

into the stock. For the longer-term investor, this becomes a good place to start building

another position. The buyers start becoming evident on the next day after the Doji. A

purchase at this level creates a relatively safe trade. A stop at the lows is a logical point

for getting out. The rationale being that if those levels did not support, the sellers were

still in control.

Figure 31, BKS Barnes & Noble 

 

On major gap down days, major being a 20% down move or more, there is always the

initial 30 minutes of churning. The traders who were short start buying to cover, while

the sellers are unloading. After that period, the buyers or the sellers will start to

overwhelm the other side. This is where an immense amount of information will be

revealed. If the price starts acting weaker, the news still had sellers participating. If the

price starts up, that would indicate that the news scared out the weak holders and did so at

the level where the buyers felt it was oversold, and they stepped in immediately to buy

the bargain. This should reveal to the Candlestick investor that the white candle forming

represents a buying level. Hold on to the position for awhile. It is not unusual after a

major gap down to see the price move back up to the area from where it gapped down.

This would occur over a six to twelve week period. Still not a bad return, 20% to 30%,

over that time frame.

Market Movement

The J-Hook Pattern 

 

The J-Hook Pattern is another example of being alerted when a gap up could occur. The

J-Hook Pattern occurs after a trend has had a fairly strong run up. It backs off for a

period, most likely profit taking. The stochastics do not get back down to oversold, they

start leveling out and curl back up near the 50 area. As the price stabilizes and starts back

up, the previous high becomes the logical target. This is the prime time to look for a gap

up. The buyers, who saw the price have a strong move, then see it pull back, are now

seeing it stabilize and try to move higher again. Once they become convinced that the

sellers have been exhausted, the buyers will come back into the stock with confidence.

This new confidence, the appearance of a gap, could be strong enough to breach the

recent high and take prices up to new levels.

 

Figure 28 – D.R. Horton Inc. 

 

D.R. Horton Inc. is an example of gaps playing an important part in recognizing when the

next run-up will occur. Once the initial run up had run its course, the consolidation period

or the hook area didn’t allow the stochastics to get down to the oversold area before

turning back up.

 

The J-Hook Pattern is also a function of what the markets are doing in general. It is not

unusual for the price of a stock to rise with the markets, pull back with the markets, then

resume its uptrend when the market starts heading up again.  But these stocks usually act

with greater volatility than the market in general.

 

Identifying the J-Hook Pattern requires a minor amount of previous visualization. After

seeing a major run-up in a stock price, then witnessing “sell” signals, makes for a good

profit taking period. However, if an uptrend has been reasonably strong, without many

zigs and zags, it is definitely profitable to keep monitoring that stock after the pullback

has started. Depending on market conditions, considering that the stock is selling off but

that the markets in general are still holding their own, it is worthwhile to check the

progress of that stock for the next week or so.

 

After the “sell” signal and seeing that the stochastics have turned back down, the

potential for a J-Hook Pattern to form is always there. About the third or fourth day,

investigate to see if the stochastics are showing signs of leveling out. This may be

occurring when the stochastics are in the 50 area. If so, watch for Candlestick buy signals

forming. The signals will usually be smaller in size compared to a full-fledged bottoming

signal. For instance, a series of small Hammers may form for a few days at the same

price area. This starts to flatten the trajectory of the stochastics. After this stabilization

period, a small Bullish Engulfing pattern may appear. Buying in at this time produces two

possible profit potentials. First, it is likely that the price is now going up to test the recent

highs. This may be a 4%, 8%, or 10% move in itself. The second potential profit is

breaking through the recent high and having a strong run up. A gap up at or near the

previous highs indicates that the buyers are not concerned about the recent high acting as

a resistance level.

