21
CANDLESTICKS
EVERY TRADER
SHOULD KNOW
Dr. Melvin Pasternak
Working Title: 21 Candlesticks Every Trader
Should Know
Author:
Dr. Melvin Pasternak
Publisher:
Marketplace Books
Release Date: January 2006
Format:
Paperback
Pages:
approx. 120 pages
Retail Price: $19.95
21 CANDLESTICKS EVERY TRADER SHOULD KNOW BY NAME
Optimism and Pessimism as Shown by Candles Advantages of Candle vs. Bar Charts
Candles 1-4: The Four Dojis Show Stocks That Have Stalled
Candles 5-6: Hammer and Hangman Candlesticks Signal Key Reversals
Candles 7-8: Bullish and Bearish Engulfing Candles Spot Key Trend Changes Before They Take Place
Candle 9: Dark Cloud Cover Warns of Impending Market Tops
Candle 10: The Piercing Candle Is a Potent Reversal Signal
Candles 11-12: The Three Candle Evening and Morning Star Patterns Signal Major Reversals Candle 13: The Shooting Star Can Wound Candle 14: The Inverted Hammer Indicates The Shorts May Be Ready To Cover
Candle 15: The Harami is "Pregnant" With Possibilities
Candle 16: The "Full" Marubozu Is a Candle Without Shadows
Candles 17-18 High Wave and Spinning Top Express Doubt and Confusion
Candle 19: The Ominous Call of Three Black Crows
The Four Types of Gaps: Common,
Candlest icks are one of t he m ost powerful t echnical analysis t ools in t he t rader's t oolkit . While candlest ick chart s dat es back t o Japan in t he 1700's, t his form of chart ing did not becom e popular in t he w est ern w orld unt il t he early 1990's. Since t hat t im e, t hey have becom e t he default m ode of chart ing for serious t echnical analyst s replacing t he open- high- low- close bar chart .
There has been a great deal of cogent inform at ion published on candlest ick chart ing bot h in book form and on t he worldwide web. Many of t he works, however, are encyclopedic in nat ure. There are perhaps 100 individual candlest icks and candle pat t erns t hat are present ed, a daunt ing am ount of inform at ion for a t rader t o learn.
I n t his book I have select ed 21 candles t hat I believe every t rader should know by nam e. These are t he candles t hat in m y
t o appreciat e it s t echnical im plicat ions and increases t he accuracy of your predict ions.
I n m y t rading, I t ry t o int egrat e candlest ick analysis, m oving averages, Bollinger bands, price pat t erns ( such as t riangles) and indicat ors such as st ochast ics or CCI t o reach decisions. I find t he m ore inform at ion w hich is int egrat ed, t he m ore likely t he decision is t o be correct . I n t his book, I have chosen t o com bine m oving averages, Bollinger bands and t wo indicat ors, st ochast ics, and CCI on various chart s. As w e discuss individual candlest icks or candle pat t erns, I int egrat e t hese t ools int o t he discussion. Hopefully, you w ill not only learn how t o recognize candles from t his book, but also appreciat e how you can com bine t hem wit h t he t radit ional t ools of t echnical analysis.
I n t his book m y focus is on Minor t rend reversals, t he kind of reversal of m ost int erest t o a t rader. The Minor t rend t ypically last s 5 t o 15 days alt hough on occasion, I have seen it st ret ch out t o about 30 t rading days. These sam e candle principles work equally as well, however, on 5 m inut e or weekly chart s. I t is ant icipat ory indicat or gives a signal in advance of m uch ot her m arket act ion - - in ot her words it is a leading indicat or of m arket act ivit y.
Mom ent um indicat ors such as CCI or st ochast ics are also
signal followed by a m om ent um signal such as st ochast ics w hich com m unicat es t he sam e m essage, it is likely t hat in com binat ion t hey are accurat ely predict ing what will happen wit h a st ock.
On t he ot her hand, t he break of a t rendline or a m oving average crossover is w hat I call a " confirm ing" signal. I t usually occurs days lat er t han t he peak or bot t om of price and m uch aft er t he candlest ick and indicat or signal.
Depending on your t rading st yle, you can act on t he ant icipat ory signal. However, if you prefer t o be caut ious and wait for m ore evidence, candlest icks ant icipat e a change in t rend and put you on t he alert t hat a reversal m ay be im m inent .
H OW TO READ A CAN D LESTI CK CH ART
I f you are already fam iliar wit h t he basics of candlest icks, you can skim t his sect ion. I f you have seen candles on t he web, but have not st udied t hem in som e det ail, t hen you'll now be given t he background you need t o use candles.
Candles m ay be creat ed for any " period" of chart —m ont hly, weekly, hourly, or even one m inut e. When I discuss candles in t his book, I will use daily chart exam ples, but be aware t hat you can creat e candle chart s for virt ually any period.
BAR V S. CAN D LESTI CK CH ARTS
I n a candlest ick chart , however, t he nam es are changed. The difference bet ween t he open and t he close is called t he r e a l
body. The am ount t he st ock w ent higher beyond t he real body is called t he u ppe r sh a dow. The am ount it went lower is called t he low e r sh a dow. I f t he candle is clear or whit e it m eans t he opening was low er t han t he high and t he st ock went up. I f t he candle is colored t hen t he st ock went down. This inform at ion is shown below:
OPTI M I SM AN D PESSI M I SM AS SH OW N BY CAN D LES
Here is an idea about candlest icks t hat helps m e bet t er use t hem and w hich I haven't seen in books or on t he web.
I t is generally acknowledged t hat t he opening of t he t rading day is dom inat ed by am at eurs. The close, on t he ot her hand, is dom inat ed by professional t raders. The low of t he day, one m ight say, is set by t he pessim ist s - - t hey believed t he m arket was going lower and sold at t he bot t om . The high of t he day is set by t he opt im ist s. They were willing t o pay t op price but were incorrect in t heir analysis, at least in t he short t erm .
Shaven Bot t om / Shaven Head. The shaven bot t om / shaven t op candle depict s a day in w hich t he m arket opened at t he low and closed at t he high. I t is a day on which t he am at eurs are also t he pessim ist s. They sell early and t heir shares are gobbled up by eager buyers. By t he end of t he day t he opt im ist s and
professionals close t he st ock sharply higher. This bullish candle frequent ly predict s a higher open on t he next day.
Shaven Head/ Shaven Bot t om . This candle is t he opposit e of t he one j ust described. Depict ed here is a day when t he am at eurs are t he opt im ist s. They buy at t he t op of t he day, only t o wat ch prices st eadily decline. By t he end of t rading, prices have
declined sharply and t he professional pessim ist s are in cont rol of t he m arket . The opening t he next day is oft en lower.
Candles can be m ade m ore sense of by reasoning t hem out in t his way. Part icularly when you see a candle wit h a large real body, ask yourself who w on t he bat t le of t he day, t he opt im ist s or t he pessim ist s, t he am at eurs or t he professionals. This quest ion will oft en provide you wit h an im port ant clue t o subsequent
t rading act ion.
AD V AN TAGES OF CAN D LE V S. BAR CH ARTS
1. Candlest ick chart s are m uch m ore " visually im m ediat e" t han spend your energy on analysis, not figuring out what happened wit h t he price.
2. Wit h candles you can spot t rends m ore quickly by looking for whet her t he candles are clear or colored. Wit hin a period of t rend, you can easily t ell what a st ock did in a specific period.
The candle m akes it easier t o spot " large range" days. A large candlest ick suggest s som et hing " dram at ic" happened on t hat t rading day. A sm all range day suggest s t here m ay be relat ive
When t radit ional t echnical analysis t alks about reversals,
usually it is referring t o form at ions t hat occur over long periods of t im e. Typical reversal pat t erns are t he double t op and head and shoulders. By definit ion, t hese involve sm art m oney
dist ribut ing t heir shares t o naive t raders and norm ally occur over weeks or even m ont hs.
swing in t he m arket . I f you pay m et iculous at t ent ion t o t hem , t hey oft en warn you of im pending changes.
