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