 

Review the Tiffany & Co. chart, Figure 28a. After an extended uptrend, the stock ran into

selling (profit taking) at the $30.00 area. It pulled back to about $27.50 when buying

seemed to start supporting the price. It became evident that the selling had waned. As the

pullback flattens out, it appears as if the buyers are starting to step backing at around

$28.00. Buying at these levels gives the investor the potential to make $2.00, or about 7%

profit over a three or four day period. As can be seen in this example, once the price got

back to the highs, the stochastics had some juice left in them. At this point, watching the

market direction in general should have been built into the decision of whether to

liquidate or hold. If the market movement was stable to upward, then holding at the

resistance level of the previous high would be warranted.

 

The gap up to a new trading range was evidence that the sellers were not going to stand in

the way. Unless something severe is taking place when the gap up occurs, such as a

severe drop in the market or a surprise announcement about the company or the industry,

anticipate seeing the buyers continue to move the price higher.

 

 

Figure 28a – Tiffany & Co. 

 

The J-Hook does not have to be a complete retracement to the recent highs to have a gap

effect the break out. Note in the Monaco Coach Corp. chart, Figure 28b, how the gap up

occurred prior to actually getting to the previous high.

 

Figure 28b – Monaco Coach Corp. 

 

 

Hopefully the Candlestick investor would have been in the position after the Hammer

signal. The gap up to new highs simply indicates that the high was not going to act as a

lid on the price, giving buyers new impetus to take prices even higher.

 

Figure 28c – Jones Apparel Group 

Jones Apparel Group, Figure 28c, provides an obvious visual depiction of the prices

gapping up at the previous high. The alert investor would have been in near the $26.75

level, upon seeing the Inverted Hammers slowing down the pullback.

 

Participating in the J-Hook Pattern usually requires being familiar with the price

movement of a stock. It is difficult to write a search program that would encompass all

the parameters describing a J-Hook Pattern. The easiest method for locating this pattern is

to watch for an extended uptrend that is now in a pullback.  The aggressive trader will

want to get in as the pullback levels out. The more conservative investor will want to get

in upon seeing a gap up as the trend is heading back up, especially if the previous high is

within a reasonable range.

 

Being educated in Candlestick signals produces the extra advantage that other trading

methods do not provide. This additional knowledge rewards you by illuminating

profitable trade set-ups. You gain the benefits of always having profit potential that other

investors cannot see. You can be racking up profits when the majority of investors are

just getting what the market will give them. Even in difficult markets, you will be able to

generate profits.

Investment Strategy

San-Ku  – Three Gaps Up 

 

As mentioned in Japanese candlestick analys is, the num ber three plays a very relevant

part of the investment doctrine. Many of the  signals and formations consist of a group of

three individual signals. It has becom e a  deeply rooted num ber for the Japanese

investment com munity whether applied to Ca ndlestick analysis or not. This creates a

highly profitable investment strategy when applied to Gaps or Windows.

 

San-ku provides the best opportunities for buyi ng and selling at the optim al points in

time. After observing the bottom ing signals, the  first gap (ku) indicates that the buyers

have entered the position with force. The s econd gap indicates further enthusiasm  for

getting into a stock position. This should have  a mixture of short covering involved. The

third gap is the result of  the bears f inally realizing that this is too f orceful for them to

keep holding short positions, they cover al ong with the later buyers. Upon seeing the

third gap up, the Japanese recom mend that th e position be closed out, take the profits.

This is due to the price having probabl y reached the overbought area well before it

should. The presence of three gaps up probably has resulted in very good profits over a

very short period. The same parameters will occur in the opposite direction, in a declining

price move.

 

Note in Figure 22 – URI, United Rental Inc., how the first gap demonstrated that the

reversal picked up a lot of strength, buyers gapped up the price and it closed at a high for

many months. A few more days of buyers showed that the price was not going to back

off. This led to another gap up, probably the shorts deciding that the trend is now firmly

against them. After a couple of more days of no real weakness, the price gapped up again.

Panic short covering? Also the Japanese rule suggests, sell after the third gap up. In this

case, selling on the close of the third gap up day would have gotten you most of the gains

possible from this trade. There was a day or two that you could have gotten a few

percentage gains more, but why risk it? The Japanese have watched these moves for

hundreds of years. Why try to squeak out a few more percentage points profit? 28% in

the couple of weeks should be plush enough. Go on and find another trade that is starting

at the bottom.