CAN D LES AN TI CI PATE SH ORT TERM REV ERSALS sellers have been in cont rol for several days or w eeks. Prices have gone down t oo far t oo fast . Most of t he t raders who want t o sell have done so and t here are bargains - - at least in t he short t erm - - t o be had.
There are m any overbought and oversold indicat ors, such as CCI , RSI , and William s' % R. However, one of t he best is st ochast ics, w hich essent ially m easures t he st ock's price in relat ion t o it s range usually over t he past 14 periods. CCI t ypically agrees wit h st ochast ics and is useful for providing confirm at ion of it s signal. I also alm ost always put a Bollinger Band on chart s I analyze. John Bollinger creat ed t his t ool t o include 19 out of every 20 closing prices wit hin t he bands. Therefore, a close out side t he band is significant . A close out side t he upper band usually say t he st ock is overbought . When it is out side t he lower band it is oversold.
When bot h st ochast ics, CCI and t he Bollinger bands agree a st ock or index is overbought or oversold, I t ake t heir alignm ent very seriously. There is a good chance a reversal is overdue. A significant candlest ick t ells m e m ore exact ly when t he
reversal m ight be here.
A chart m ay be t hought of as pict ure of t he war bet ween supply and dem and. When a st ock is m oving up, t he buyers are in cont rol. There is m ore dem and t han supply. Purchasers are eager t o acquire t he st ock and will pay up, hit t ing t he ask price t o do so. When a st ock is declining, t he reverse is t rue. Sellers are fearful and will not dicker over a few cent s, being m ore likely t o accept t he bid. Candlest icks graphically show t he balance bet ween supply and dem and. At key reversal j unct ures, t his supply/ dem and equat ion shift s and is capt ured in t he candle chart .
" Th e Ru le of Tw o"
Generally, no one candlest ick should be j udged in isolat ion. The general principle is even if you see a key reversal
candlest ick, you should wait at least part of one m ore day
As st at ed, in candlest ick t heory, t here are m any candles which signal im port ant reversals. To conclude t his sect ion, w e will focus on only four ( ! ) candlest icks which called every m aj or t urn in t he Dow Jones I ndust rial Average over nearly a six m ont h period! Think how m uch m ore accurat ely you could have t raded t he m arket if you knew t hese candles nam es and im plicat ions as well as had recognized t hem when t hey
BULLI SH ENGULFI NG.
The bullish engulfing is m ost significant w hen it occurs aft er a prolonged dow nt rend. The st ock or index has been selling off sharply. On t he day of t he bullish engulfing, prices will oft en st art t he day by falling. However, st rong buying int erest com es in and t urns t he m arket around.
The bullish engulfing is nam ed because t his candle surrounds or engulfs t he previous one. When I discuss t his candle wit h college st udent s enrolled in m y st ock m arket course, I call it " Pac- Man" because like t he video gam e charact er, it " eat s" t he candle before it . The bullish engulfing represent s a reversal of supply and dem and. Whereas supply has previously far
out st ripped dem and, now t he buyers are far m ore eager t han t he sellers. Perhaps at a m arket bot t om , t his is j ust short -covering at first , but it is t he cat alyst which creat es a buying st am pede.
When analyzing t he bullish engulfing, always check it s size. The larger t he candle, t he m ore significant t he possible
reversal. A bullish engulfing w hich consum es several of t he previous candles, speaks of a powerful shift in t he m arket .
This ham m er m arks a reversal off a bot t om or off an im port ant support level. On t he day of t he ham m er, prices decline. They hit bot t om and t hen rebound sharply m aking up all t he ground – and som et im es m ore – com pared t o w here t he sell- off
st art ed. The candle shows t hat t he buyers have seized cont rol. A bullish candlest ick on t he following day confirm s t his
analysis.
THE DOJI .
I f you w ere t o learn only one candle by nam e, t his would have t o be t he one. A " com m on" doj i, as I call it , is shaped like a cross. A doj i has no real body. What it says is t hat t here is a st alem at e bet ween supply and dem and. I t is a t im e when t he opt im ist and pessim ist , am at eur and professional are all in agreem ent . This m arket equilibrium argues against a st rong upt rend or dow nt rend cont inuing, so a doj i oft en m arks a reversal day.
A doj i in an overbought or oversold m arket is t herefore oft en very significant . The opening of t he next day should be
GRAVESTONE DOJI .
The gravest one doj i occurs far less frequent ly t han t he
com m on one, but gives even a clearer signal. At t he t op of an Average went sideways in a broad t rading range bet ween
10000 and 11000. I have placed only one m oving average on t he chart , t he 50- day. A 50- day m oving average describes t he round num bers represent key support and resist ance in t he m aj or averages and t his t op was no except ion. The candle form ed was a gravest one doj i. Not e t he long upper shadow and t he absence of a real body. This com binat ion signalled t hat t he bulls did not have t he st rengt h t o push t he Dow t hrough t he 11000 m ark. Over t he next m ont h t he Dow
The lat e April bot t om at 10000 is m arked by a bullish engulfing candle. I m m ediat ely before t he bullish engulfing not e t he
t hree very large back candles w hich saw t he Dow drop nearly 500 point s in t hree days. That left it subst ant ially oversold as shown by t he st ochast ics indicat or w hich reveals an oversold reading when it goes below 20 ( above 80 is overbought ) . An oversold m arket can be described as one which has gone dow n t oo far, t oo fast .
The bullish engulfing candle was very large, adding t o it s
significance. I t im plied t hat wit h t he Dow able t o hold 10000, t he short s were covering, buying int erest had em erged at t his level, or bot h. While t he Dow didn't soar higher in t he com ing day, neit her did it drop below 10000 again. By early May it rallied back t o resist ance near 10400. Not e how a horizont al line can be draw n across t he chart t o m ark t his resist ance level and how it s role as bot h support and resist ance alt ernat ed
The Minor upt rend brought t he Dow back t o 10400. Traders t here is a candle you have seen before—t he bullish engulfing.
From 10075 t he Dow advanced over t he next m ont h t o a peak j ust below 10600. For alm ost a m ont h, in what m ust have seem ed like an et ernit y for t raders, t he Dow vacillat ed in an excruciat ingly narrow range bet w een 10400 and 10600. When it finally got beyond resist ance at 10600, it form ed t hree doj i-candle occurred aft er t he Dow had found support near 10250 for several days.
SUM M ARY
I find it int riguing t hat t he sam e candlest ick pat t erns repeat over and over. Candles are your personal sent ry providing you wit h consist ent early warnings of im pending t rend change. They provide t he earliest signal I know of t hat t he pat t erns in t he m arket are about t o reverse.
2 1 CAN D LES EV ERY TRAD ER SH OULD KN OW BY N AM E
I n t he previous sect ion of t his book, I showed how cert ain key candlest icks were able t o ident ify every m aj or t rend reversal in t he Dow Jones I ndust rial Average for a period of several
m ont hs. I t is vit al for t rading success, I argued, t o recognize candlest icks and assess t heir im plicat ions.
Candles are vit al t o t rading because t hey ident ify possible reversals in t rend. Failure t o spot t hese key candles can lead prices opened and closed at t he sam e level. I f prices close very close t o t he sam e level ( so t hat no real body is visible or t he real body is very sm all) , t hen t hat candle can be int erpret ed as a doj i.
om inous warning sign t hat t he t rend has peaked or is close t o peaking. A doj i represent s an equilibrium bet ween supply and dem and, a t ug of war t hat neit her t he bulls nor bears are
winning. I n t he case of an upt rend, t he bulls have by definit ion won previous bat t les since prices have m oved higher. Now, t he out com e of t he lat est skirm ish is in doubt . Aft er a long
dow nt rend, t he opposit e is t rue. The bears have been
vict orious in previous bat t les, forcing prices down. Now t he bulls have found courage t o buy and t he t ide m ay be ready t o t urn.