Figure 22 – United Rental Inc. 

 

 

The same dynamics can be seen in the Inge rsoll-Rand Ltd. Chart. In Figure 23, the first

gap broke out prices above the recent hi gh, the second gap still shows strong buying and

the close of the third gap up day is as good a spot to take profits as any.

 

Figure 23 – Ingersoll-Rand Ltd. 

 

One more illustration shows the factors at work in a San-ku formation. Note in the

Maytag Corp. stock price in Figure 24, the initial gap up should have prepared the

Candlestick investor for the possibility of the exhaustion gap. However, this stock price

opened and steadily moved higher, not affecting any stops. As it closed near its high for

the day, a white Maruboza, a bullish continuation pattern, should have now alerted the

Candlestick investor that the buyers were still around in force. The second gap up now

makes the investor aware that a San-ku may be in the making. As evidenced in the last

two examples, selling after the third gap up, although more lengthy a period than the

previous examples, would have captured a great majority of the potential of this move.

 

Figure 24 – Maytag Corp. 

 

 

 

Having the knowledge of what should occur after gaps provides that extra advantage.

Most investors are leery of gaps because th ey don’t understand all the ram ifications gaps

introduce. This allows the Candlestick invest or to exploit m arket m oves because the

majority of the investment community does not understand how to use them . The San-ku

formation can get investors in when m any investors would be afraid to chase a gap up or

gap down. It also gets the Candlestick invest or out at the appropriate tim e where other

investors would hold too long and not get the best return on investment.

 

Breakouts  

 

As revealing as the gaps are for alerting when  a major run-up is about to occur, it is even

more beneficial to know when the gap is a bout ready to occur. There are particular

patterns that forewarn when a gap is likely to occur. And when they do, it m eans that a

whole new trading area is going to be reach ed. Having this forewarning perm its the

investor to be ready to get into the trade at the optim al time and have the funds available

to take advantage of the profitable move that it initiates.

 

Note how the gap up at a level that had not been breached for a couple of months now

indicates the buyers not being apprehensive about buying above the past highs. This

easily reveals that the price is going to new levels.

 

Notice the breakout in Figure 25 – DCN, Dana Corp.  DCN starts its major run once it

broke out of a trading range over the past two months. The gap is the alert. The gap up at

this important level is a profitable transaction. In this example, volume had a great

increase once the new trading levels were reached. Stochastics stayed up near the

overbought range but they do indicate that they are pointing up when this new move

starts. The protective stops, placed on a gap up day near the highs, would not have been

affected with the price continuing higher.

 

Figure 25 – Dana Corp.  

The Prepaid Legal chart, Figure 26, is a chart that one could anticipate a gap occurring.

The best entry level was the confirmed Inverted Hammer pattern with volume

dramatically increasing over the next few days. As the price came back up towards the

trading area of $22.00, it was feasible that if the price broke that level, it could head much

higher. The appearance of the gap should have been an immediate indication that buying

was coming into the stock. The long bullish candle would have revealed that the old

trading levels were now being disregarded, new buying dynamics were in the stock price.

 

Figure 27 – Cooper Tire Company   

 

Despite the very small gap in the price rise of Cooper Tire’s stock move, it still indicated

strong buying even after a strong up day. The fact that the buying after the gap up took

prices to new highs would have alerted the Candlestick investor that a new level should

be reached.

 

All of the above examples had chart set-ups that would leave room for anticipating that a

gap up could occur. All illustrate that when a gap up is noticed, new buying strength is

involved, moving prices up to much higher prices.

Investment Technology

As always, there are exceptions to all rules. The Gapping Plays are those exceptions. As 

previously discussed, the gap at the top of a trend is the exhaustion gap. The same is said

for the gap at the bottom of a trend. The appearance of those gaps is either the last gasp

exhilaration (at the top) or the last gasp panic (at the bottom). However, the Gapping

Plays represent a different set of circumstances at the top or bottom.