What I call a " com m on" doj i has a relat ively sm all t rading range. I t reflect s indecision. Here's an exam ple of a com m on doj i:
A " long- legged" doj i is a far m ore dram at ic candle. I t says t hat prices m oved far higher on t he day, but t hen profit t aking
kicked in. Typically, a very large upper shadow is left . A close below t he m idpoint of t he candle shows a lot of w eakness. Here's an exam ple of a long- legged doj i:
When t he long- legged doj i occurs ou t side a n u ppe r Bollin ge r ba n d aft er a sust ained upt rend, m y experience says you
A " gravest one doj i," as t he nam e im plies, is probably t he m ost om inous candle of all. On t hat day, prices rallied, but could not st and t he " alt it ude" t hey achieved. By t he end of t he day t hey cam e back and closed at t he sam e level. Here's an exam ple of a gravest one doj i:
Finally, a " dragonfly" doj i depict s a day on which prices opened at a high, sold off, and t hen ret urned t o t he opening price. I n m y experience, dragonflies are fairly infrequent . When t hey do occur, however, t hey oft en resolve bullishly ( provided t he st ock is not already overbought as shown by Bollinger bands and indicat ors such as st ochast ics) . Here's an exam ple of a dragonfly doj i:
When assessing a doj i, always t ake careful not ice of where t he doj i occurs. I f t he securit y you're exam ining is st ill in t he early st ages of an upt rend or downt rend, t hen it is unlikely t hat t he doj i will m ark a t op. I f you not ice a short - t erm bullish m oving average crossover, such as t he four- day m oving average
heading above t he nine- day, t hen it is likely t hat t he doj i m arks a pause, and not a peak. Sim ilarly, if t he doj i occurs in t he
m iddle of a Bollinger band, t hen it is likely t o signify a pause rat her t han a reversal of t he t rend.
act ion. That does not necessarily m ean, however, t hat you need t o wait t he ent ire next day. A large gap dow n, aft er a doj i t hat clim axed a sust ained upt rend, should norm ally provide a safe short ing opport unit y. The best ent ry t im e for a short t rade would be early in t he day aft er t he doj i.
The chart of t he Disk Drive I ndex ( $DDX) shows t hree of t he four doj is j ust described and gives som e guidance as t o how t o effect ively int erpret t his candle depending on where it occurs in a t rend. The Disk Drive I ndex consist s of 11 st ocks in t he
com put er st orage and hard drive businesses. This index's perform ance t herefore usually correlat es highly w it h t he
Finally, t he buyers were able t o overw helm t he sellers and t he $DDX pierced 100. Not e on t his day, t he four- day m oving average penet rat ed t he nine- The 4- day m oving average day and bot h began t o slope upward. That pat t ern suggest ed an upt rend was beginning. The four- day m oving average going above t he nine is a bullish m oving average crossover. While I wouldn't t rade on t his very short - t erm signal in isolat ion, it provides a useful confirm at ion t hat t he im m ediat e t rend is up.
day before t aking t rading act ion. The following day was posit ive.
Two days lat er a dragonfly doj i appeared ( " 2" ) wit h prices closing at t heir highs. Again, a dragonfly doj i oft en resolves posit ively as did t his candle. Three days aft er t hat ( " 3" ) a second dragonfly doj i occurred. This one was m ore worrisom e since it cam e aft er a subst ant ial advance and w as close t o t he t op of a Bollinger band. However, t he upt rend cont inued.
By early June, t he $DDX was t rading close t o 115. I t had rallied nearly 20% off it s early May low. Whereas during t he core of t he upt rend, t here had been several large whit e candles indicat ing bullish ent husiasm , now t he real bodies of
t hecandles t urned sm all showing caut ion on t he part of buyers. Always observe t he size of t he candles in your analysis.
I n m id- June, t w o consecut ive doj is ( " 4" ) appeared on t he chart . The first was a com m on doj i; t he second closer t o a long- legged variet y. For t hose t raders in a long posit ion,
ext rem e vigilance was now warrant ed. Subst ant ial profit s were t here for nailing dow n in t he $DDX. The index was st alling; t he bulls and bear were st alem at ed.
I n t he t wo days aft er t he doj is appeared, t he $DDX st ruggled t o m ove higher wit hout m uch success. On t he second day, t he candle t urned dark showing selling pressure. Not e also t hat t he four- day m oving average penet rat ed dow n t hrough t he nine- day, t he first t im e t his had happened since t he upt rend began in early May.
The one kind of doj i not found in t he $DDX chart is t he gravest one doj i, already seen in t he chart of t he Dow Jones I ndust rial Average. Candlest ick nam es are t ypically very colorful and t his one is no except ion. I f you are a bull, t he gravest one doj i should sound om inous and one should alw ays be prepared t o t ake rapid act ion on it s appearance. When it occurs aft er a prolonged upt rend, and t he upper shadow
penet rat es t hrough t he upper Bollinger band, t he candle t akes on added significance.
Traders who required addit ional evidence t hat a reversal had occurred did not need t o wait long. Not ice, how t he four day-m oving average crossed below t he nine day. A t rendline break also occurs short ly aft er t his crossover, suggest ing AMR's flight pat h is now lower. Traders who ignored t hese signals, paid a high price. By t he end of June, AMR was probing $11, not far from w here t he rally began. This was one round t rip t hat
would have been avoided t hrough assessing t he im plicat ions of t he gravest one doj i.
The doj i candle is probably t he single m ost im port ant candle for t he t rader t o recognize. Not far behind in value are
ham m er and hangm an.
I t is easy t o get t hese t wo candlest icks confused since t hey look ident ical. Bot h t he hangm an and ham m er have a very long shadow and a very sm all real body. Typically, t hey have no upper shadow ( or at t he very m ost , an ext rem ely sm all one) . To be an " official" ham m er or hangm an, t he lower
shadow m ust be at least t wice t he height of t he real body. The larger t he lower shadow, t he m ore significant t he candle
becom es.
How can you t ell t he t wo candles apart ? The hangm an candle, so nam ed because it looks like a person who has been
execut ed wit h legs swinging beneat h, alw ays occurs aft er an ext ended upt rend. The hangm an occurs because t raders, seeing a sell- off in t he shares, rush in t o snap up t he st ock at bargain prices. To t heir dism ay t hey subsequent ly find t hey could have bought t he st ock at m uch cheaper levels. The hangm an looks like t his:
On t he ot her hand, t he ham m er put s in it s appearance aft er a prolonged dow nt rend. On t he day of t he ham m er candle, t here is st rong selling, oft en beginning at t he opening bell. As t he day goes on, how ever, t he m arket recovers and closes near t he unchanged m ark, or in som e cases even higher. I n t hese cases, t he m arket is pot ent ially
The ham m er candle occurred on t he final day of April. On t his day, t he Com posit e breached 1900 int raday, but t he bears did not have t he power t o close it under t hat
psychological support level. I nst ead, t he Com posit e closed slight ly posit ively on t he day, hence t he sm all w hit e head at t he t op of t he candle.