 

After a strong run up, it is not unusual to see a price back off and consolidate before the

next leg up in a rally. This could be in the form of a back off in price or a backing off

from further advance. The latter is a period of the price trading flat at the high end of the

previous uptrend.  After the flat trading period, a new burst of buying, causing a gap up,

illustrates that the buyers have not been discouraged. This new buying is evident by the

gap up. As a gap expresses enthusiasm, this is usually the reinstatement of the previous

move, taking prices up to a new level.

 

As seen in Figure 16 – ITG, Investment Technology, the gap up after prices had stayed

flat and at the top end of the last large white candle, for about a month and a half, finally

convinced buyers that the sellers were not around. The gap up should have alerted the

Candlestick investor that prices should be moving up to a new level. This becomes a

High Level Gapping Play.

Figure 16 – Investment Technology 

The same is true for a declining trend. After a significant downtrend, prices level out.

Once the sellers are convinced that there are no buyers around to move the price up, they

can sell again with confidence. This confidence is seen in the gapping down of price. At

that point, much lower prices can be expected.

 

As seen in Figure 17 – PCSA, Airgate PCS, after the price dropped dramatically, the

buyers and sellers have a few days of indecision. The prices remain flat for three or four

days. But after the sellers realize that the buyers are not strong enough to get the prices to

move back up, they get out with force. This is known as a Low Price Gapping Play.

 

Dumpling Tops and Fry Pan Bottoms 

 

Sometimes a gap or window is required to demonstrate that the price move is picking up

steam. Otherwise, the move may not create any signs that a move is forming. The best

illustration is the Dumpling Top. The slow curvature of the top would not attract any

attention. However, being prepared for a gap down allows the investor to make profits

that otherwise would just blend into the trend with no great expediency needed.

 

Figure 18 illustrates the Dumpling Top. The Gap is the crucial sign in this pattern. Once

the gap occurs, the downtrend should prevail for a number of days. Prior to the gap, there

is so little price volatility, nobody would be interested in what was occurring in this

stock. The Candlestick investor gets a forewarning of a profitable trade.

 

Figure 18  – Dumpling Top. 

Note in Figure 19 – CMH, Clayton Homes, Inc., that the trading became listless until the

gap down instigated a sell off.

 

Figure 19 – Clayton Homes, Inc. 

 

Just as the gap down is the main initiative for expecting the downtrend after the

Dumpling Top, the same is true for expecting an up-move after a Fry Pan Bottom. The

Fry Pan Bottom gets its name from the slow gradual curve made at the bottom of a trend.

This provides a lot of time for the sentiment to change from bearish back to bullish.

 

Figure 20 – Fry Pan Bottom. 

 

As the change becom es more bullish, the bulls f eel more confident that all the selling is

gone. This leads to some exuberance into getting back into the position. Upon witnessing

this gap up, the Candlestick investor should  be willing to com mit funds as fast as

possible. It usually signifies the beginning of a new trend.

 

Note in the New Focus Inc. chart, Figure  21, how the bottom  slowly curved back up as

the selling diminished and the buyers began to build confidence. The sm all gap up on the

ascending side of the Fry Pan alerts the i nvestor that the buying is now getting m ore

enthusiastic. This is the spot that a Candles tick investor wants to com mit funds to grab

some of the 100% gain over the next few weeks.

 

Having the foresight that the slow curving  moves are not just dull m arket conditions

creates an opportunity for the Candlestick invest or to be ready for that telltale gap. Once

the gap appears, putting money into that trade maximizes the returns by being in the trade

as it is now moving.

 

Figure 21 – New Focus Inc.  

 

As witnessed in both the Dum pling Top and the  Fry Pan Bottom, the gap is the alert that

the trend has started, and started with m ore force behind it than what had been witnessed

prior to the gap. Having the foresight to r ecognize the forming of a Dumpling Top and a

Fry Pan Bottom  creates the opportunity to ge t into a position that is able to produce

profits immediately. The appearance of the gap is the best spot to exploit the new strength

in a move.