I n it self, t he ham m er gave a powerful, warning t hat Nasdaq was reversing course. The alert t rader m ight t ake a long posit ion in a leading Nasdaq st ock or an ETF such as t he QQQQ on t he next t rading day when t he Com posit e bullishly followed t hrough on t he previous day's act ion. On t he
Addit ional t echnical confirm at ion of t he ham m er cam e from t he behavior of t he st ochast ics oscillat or. St ochast ics
com pares t he behavior of price relat ive t o it self. I t is a rapidly m oving indicat or which gives t im ely buy and sell signals. I n t his case, st ochast ics dem onst rat ed bullish m om ent um divergence as m arked on t he chart . Bullish
From t hat t im e onward, t hroughout t he ent ire m ont h of May, Nasdaq was off t o t he races. The Com posit e rallied roughly 200 point s, from below 1900 t o nearly 2100. The ham m er candle was t he t echnical signal t hat it w as t im e t o be long not short Nasdaq.
The candle opposit e of t he ham m er is called hangm an. When I have t aught candlest icks in college st ock m arket classes, st udent s have easily becom e confused bet ween t he t wo. This is because t hey look exact ly alike. The key t he $38 area when it announced below expect at ion earnings. Forest bot t om ed at $32.46, in conj unct ion wit h st rengt h in t he pharm aceut ical st ocks began a gradual m ove higher. On t he day of t he ham m er, it recovered t o a peak of $40.76,
The ham m er was indeed t he profit - t aking signal in FRX. The next day t he st ock opened j ust above $40 and slid
persist ent ly during t he day, reaching a low of $37.60 before recovering. A sim ple t rendline drawn from t he $32.46 low confirm ed t hat it was t im e t o exit t he posit ion. The t rendline was broken t he next t rading day. CCI also dipped below t he + 100 level, giving a sell signal on t his indicat or. When a candlest ick, indicat or and t rendline all give t he sam e
CAN D LES 7 - 8 : BULLI SH AN D BEARI SH EN GULFI N G CAN D LES SPOT TREN D CH AN GES BEFORE TH EY TAKE PLACE
I f t he doj i wins t he race as t he m ost im port ant candle t o recognize, and ham m er/ hangm an is a close second t hen t he " engulfing" candle places t hird. Whereas t he doj i and
ham m er/ hangm an are a single candle, t he engulfing pat t ern consist s of t wo candles.
The engulfing candle m ust com plet ely " consum e" t he real body of t he previous candle. Because st ocks have fewer gaps t han com m odit ies, an engulfing candle m ay violat e t his consum es t he previous candle.
A bullish engulfing candle occurs aft er a significant
downt rend. Not e t hat t he engulfing candle m ust encom pass t he real body of t he previous candle, but need not surround t he shadows. Below you will find an illust rat ion of a bullish engulfing candle:
The power of t he engulfing candle is increased by t wo
fact ors - - t he size of t he candle and t he volum e on t he day it occurs. The bigger t he engulfing candle, t he m ore significant it is likely t o be. A large bullish engulfing candle says t he bulls have seized cont rol of t he m arket aft er a downt rend. Meanw hile, a large bearish engulfing says t he bears have t aken com m and aft er an upt rend. Also, if volum e is above norm al on t he day when t he signal is given, t his increases t he power of t he m essage.
A good exam ple of a bearish engulfing candle ending a rally is found in Avid Technology ( AVI D) , a m aker of video edit ing soft ware. I n early March t he st ock peaked in conj unct ion wit h t he S&P 500 and Nasdaq Com posit e j ust above $68. A few days lat er, when it was t rading at $62, it m ade an
acquisit ion and was punished severely. I nt raday, t he st ock was off nearly $5 and left a large gap bet ween
approxim at ely t he $60 and $62 level on t he chart . Not e also t he large volum e spike on t hat day. As we shall see lat er in t his book, gaps in candlest ick t heory are called " windows," and creat e resist ance t o furt her price advances.
AVI D event ually bot t om ed in lat e April at $47.64 and began t o recover. By m id- June it was back above $60 and t rading int o t he window it had creat ed t he day of t he acquisit ion. That in it self should have m ade any long caut ious on AVI D. Anot her reason for prudence, however, was t hat it was
overbought . I t was out side t he Bollinger band. I n addit ion t o being in overbought t errit ory on st ochast ics, t here was also bearish m om ent um divergence. The day aft er t he bearish engulfing candle, t he st ock gapped dow n.
from t he lat e April low was broken soon aft er. AVI D ret reat ed t o near $51 before finally going out side t he Bollinger band and becom ing oversold, t hen st aging a m odest recovery.
The Ut ilit y TXU Corp ( TXU) provides a good exam ple of a bullish engulfing candle. From a low j ust under $60 in
I n a single day in early May TXU went from j ust over $80 dow n t o support at $74. Not e t he long lower shadow w hich probed out side t he Bollinger band on t his session. While t his candle does not m eet t he requirem ent s of a ham m er ( t he shadow is not double t he real body) , t raders should st ill pay close at t ent ion t o long shadows especially in areas of
support . They suggest t hat t here is buying int erest at t hat level.
Not e also t he bullish divergence on t he CCI indicat or w hich was recovering from oversold levels. Traders needed t o wait t wo addit ional days for t he bullish engulfing candle, but
was fairly large as t he st ock m oved alm ost $2.50 on t he day. CCU subsequent ly recovered t o near $85, j ust below t he previous highs.
Bullish and bearish engulfing candles warn of t rend change before it happens. Com bine t he appearance of t hese candles wit h ot her t echnical t ools such as CCI , and you should
quickly pick up on t rend changes. The abilit y t o spot t he t rend change is key t o posit ioning yourself on t he right side of t he m arket , and is vit al for t rading success.
CAN D LE 9 : D ARK CLOUD COV ER W ARN S OF I M PEN D I N G M I N OR TOPS
The candlest ick we will next explore is called " Dark Cloud Cover." I t is a close relat ive of t he bearish engulfing, but is not quit e as negat ive in it s im plicat ions. St ill, t he
appearance of t his candle should be a warning t o t he t rader t o prot ect profit s in a posit ion. I t also suggest s t hat you should wat ch a st ock as a possible short candidat e in t he t rading days ahead.
As t he day wears on, however, t he bears wrest cont rol. On t he dark cloud cover day, t he st ock closes a t le a st h a lfw a y
int o t he previous whit e " capping" candle. The larger t he penet rat ion of t he previous candle ( t hat is, t he closer t his candle is t o being a bearish engulfing) , t he m ore powerful t he signal. Traders should pay part icular at t ent ion t o a dark cloud cover candle if it occurs at an im port ant resist ance area and if t he end- of- day volum e is st rong. Below you will find an exam ple of a Dark Cloud Cover candle:
Film and digit al cam era m aker East m an Kodak ( EK) provides an exam ple of t he dark cloud cover. The st ock t raded as high as $33 in April, im m ediat ely before it released earnings and it s second quart er forecast . Wit h earnings cam e out in m id- April t he shares were changing hands at j ust above $30. Result s were below expect at ions, t he st ock dropped
precipit ously on t heir release, gapping down t o $27.16 and over t he next several days an falling as low at $24.40. As we shall see when gaps are explored, t he t rader should now ant icipat e resist ance bet ween $27.16 t he low end of t he gap and j ust above $30, t he upper end.
Over t he next m ont h and a half, EK began a grudging recovery, regaining $27, backing off and t hen finding consist ent support at $26. The shares t hen broke out
form ing four consecut ive whit e candlest icks and reaching a high of $28.19. While t he t hird candlest ick was not large, it if t he four candles were com bined int o one, it cert ainly
When t he dark cloud cover em erged t herefore, t raders should have been wary. While t his candle was relat ively sm all, it ret reat ed half- w ay back int o t he final whit e candle. The next day a doj i appeared, em phasizing t he resist ance near $28. EK t hen ret reat ed t oward t he $26 level before finding support and rallying. While t he Dark Cloud Cover is not as pot ent a reversal candle as bearish engulfing, it s appearance in t he chart should be respect ed.
CAN D LE 1 0 : TH E PI ERCI N G CAN D LE I S A POTEN T REV ERSAL SI GN AL
Whereas t he dark cloud cover w arns t hat an upt rend m ight be com ing t o an end and is t hus a signal t o t ake profit s on long t rades, a piercing candle int im at es t hat a downt rend m ay be about t o reverse and short s should be covered.
The first t hing t o look for t o spot t he piercing pat t ern is an exist ing dow nt rend. Wit h daily candles, t he piercing pat t ern will oft en end a m inor downt rend ( a downt rend t hat oft en last s bet ween five and fift een t rading days) . The day before t he piercing candle appears, t he daily candle should ideally have a fairly large dark real body, signifying a st rong down day. Here is an exam ple of t he piercing candle:
I n t he classic piercing pat t ern, t he next day's candle gaps below t he lower shadow, or previous day's low. I find wit h st ocks ( in com parison t o com m odit ies) , however, t hat t he piercing candle and needs t o be called by a different nam e. ( The candle is " on- neck" if it closes at day one's low, " in-neck" if it closes slight ly back int o day one's real body, and " t hrust ing" if it closes subst ant ially int o t he real body, but less t han halfway.) I n addit ion, t he second day's candle
cannot t ot ally m ake up t he ground lost in day one, ot herwise it would be a bullish engulfing.
posit ive it is, and t hus t he great er t he possibilit y of a
reversal. Second, t ake part icular not e of t he piercing candle if it occurs at an im port ant support level. Third, if volum e is st rong on t he piercing day, t hen t he candle gains added significance.
An int erest ing exam ple of a piercing candle is found in t he chart of Avici Syst em s ( AVCI ) a VOI P or Voice Over I nt ernet Prot ocol play. I n m id- April, AVCI had bot t om ed near $3.70 for several days, creat ing a short - t erm basing form at ion. Toward t he end of t he m ont h, it creat ed a gap bet ween
approxim at ely t he $4.15 and $4.50 area, and t hen ret reat ed t o $4.16. Not e t he long lower shadow of t he day t he $4.16 bot t om was m ade. Large lower shadow s oft en serve as
The piercing candle appeared at support t wo days lat er. I t was not a large range day and w as accom plished on low volum e. A t rader who observed it m ight have m ade a
m ent al not e and wat ched wit h int erest t he t rading act ion of t he second day. Now t he t rend becam e m uch clearer. AVCI broke t he dow nt rend line off t he $4.90 high. I t went back above it s 4 and 9 day m oving average w hich gave a buy signal. Event ually, AVCI ran t o $5.10 in m id- June before t opping. Even if t he t rader had purchased at $4.50 and sold a few days lat er near $5, t he percent age gain was
subst ant ial.
CAN D LES 1 1 - 1 2 : TH E TH REE CAN D LE EV EN I N G AN D M ORN I N G STAR PATTERN S SI GN AL M AJOR
REV ERSALS
By t his point in 21 Candles, you should be able t o spot several reversal candles. Many t im es, only one candle is necessary t o put a t rader on high alert t hat a reversal m ay be happening. A doj i candlest ick, whet her it occurs aft er a long upt rend or dow nt rend, indicat es t hat supply and
dem and are in equilibrium and t hat t he recent t rend m ay be com ing t o a conclusion.
Several m aj or reversal pat t erns consist of t wo candlest icks. A bullish or bearish engulfing candle oft en signals a t rend's conclusion. This t wo- candle pat t ern is also relat ively easy t o spot .
The evening st ar and m orning st ar are, in m y experience, harder pat t erns for t he eye t o pick out . The reason for t his is sim ple - - since bot h pat t erns consist of t hree candles, t hese candles m ust be perceived a s a gr ou p. However, once
you've ident ified one of t hese pat t erns, t hen your j ob is pret t y m uch over. Unlike m ost ot her candle form at ions, no furt her confirm at ion is needed. The evening and m orning st ar are com plet e in and of t hem selves, so t he t rader should st rongly consider t aking t rading act ion im m ediat ely upon t heir appearance.
The e ve n in g st a r pat t ern occurs during a sust ained
On t he first day we see a candle wit h a long whit e body. Everyt hing looks norm al and t he bulls appear t o have full cont rol of t he st ock. On t he second day, however, a st ar candle occurs. For t his t o be a valid evening st ar pat t ern, t he st ock m ust gap higher on t he day of t he st ar. The st ar can be eit her black or whit e. A st ar candle has a sm all real body and oft en cont ains a large upper shadow.
The st ar com m unicat es t hat t he bulls and bears are involved in a t ug of war, yet neit her side is winning. Aft er a sust ained upt rend, t hose who want t o t ake profit s have com e int o
balance wit h t hose eager t o buy t he st ock. A large upper shadow indicat es t hat t he st ock could not sust ain it s probe int o new high ground. A pot ent ial reversal has been
signaled.
On t he t hird day, a candle wit h a black real body em erges. This candle ret reat s subst ant ially int o t he real body of t he first day. The pat t ern is m ade m ore pow erful if t here is a gap bet ween t he second and t hird day's candles. However, t his gap is unusual, part icularly when it com es t o equit y t rading. As such, it is not a required part of t he pat t ern. Th e fu r t h e r t h is t h ir d ca n dle r e t r e a t s in t o t h e r e a l body of t h e fir st da y's ca n dle , t h e m or e pow e r fu l t h e r e ve r sa l sign a l. Since t he t hird day affirm s t he st ar's pot ent ially bearish im plicat ions, no furt her confirm at ion is needed.
Cont inent al Airlines ( CAL) provides a good illust rat ion of t he evening st ar form at ion. The shares bot t om ed in lat e April as t he st ock creat ed a ham m er candle. The bot t om was
The evening st ar pat t ern is circled on t he chart below. On t he first day, t here is a reasonably large whit e candle. The second session see a gap higher, indicat ed by t he t op of t he black candle being som ewhat higher t han t he whit e candle before it . Not e t he large upper shadow on t his candle,
On t he t hird day of t he form at ion, prices closed well back int o t he range of t he first day, t he final requirem ent of t he evening st ar. Daily st ochast ics and CCI gave sell signals during t his session also suggest ing t hat t he t op for CAL was in. Not e, how m uch earlier t hese signals were t han t he
broken upt rend line which lagged t he evening st ar by alm ost t wo weeks. , And rem em ber m y t rader's rhym e, " if you see t he evening st ar, a t op is oft en not very far."
Having explored t he evening st ar in det ail, we need say lit t le m ore about t he m or n in g st a r form at ion since it is t he exact opposit e of t he evening st ar. I t occurs in a dow nt rend and st art s wit h a large black candle. On t he second day, a st ar form s on a gap. The t hird day com plet es t he reversal by closing well int o t he real body of day one.
Pharm aceut ical giant and Dow Jones I ndust rial Average com ponent Merck ( MRK) is a st ock in a long- t erm
Aft er reaching $34.95, MRK went sidew ays for several w eeks and t hen hit a secondary peak of $34.79 in early May. From here, MRK went int o a prolonged slide reaching a low of
$30.12 ( not ice again t he $5 int erval) in lat e June, rallying slight ly and t hen t est ing a slight ly lower low of $29.90 in early July.
The second low was revealing in a num ber of ways. First , as shown by t he st ochast ics and CCI oscillat ors t here was
bullish m om ent um divergence as price was low er, but
near $32 several days lat er. The Morning St ar, t rue t o it s nam e, had seen Merck's prospect s bright en considerably.
CAN D LE 1 3 : TH E SH OOTI N G STAR CAN W OUN D
Candle t heory ident ifies four kinds of st ars: m orning, evening, doj i and shoot ing. I now want t o focus on t he shoot ing st ar.