Selling Gaps

Now turn the tables over.  The same enthusiasm demonstrated by a gap to the upside is 

just as pertinent for sellers on the downside. A gap down illustrates the desire for

investors to get out of a stock very quickly.  Identifying clear Candlestick “sell” signals

prepares the investor for potential reversals. The Doji at the top, Dark Clouds, Bearish

Engulfing patterns are obvious signals to be prepared for further downmoves. The Doji is

the best signal to witness a trend reversal.

 

The Doji should stand out at the top of a trend just like a blinking billboard. Note the Doji

at the top of the ISSI, Integrated Silicon Solution chart, Figure 13. The Candlestick

investor would have already been prepared upon seeing that a Doji was forming that day

as the close was getting near. At worst, the position should have been liquidated when the

pre-market indications showed a weak open.

 

Figure 13 – Integrated Silicon Solutions  

 

The existence of the gap down demonstrates an urgency to get out of this position. Being

prepared for this event prevented giving back a major portion of profits.

 

Illustrated in the ASTSF chart, Ase Test Limited Ord Shr, Figure 14, the gap down

confirms the downtrend a day later after the appearance of the Doji. A clear Evening Star

signal requires the black candle after the Doji to close more than half-way down the

previous large white candle. In this case, it closed right at the midpoint, still leaving some

doubt as to whether the uptrend is truly over. The gap down the following day confirms

that the sellers are now in control.

 

Knowing the simple description of the signals gives the candlestick investor that extra

head start in preparing to take profits or go short.  Utilizing the statistical probabilities of

what the signals convey allows the mental, as well as the actual preparedness. The ease of

identifying a gap, and knowing what messages a gap conveys, instigates the investor to

change the position status immediately.

 

 

Figure 14 – Ace Test Limited Ord. Shrs. 

These are examples that demonstrate the obvious benefits of what the windows /gaps

portray. However, there are many more situations where they provide important

investment decision-making aspects.

 

For example, review the Toll Brothers chart, Figure 15, April of 1999. Notice how the

initial gap acted as a support level. In the weeks after the gap up the price would come

back to the top of the gap but would not close lower. As long as the gap was not filled,

the uptrend stayed intact. This is a good rule of thumb. If a gap cannot be filled, the

predominant trend will continue. The Japanese term for filling a gap is anaume.

Knowing that a gap will act as a support or resistance level gives the Candlestick investor

time to prepare when one of these levels is approached. The condition of the Stochastics

and the potential set up of another reversal signal informs the investor as to whether that

gap is going to act as a support or if the gap will be filled. This may be occurring at a

time when no other technical indicators are present in that price area. Note how the gap

acts as a support level in the Toll Brothers chart. Each time price dipped to this level, the

buyers stepped in and would not let the price fill the gap. This should obviously become a

support consideration.

Gaps At The Top Of A Trend

A gap that occurs well after the beginning of a trend reversal, where stochastic are still

in the midrange of an uptrend, has different implications. How do you distinguish

whether a gap is a potential measuring gap? Evaluate where the stochastic are in the

trend. If they are still relatively low, the trend has more room to create another gap before

getting to the overbought area. Note in the CTX chart, Figure 9 – Centex, how the trend

started with a small gap up. The next few days, another gap forms, in the midrange of this

trend. The bears could not push prices back down through that gap over the next few

days.

 

Figure 9 – Centex  

Eventually the bulls gapped up the price again. Notice that the beginning of the trend up

to the first gap [B] is about the same price movement as the move after the second gap to

the top of the trend [A]. This simple measurement gives the gaps their name. The telling

ingredient is the fact that the bears could not push prices back down through the first

measuring gap. That factor gives the bulls renewed confidence and they step back in. The

next day they gap it up again due to not being afraid of the bear camp.