The shoot ing st ar can only appear at a pot ent ial m arket t op. I f you are looking at a daily chart , t hen it is possible t hat t his candle will warn of a reversal in t he Minor upt rend.
Since a m inor upt rend t ypically last s bet ween six and fift een days, t he swing t rader should be very alert if t he Minor
upt rend is m at ure.
I f a shoot ing st ar occurs aft er a candle wit h a large real body it t ypically is t hat m uch st ronger a warning since it shows price can not sust ain high levels. The day t he shoot ing st ar occurs, t he m arket should ideally gap higher ( alt hough wit h st ocks rat her t han com m odit ies, t his gap is som et im es not present ) .
The st ock should t hen rally sharply. At t his point , it appears as t hough t he longs are in com plet e cont rol. Som et im e
The sm all real body show s t hat t he bulls and bears are at war wit h each ot her. Whereas t he bulls had been in cont rol during t he upt rend, t he t wo sides are now evenly m at ched.
The Sem iconduct or I ndex provides a clear exam ple of why it is im port ant t o pay at t ent ion t o t he shoot ing st ar candle. The sem is bot t om ed wit h t he rest of Nasdaq in lat e April at 376.64. On t hat day, t he $SOX broke support at 380
int raday, but t hen rallied st rongly t o close wit hin t he
From here, t he $SOX com m enced a st rong rally which lift ed t he index nearly 64 point s or approxim at ely 17% in 24
t rading days t o t he 440 level. At t his point , bot h Nasdaq and t he $SOX hit resist ance. The $SOX t ried t o break 440 on six separat e occasions, but w as unable t o do so. Finally it ret reat ed t o j ust below 420 and began anot her rally back t oward resist ance.
above t he upper Bollinger band and t he sm all real body. The $SOX had t est ed im port ant resist ance and failed.
The next t rading day, it sold off sharply bearishly engulfing t he real body of t he st ar candle. The $SOX t hen ret reat ed t o support near 418. The t rader who m issed t he
im plicat ions of t he shoot ing st ar, would have needlessly held sem iconduct or st ocks t hrough a sharp decline. I f you can accurat ely recognizing t he shoot ing st ar candle, t hen you'll have anot her im port ant t ool t o assist you in spot t ing early signs of a reversal. The candle will warn of t he end of a Minor upt rend be for e t rend following t ools such as m oving averages or MACD. Recognize t he shoot ing st ar or suffer t he slings and arrows of st ock m arket m isfort une. discussed above. The difference is t hat t he shoot ing st ar occurs at t he end of a long upt rend. The invert ed ham m er, on t he ot her hand, occurs aft er a significant decline has t aken place.
I f you exam ine t he invert ed ham m er carefully, it hardly
candle looks bearish. The bulls could not sust ain a rally, so t he bears t ook t he st ock back t oward it s lows for t he day.
So, w hy should t his candle pot ent ially set up an im port ant reversal? My t heory is t hat t he invert ed ham m er oft en is a signal t hat short s are beginning t o cover t heir posit ions.
Here is m y reasoning. Since t he invert ed ham m er can only occur aft er a sust ained dow nt rend, t he st ock is in all
probabilit y already oversold. Therefore, t he invert ed
ham m er m ay signify t hat short s are beginning t o cover. I n addit ion, t raders who have held long posit ions in t he
securit y, m ost of whom are now showing large losses, are oft en quick t o dum p t heir shares by selling int o st rengt h. short - covering sit uat ion. However, when you do see it s appearance on a chart , t hen I suggest you do t wo t hings.
EGOV peaked at $5.44 in early March and by lat e April had ret reat ed t o $4.13, a support level in t he vicinit y of it s Oct ober low. On t he day t he st ock bot t om ed, EGOV went out side t he lower Bollinger band. Alt hough it form ed a large black candle, not e t he large lower shadow as well,
confirm ing t hat t here was support j ust over $4.
have not iced t hat daily st ochast ics was bullishly divergent during t his period. Again, bullish divergence occurs when t he m om ent um indicat ors m ake a higher low w hile price it self is m aking a lower low. Since m om ent um oft en
proceeds price, it can be an im port ant signal a reversal is im m inent .
That reversal cam e t he next day, as EGOV form ed a large whit e candle t hat reached approxim at ely half- way back int o t he bot t om ing candle of t wo days previous. From t here, EGOV t raded int o resist ance at $4.60, backed off t o a t est of support and t hen rallied sharply t oward $5. The invert ed ham m er signaled t he st ock was close t o a low.
CAN D LE 1 5 : TH E H ARAM I I S " PREGN AN T" W I TH TRAD I N G POSSI BI LI TI ES
When you visualize t he haram i candle, you should im agine t hat t he first candle is like a m ot her and t he second candle t he child t hat em erges from it s belly. That is where t he nam e haram i or pregnant com es from .
The haram i candle can occur bot h aft er an upt rend or
dow nt rend. To keep t his discussion clear, however, for t he sake of exam ple I will assum e a st ock is in a upt rend.
I m m ediat ely preceding t he haram i candle, t here should be a large, real body dark candle. When t his candle occurs, t he bulls appear t o be fully in t he driver's seat .
The next day, however, a sm all real body candle appears
day's candle is near t he m iddle of t he t rading range of t he has st alled. The bulls are now on st rong ground and are engaged in a st ruggle for power wit h t he bears. The upper and low er shadows can be of any size, and t heoret ically could even go above t he real body of t he clear candle day. I n pract ice, how ever, t he haram i day's shadows are oft en sm all and are t ypically cont ained well wit hin t he real body of t he previous day's candle.
Always look carefully at t he next day's candle - - t he one t hat follow s t he haram i candle. Som et im es haram i m erely
signifies t hat t he st ock is ent ering a period of consolidat ion ( t he shares will t rade sideways) . I f, however, t he st ock you're exam ining rallies t he day aft er t he haram i candle t akes place, t hen t here is an increased likelihood t hat t he shares have put in a Minor bot t om .
The day before t he haram ai appeared, PLCM fell from near t he $15 range t o j ust below $14. A large dark candle
appeared on t he chart , m arked by volum e, approxim at ely 250% higher t han norm al.
able t o force prices any lower. From t here, PLCM rallied nicely. By m id- m ont h, t he shares were t est ing $16, a gain of nearly 50% of t he ground lost during t he decline. Not e t hat t he st ochast ics buy signal from oversold levels which confirm ed t he haram i candle did not com e unt il several days aft er t he candlest icks signaled t he reversal.
While t he haram i candle is considered less pot ent t han m any of t he key reversal candles, it nevert heless has subst ant ial predict ive power. I f it occurs in a st ock in which you have a posit ion, t hen you should be alert t o a change in t rend from up t o sideways, or even up t o down. ( I f t he st ock is in a dow nt rend, t hen t he haram i candle can also warn of an im pending period of sideways t rading, or perhaps even an upt rend.) The next t im e you observe t he haram i candle, candle t hat im plies t he day's t rading range has been large. A m arubozu candle lacks eit her an upper or lower shadow . On rare occasions it can lack bot h an upper or lower
shadow. I am going t o add a new t erm t o candlest ick
I f you spend a lot of t im e at t he t rading screen, t hen you probably realize t hat a full m arubozu is a very unlikely occurrence. Even aft er a st rong up gap, m ost st ocks experience a m inor reversal, which leaves a sm all lower
shadow. The sam e is t rue for t he down gap. I n addit ion, if a st ock has m oved sharply higher during t he day, day
t raders oft en seek t o nail down profit s t oward t he end of t he session. This creat es a sm all upper shadow. Conversely, if a st ock has sharply declined, t hen som e short sellers will
generally cover before t he close of t rading. Because of t his, st ocks rarely close on t heir absolut e low. I n t hese cases t here will be a sm all low er shadow.
When a " full m arubozu" occurs, or one t hat is very close t o full, it is very well wort h not ing. I f it is a whit e candle, t hen it signals ext rem e convict ion am ong buyers. Conversely, if it is a dark candle, t hen it indicat es sellers were eager t o flee. As always, you should pay careful at t ent ion t o t he next day's t rading t o see if t here is follow t hrough. A full or nearly full Marubozu im plies t hat t here is st rong buying or selling
int erest depending on t he color. I f t here is follow- t hrough early t he next day, t he st ock is likely t o t rend in t hat sam e direct ion for t he next few sessions. That awareness can be im port ant for t he t rader.
Below you will find an illust rat ion of a st ock w hich form s m any nearly full m arubozu candles, Am erada Hess ( AHC) an oil com pany. Why does Am erada form so m any m arubozu or close t o m arubozu candles? I t is because t rading in t he st ock correlat es very close wit h t he price of crude oil. When oil is down t he st ock sells off usually falling consist ent ly
during t he day. The reverse is t rue w hen oil rises.
As show n by t he 50- day m oving average which is sloping higher and below t he share price, AHC was in a st rong
aft er t he Maurbozu candle wit hin t wo t rading days in all cases, t he t rade was profit able. That is because t he
Marubozu signaled a st rong t hrust in t he t rend oft en aft er a short period of consolidat ion.
The " full m arubozu" is not generally considered a m aj or candlest ick. I n m y opinion, how ever, it should be added t o t his cat egory. Alt hough it is infrequent , t his candlest ick t ends t o be significant when it occurs. I f you observe it in a include bot h spinning t ops and high waves. I 've provided you wit h an illust rat ion of bot h of t hese candles below.
Why should t hese candles be considered opposit es relat ive t o t he m arubozu? When a m arubozu candle occurs, it shows a great deal of convict ion on t he part of t he m arket . A black m arubozu port rays a very weak m arket in which t he sellers are eager t o exit and willing t o get out of t heir posit ions at alm ost any price. Meanw hile, a whit e m arubozu port rays t he opposit e sit uat ion, where buyers are willing t o pay higher and higher prices t o ent er t he st ock.
What is t he difference bet ween t he spinning t op and t he high wave? I n t he spinning t op, t he shadows are relat ively sm all and t he candle has a very sm all range. When
com bined wit h low volum e, t raders m ay be expressing disint erest .
A high w ave candle, on t he ot her hand, port rays a sit uat ion where t here is an act ive t ug of war bet ween t he bulls and t he bears. This candle shows a m arket t hat has lost a clear sense of direct ion. I f it occurs on high volum e, t hen it
indicat es t he m arket 's general confusion about t he direct ion prices are headed.
I n lat e April, Zim m er peaked at $83.70 out side t he upper Bollinger band and began a slow , rolling decline t hat brought it back t o t he lower Bollinger band in bot h m id- May and
sessions. The volum e w as well below t he m oving average line.
All t oget her, t he t echnical indicat ors and t wo candles
suggest ed t hat doubt and confusion exist ed in t he m inds of bot h buyers and sellers. Sellers were no longer m ot ivat ed t o exit t he posit ion, but buyers were not willing t o st ep forward eit her. That sit uat ion changed t he next day, when ZMH bounced sharply off support and form ed a large w hit e
candle. On t his session, Zim m er's fut ure direct ion becam e clear in t he short t erm - – up.
ZMH ult im at ely recovered t o a high of $81.28, before
succum bing t o profit t aking and ret reat ing t o support near $75. But for t he alert t rader, t he com binat ion of candle signals and t echnical indicat ors signaled a good opport unit y.
CAN D LE 1 9 : TH E OM I N OUS CALL OF TH REE BLACK CROW S
The t hree black crows candle form at ion does not happen very frequent ly in st ock t rading, but w hen it does occur swing t raders should be very alert t o t he crow's caw.
The candlest ick's m et aphor is t hree crow s sit t ing in a t all t hree. On t he day t he first black crow m akes it s appearance, t he form at ion is m ost predict ive if t he first " crow" - - or dark candlest ick - - closes below t he previous candle's real body.
Two m ore long- bodied consecut ive down days t hen ensue. On each of t hese days, it appears as if t he st ock want s t o regain it s form er st rengt h, as t he st ock opens higher t han t he close on t he previous day. By t he end of each session, however, t he sellers regain cont rol and t he st ock drops t o a new closing low. Here is what t hree black crows candlest ick pat t ern looks like:
Not e t hat t he lower shadows on t hree black crows are sm all, or in som e cases even nonexist ent . Alt hough t hree black crows is a com plet e pat t ern in and of it self, t raders should always be alert t o what happens on t he fourt h day aft er t he pat t ern is form ed. Since t here has been int ense selling
Several days lat er, t he first of t he t hree black crows form ed j ust above $40. The second crow broke decisively t hrough t he $40 level and t he t hird crow t ook t he shares dow n t oward $38. By t his t im e, MACR had fallen alm ost $4 in t hree days and on a very short t erm basis was subst ant ially oversold. Oversold condit ions m ay be relieved by a st ock going eit her up or sideways and in t his case MACR went lat erally for t he next four days. Event ually, t he shares t est ed $35 before finding a short - t erm bot t om .
Three black crows is an infrequent , but powerful candle
form at ion. Aft er observing it s occurrence, t he t rader should likely resist t he t em pt at ion t o short since t he issue is already
The bullish count erpart of t hree black crows is known as " t hree w hit e soldiers" and is considered by som e candle t heorist s as one of t he m ost bullish candle pat t erns.
The t hree whit e soldiers pat t ern is m ost pot ent w hen it
occurs aft er an ext ended decline and a period of subsequent consolidat ion. When a part icular st ock post s a decline
point of t hree w hit e soldiers signals t hat higher prices are likely ahead.
The first of t he t hree advancing whit e soldiers is a reversal candle. I t eit her ends a downt rend or signifies t hat t he st ock is m oving out of a period of consolidat ion aft er a decline. The candle on day t wo m ay open wit hin t he real body of day appears following a long advance in price. I f you spot t hree whit e soldiers aft er a sust ained rally, t hen it m ay m ean a t op is near. Be on t he alert t hen for a reversal candle such as a doj i or negat ive engulfing.
An ext rem ely int erest ing exam ple of t hree whit e soldiers occurs in t he Biot ech I ndex ( $BTK) . Two chart s are
There w ere several fact ors w hich t ipped t he alert analyst t hat t he Biot ech had changed course. The first was a ham m er like candle out side t he Bollinger band. Not e also t he bullish divergence in st ochast ics on t his second bot t om . Bullish divergence occurs when price m akes a low er low and t he m om ent um indicat or a higher low. The first of t hree whit e soldier candles was also a bullish engulfing again providing st rong evidence t hat t he index was t urning around.
t hree m ont hs and saw t he biot echs lose nearly 70 point s. I n t hree days, t his group rallied t o an int raday peak of 515.69, a recovery of 34 point s or nearly half of t he ground lost in t hree m ont hs.
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Not e how t he biot echs went from one end of t he Bollinger band t o t he ot her and st ochast ics from oversold t o
overbought . The t hree whit e soldiers had consum ed a lot of buying power! Aft er t hat t he biot echs went sidew ays for m ost of t he m ont h resolving t he overbought condit ion. .
for it . These soldiers m ake great allies in your bat t le for t ake place, t hey are alm ost always significant .
What are t weezers candles?
Candlest ick t heory recognizes bot h a t weezers t op and a t weezers bot t om . The t weezers form at ion alw ays involves t wo candles. At a t weezers t op, t he high price of t wo nearby inst ances, t he lower shadows of t wo nearby candles t ouch t he sam e price level and t he st ock t hen bounces higher. A t hird possibilit y is t hat t he lower shadow of one day and t he real body of a nearby session hit t he sam e bot t om level.
t ypically a forecast ing form at ion t hat applies t o drive prices higher. Tweezers t hus signify very short - t erm support and resist ance levels.