 

Gaps At The Top 

 

The gap that appears at the top of a trend is the one that provides the ominous

information. Remembering the mental state of most investors, the enthusiasm builds as

the trend continues over a period of time. Each day the price continues up, the more

investors become convinced that the price is going to go through the roof. The “talking

heads” on the financial stations start to show their prowess. They come up with a

multitude of reasons why the price had already moved and will continue to move into the

rosy future.

 

With all this enthusiasm around, the stock price gaps up. Unfortunately, this is usually the

top. Fortunately, Candlestick investors recognize that. They can put on exit strategies that

will capture a good portion of the price move at the top. Consider the different

possibilities that can happen when witnessing the gap up at the top of a sustained uptrend.

Most of the time the gap will represent the exhaustion of the trend, thus called an

Exhaustion Gap. Or it could be the start of a Three Rising Windows formation. Or big

news, a buyout or a huge contract is about to be announced.

 

What are the best ways to participate in the new potential, if there is any, at the same time

knowing that the probabilities are that the top is in? A few simple stop-loss procedures

can allow you to comfortably let the price move and benefit from the maximum potential.

Hopefully, in the description of the gaps occurring at the exuberance of an extended

trend, you have already experienced a substantial gain in the position. Any gap up is

adding to an already big gain. Probabilities dictate that this is the top. Possibilities could

include more upside gains.

 

Upon a slight to medium gap up, the Candlestick investor should put their stop at the

close of the previous day. The thinking being that if the price gapped up, indicating that

the top is in, and the price came back down through the close of the previous day, the

buying was not sustained. If so, the stop closed the position at the level of the highest

close in that trend.

 

Look at Figure 10 – NXTP, Nextel Partners Inc. If you had bought the stock the day after

the Harami signal, showing that the selling had stopped, the open may not have been the

strength wanted to show that the buyers were stepping in.  After the price opened lower

the next day, not showing resumed buying, a good spot to put the “buy stop” would be at

the closing price of the previous day. The thinking being that if the price, after opening

lower, came up through the closing price of the previous day, then the buyers were still

around. Buying price = $4.50.

 

After a few weeks, the price starts to accelerate and finally they gap it up. News was

probably looking very rosy at this point. Now the Candlestick investor is prepared.

Knowing that a gap up at the top indicates that the top is near, they can implement

strategies to maximize profits. Most investors will know that their position is up almost

100% in three weeks. That is not the type of move that will be missed by most. Upon

seeing the bigger price days and volume picking up, the Candlestick investor will be

ready for any sell signals that appear.

 

When the gap open appears, a number of strategies can be put in place. First, a stop loss

can be put at the closing price of the previous day. If prices start falling off immediately

and come down through the previous day’s close, then the bears have taken control. You

are out at the high close of the uptrend. In this case, as the price moves up, it would be

safe to put a stop at the open price.

 

Figure 10 – Nextel Partners Inc. 

 

A fundamental change might be in progress. The same rationale as putting a stop loss at

the previous day’s open, if the price comes back down to and/or through that level, the

sellers probably have taken over control. Otherwise, if the stock price continues higher, it

may stay in a strong spike move for the next few days. Knowing that the stochastics are

now well into the overbought area, and the price was running up after a gap, selling one

half of the position would be a prudent move. Probabilities say that this is near the top.

There is always the low percentage possibility that new dynamics are coming into the

stock price, an announcement of a new huge contract or a possible buyout offer,

something new and different from the dynamic that ran the price up to these levels in the

first place. A surge of buying may create a “Three Rising Windows” pattern, moving

prices to much higher levels. The probabilities of this occurring at the top of a trend are

very small but feasible. Moving the stop losses up to each close or next day’s open price

maximizes the potential profits from that trade.

 

As seen in NXTP, a Shooting Star formed, definitely a sell signal. If the price opened

lower the next day, the position should be liquidated immediately. That is what the

Shooting Star is telling you, that the sellers are showing up. The next day opened higher

and stayed up all day. Things still look good. However a Hanging Man formation appears

the next day.  This is where the Candlestick investor should be thinking, “a Shooting Star,

a sell signal, now a Hanging Man, another sell signal, be ready to get out.” The next day

after the Hanging Man, a lower open should have instigated the liquidation of any

remaining position. At worst, the average selling price should have been in the $8.10

area. The gap was the alert signal that positions should be liquidated. This trade produced

an 80% return over three weeks. Now go find another bottom signal.

 

Figure 11 – Omnivision Technologies Inc. 

 

 

 

Figure 11 – OMVI, Omnivision Technologies Inc. demonstrates a gap open at the top

with absolutely no follow through. This is when having a stop at the previous day’s close

will be the best exit. Whether the position was established at the breakout gap or the Tri-

Star pattern, the profits were substantial. Being prepared for the gap up was the profit

maximization technique.

 

If the gap up is substantial, after a long uptrend, it might be prudent to liquidate one half

of the position immediately. The remaining position would have a stop placed at the

previous day’s close. If the price pulled back to the previous close, again it would be

apparent that the sellers had stepped in after the gap up. The method locked in a price

above the highest closing price of the trend.

 

Illustrated in Figure 12 – MGAM, Multimedia Games Inc., the end of the up move was

foretold by a large green candle forming after a run up, then a gap up follows. This

should have alerted Candlestick investors to start profit taking. It produced a good 33%

profit in a just over a week. Now go find a low risk bottoming trade again.

 

Figure 12 – Multimedia Games Inc. 

 

 

If the gap is up substantially, and it continues higher, put the stop at the open price level.

On any of the scenarios described, the price moving back to the stops would more than

likely create signals that warranted liquidating the trade, forming Shooting Stars, Dark

Clouds, Meeting Lines or Bearish Engulfing patterns. In any case, sellers were making

themselves known. It is time to take profits in a high-risk area and find low-risk buy

signals at the bottom of a trend.

Gaps at the Bottom

Figure 5 – Standard Pacific Corp. 

Many investors are afraid to buy after a gap up. The rationale being that they don’t like

paying up for a stock that may have already moved 3%, 5%, 10% already that day.

Witnessing a Candlestick “buy” signal prior to the gap up provides a basis for

aggressively buying the stock. If it is at the bottom of a trend, that 3%, 5%, 10% initial

move may just be the beginning of a 25% move or a major trend that can last for months.

 

Huge gains can be made by finding and knowing the significance of a candlestick signal.

Figure 6 – XMSR, XM Satellite, has signs of bottoming in early April, 2001. The Homing

Pigeon, a form of Harami, shows the selling has stopped. A small Hammer, then a

Doji/Hammer should be evidence that the sellers are losing strength. The Doji/Hammer

should produce an alert that there is major indecision going on at this point. Watch for a

strong open the next day.

 

Figure 6 – XM Satellite 

 

The bigger the gap up, the more powerful the new trend will be. This was evidenced by

another small gap up a few days later. Traders may have gotten out at the $8.00 range,

still a good return. The longer-term investor should have gotten out at the $16.00 area.

The $12.00 area could have been scary, but notice that after a gap up at $12.25, the lower

close still didn’t come into the last white body’s range. The next black candle also didn’t

close in the white candle’s range. Profit taking. The bears could not move the price back

to the big white candle’s trading range. The bulls took note of this and came back strong

after their confidence was built back up. This moved prices to the next level. When prices

gapped higher at the $16.00 range, then gapped down from that level, the selling was

picking up strength. If the position was not liquidated then, it would have been logical to

do so a few days later when a new high was not reached and an Evening Star formation

was seen. Getting out at $15.50 around 5/23 would have produced a very nice 300% plus

profit for a little under two months time.

 

That is what you use Candlestick analysis for. Getting rid of the losing trades quickly.

Finding and exploiting the maximum gains from the good trades. Finding! An important

element. The gaps produce the opportunities.