Tweezers som et im es occur on t wo consecut ive t rading sessions. I n t hese cases t hey are relat ively easy t o spot . However, t hey can also occur several sessions apart - - say six or eight . ( I f t hey are spread furt her apart t han t hat , t hen t he form at ion is beginning t o approach t he double bot t om or t op described above.) When t he t weezers occur
consecut ively t heir forecast ing value generally increases. Why? Well, in t hese cases a bullish or bearish m ove has been absolut ely st opped in it s t racks and is m ore likely t o reverse.
A t weezers bot t om t hem m arked t he conclusion of t he selling pressure. The first low occurred at $46.59. Eight t rading days lat er, BNI t est ed $46.54, five cent s lower t hen t he first t weezers candle. Not e t he long lower shadow s on bot h candles saying sellers were eager t o st ep in and buy in t his zone of support .
on t he chart . When it is rising and below t he share price, it provides support and oft en st ops a correct ion part icularly t he first t im e it is t est ed.
From t he m id- $46 range, BNI rallied t o $51.62 on May 6t h and $51.59 on May 9t h. These days were Friday and
Monday, so t hey were consecut ive. A t weezers t op st alled t he recovery and t he shares again pulled back falling t his t im e t o a low j ust over $47.
Tweezers candles do not occur as frequent ly as ot her
candles such as doj is. When t hey do arise, however, t hey generally give rise t o high- probabilit y t rading opport unit ies. Recognize t his candle form at ion and you'll have a m uch easier t im e ext ract ing m oney from t he m arket .
GAPS FROM A JAPAN ESE CAN D LESTI CK V I EW POI N T
A gap is a 'hole" in t he chart . I t occurs because on a
part icular day a st ock opens or closes m uch higher or low er t han on t he previous session. The cause of a gap can be varied. Som e com m on reasons for gaps are earnings announcem ent s, im port ant corporat e news or even large m oves in t he overall m arket at t he opening of t rading.
TH E FOUR TYPES OF GAPS
The t rader should be able t o ident ify four different t ypes of gaps: area ( com m on) , breakaway, cont inuat ion ( m easuring) and exhaust ion.
An " area" gap occurs wit hin a t rading pat t ern such as a t riangle, rect angle or base. Typically, t he " area" gap is of lit t le significance. Since area gaps are oft en filled quickly, t hey conform t o t radit ional wisdom t hat gaps are filled. The st ock Aladin Knowledge Syst em s ( ALDN) shows t wo
A " breakaway" gap is an ent irely different m at t er. The
" breakaway" gap ends a consolidat ion pat t ern and happens as prices break out . Oft en, a " breakaway" gap occurs on very large volum e, as t he supply available wit hin t he
consolidat ion pat t ern has been consum ed and bidders w ho want t o ent er t he st ock m ust pay up for it . A genuine
" breakaway" gap will oft en not be filled for weeks or m ont hs ( if ever) .
Not e how t he st ock t ried t o rally back t oward resist ance at $25.44 on t he gap of t he gap. I t failed right below t hat level and left an enorm ous upper shadow. Volum e on t hat day was about 350% high t han norm al levels. I f t he st ock w ere t o approach $25.44 again it will face very st rong resist ance as all t he buyers who have t he chance t o get out at close t o breakeven will be t em pt ed t o do so.
A " cont inuat ion" gap occurs wit hin a rapid st raight - up
A fascinat ing exam ple of a cont inuat ion gap occurs in t he chart of Brint er I nt l. ( EAT) , a rest aurant chain. The st ock peaked j ust shy of t he $40 level in March and hit a low of $33.19 in lat e April. Aft er a snappy recovery, t he st ock
closed at $36.95 on June 8t h. Not e t he m ove from $33.19 t o $36.95 was $3.76.
The next day EAT gapped up on news t hat t he com pany was boost ing bot h it s quart erly and full year earnings out look. The st ock opened at $39.25, backed off t o $38.65 and
gap day, $38.65, t he t arget becom es $42.41. The st ock hit $42.40 several t rading days lat er!
An " exhaust ion" gap occurs at t he end of a price m ove. I f t here have been t wo or m ore gaps before it , t hen t his kind of gap should be regarded very skept ically. A genuine
" exhaust ion" gap is filled wit hin a few days t o a week.
BHP Billit on is an Aust ralian m ining st ock which t rades on t he New York St ock Exchange. The com pany t ends t o form m any gaps since t he t rading w hich t akes place in Aust ralia before t he NYSE opens dram at ically influences BHP'
I n m id- June, however, not e t hat BHP m ade an unusual breakaway gap, for exam ple, m ay over t he next several
weeks be filled and t hat filling m ay be an im port ant cat alyst t o t ake t rading act ion in t he opposit e direct ion.
CAN D LESTI CK TH EORY ON GAPS
Candlest ick t heory, while less det ailed about gaps, provides som e im port ant addit ional insight s. Japanese t heory does not dist inguish bet ween t he t ypes of gaps. Nor does it even use t his t erm . I nst ead a gap is called a " window."
Whereas a great deal of em phasis in candlest icks is given t o reversal pat t erns, a window is considered a cont inuat ion pat t ern. I n ot her words, t rading is highly probable t o cont inue in t he sam e direct ion aft er t he window as it did before it .
I n his w ork on candlest icks, St eve Nison advises t raders t hat t hey should t ypically t rade " in t he direct ion of t he window." I f a part icular st ock is declining when t he window" occurs, t hen it is highly probable t hat t he decline will cont inue. I f t he st ock is rising w hen t he window occurs, t hen it should
cont inue t o rally.
edge of t he window should be t he lowest point of decline. cont inue higher. Event ually, however, prices will reverse and will t est t he open window. On t his t est , prices should hold at
window, t he decline should cont inue. Event ually resist ance, which is at t he upper edge of t he window, should be t est ed. I f buying pressure persist s and is able t o m ove prices
beyond t his upper window, t hen t he swing t rader should go long in t he sam e way t hey would if a resist ance level were overcom e.
SYN TH ESI S OF W ESTERN W I SD OM AN D EASTERN I N SI GH T
Com bining west ern wisdom and east ern insight on gaps, what t hen are som e key t rading t act ics you can t ake away? The principles below should be applied w it hin t he cont ext of ot her chart m essages such as m oving averages, t rendlines and st ochast ics. That said, here are several t rading
principles based on gaps:
1. On spot t ing a gap in a daily chart , im m ediat ely
t he m ore likely it is prices will cont inue t o t rend in t hat should, ot her fact ors considered, buy quickly. The t rader should t hen use t he m easuring principle, which applies t o t his gap, t o ident ify t he short - t erm t arget .
5. A " breakaway" gap also provides an im m ediat e buy point , part icularly when it is confirm ed by heavy volum e. 6. The t hird upside gap raises t he possibilit y an
" exhaust ion" gap has occurred. Swing t raders should look for t he gap t o be filled in approxim at ely one t rading week. I f t he gap or window is filled and selling pressure persist s, t hen t hat issue should be short ed. I f t he gap is t he t hird one t o t he downside, t hen t raders should be alert for a buy
signal.
As powerful an analyt ical t ool as gaps are, generally t hey should not be act ed on in isolat ion. View t he gap wit hin t he cont ext of t he ot her t echnical m essages given by t he chart . For a com plet e syst em of gap analysis, t raders should apply bot h west ern and east ern concept s of gap analysis.
Hopefully, t his sum m ary of gaps has filled in som e " holes" in your knowledge of how t o apply t his t echnical analysis