 

Coach Inc., Figure 7, illustrates when a trend is starting out strong. Late April, 2001

shows bottoming, a couple of Dojis appearing. If investors had been observing these

signals, they would want to see bullish signals confirming the reversal. The gap open to

$26.00 would have the Candlestick investor getting in on the open. Over the next 7

 

trading days, the trader could have realized a 27% gain. The long-term investor would

have more than doubled those gains over the next few months.

 

Figure 7 – Coach Inc. 

The Morning Star signal is an obvious visual reversal signal. A more potent signal is the

Abandoned Baby signal. This is formed by the sellers gapping down a price at the bottom

of a trend, trading through a day of indecision with the bulls, then the bulls taking over

the next day, gapping prices back up and moving them higher. The bigger that gap, the

more powerful the next up move.

 

As seen in Figure 8 – MERQ, Mercury Interactive Corp. during the early days of April,

2001, had a day where prices gapped down at the end of the downtrend. The weak sellers

finally give up and get out at the bottom. They are met with bargain hunting bulls. The

trading that day forms a Spinning Top, a day of indecision, almost like that of a Doji.

 

Figure 8 – Mercury Interactive Corp.  

 

Quite often you will witness a big volume day during this three-day period. It is most

effective if it occurs on the indecision day, showing an inordinate amount of stock

moving from the weak traders to the strong traders.  The big volume day can still occur

on any of those days. What is most important is to see this big amount of stock change

hands at this bottom period.

 

When the stock price gaps back up after the indecision day, this illustrates the sellers are

now finished and the bulls have taken control. Again, measuring gaps are seen in this

example, creating the opportunity for the trader to make 73% in about two weeks.

 

Example after example can be given on how a gap up at the bottom can produce big

profit opportunities. But just as gaps tell you something as they occur at the bottom

moving back to the upside, they are just as informative for preparing the investor to see

when a downtrend is ready to reverse.

 

Reviewing some of the observations that Candlestick analysis reveals, as found in

“Profitable Candlestick Trading”, the Japanese could not only identify when a reversal

was occurring, they could describe the trading environment that would anticipate the

reversal. For example, using candlestick formations, it was clearly obvious that after an

extended downtrend, the fear and panic would start to exaggerate. The daily trading range

would expand as more investors panicked and liquidated their positions. This series of

events would forewarn the Candlestick investor that the bottom was getting near, and to

 

 

be vigilant for a buy signal. The most informative signal at the bottom of one of these

declines is the gap.

 

For example, a stock has been in a downtrend for weeks. The talking heads on the

financial stations are all expressing their opinions about how this company/industry is in

the trash can. There is no reason to own this stock. Finally the last holdouts cannot stand

the pain of owning that stock anymore. They get out at any cost. The price gaps down the

next morning. Once this gap is spotted, a variety of profitable trading procedures can be

put in place.

 

What can happen from this point? The price has gapped down after weeks of a lengthy

decline. If it is a mild gap down, the price may keep declining. You may start seeing a

dramatic increase in volume. The price is showing another big down day. However, the

aggressive Candlestick investor realizes that the gap down was a blow-off signal. Upon

seeing the price decline finally hit bottom and appear to stabilize, the aggressive investor

can start to accumulate stock. Knowing that the gap was part of the panic selling gives

the candlestick investor the confidence to step in when there is still panic in the air.

 

If the gap down is severe, the panic may all be built into the opening price. A severe gap

down open after an extended downtrend may be a good opportunity time to buy. Watch

how the stock price reacts after the open. If it appears to be stabilizing at the open level,

with a little downside move that seems to be immediately bought up, it is time to start

establishing a position. At the end of that day, you want to see a white candle, a close

much higher than the open. This illustrates that all the sellers have been washed out. The

buyers have taken over. This is the advantage that Candlesticks have over other charting

techniques. It is much easier to see what is happening in a stock price when the color of

the bodies can be viewed. A stock price that opens down and continues to go lower has a

completely different strategy. The purchase of that position may be a few days or weeks

down the road.

Gaps at the Bottom