Encyclopedia of Candlestick Charts
Thomas N. Bulkowski is a successful investor with over twenty-five years of experience trading stocks. He is also the author of the Wiley titles Getting Started in Chart Patterns, Trading Classic Chart Patterns, and Encyclopedia of Chart Patterns, Second Edition. Bulkowski is a frequent contributor to Active Trader; Stocks, Futures & Options; Technical Analysis of Stocks & Commodities; and other publications. Before earning enough from his investments to 'retire' from his day job at age thirty-six, Bulkowski was a hardware design engineer at Raytheon and a senior software engineer for Tandy Corporation.
Encyclopedia of Candlestick Charts
The candlestick trade I'm about to describe made me enough money to pay for three months of living expenses. That's not bad for an hour's work! In a moment, I'll outline the trading setup so you can tailor it to your liking.
On May 16, 2007, I went shopping for a stock to buy and found one in the diversified chemicals aisle of the market. What caught my eye first was a consolidation pattern called a descending triangle. Figure I.1 shows the chart pattern in May. Descending triangles have a flat bottom and a downward-sloping top. They break out downward 64% of the time, but upward breakouts can post spectacular results. I was looking for an upward breakout.
Figure I.1 The combination of a descending triangle, Big W, and morning doji star set up a profitable trade.
The next pattern I noticed was the Big W. A tall left side (C to A) leads to a reversal pattern, such as the Eve & Eve double bottom AB. Eve bottoms are wide, rounded turns, unlike Adam bottoms, which are narrow, often pointed - a single spike or two wide. Eve can have spikes like that shown at B, but the spikes are shorter and more numerous than what you see on Adam. The Eve & Eve double bottom is one of the more powerful and successful chart patterns. The theory behind a Big W is that the right side will mimic the left and price will climb after that.
The pattern that sealed the deal was the morning doji star candlestick. That candle pattern ended the day that price closed above the top of the descending triangle. My research said that the morning doji star is a highly reliable candle formation. Combined with additional analysis I did on the company, both fundamental and technical, the stock was a buy only if it gapped open higher. Why? Because the next day the company was holding a conference call before the market opened to discuss earnings. A higher open would mean the market liked its story.
The news reports the night before the meeting said that net profit was 53 cents versus 61 cents during the year-ago quarter even as revenue climbed by 30%. Just 1% of the revenue gain was from higher internal sales, though. Most was from acquisitions or currency translation. Analyst estimates ranged from $0.52 to $0.58, so earnings came in at the low end. All of this sounded bearish to me, but the technicals were shouting, "Buy!"
My candle research says that opening gap confirmation from a morning doji star results in the best performance. That means trading with the trend as soon as possible.
The next day, I watched the stock open and price took off. In the first minute, it shot from the prior close of 33.46 to 34. That left a tall white candle on the chart. Again, my research and knowledge of candles said that the body of a tall candle is often a support zone. So, I placed a buy order halfway down the body, at 33.78.
Sure enough, price turned down and nailed my buy order, filling most of it before moving up again. I had trouble fitting through the door because the smile on my face was so wide. Five minutes later, the remainder of the order filled.
By day's end, the stock had recovered and closed higher by 1.16. The next day a brokerage firm upgraded the stock and price moved higher still, this time up another 1.93. The following day price coasted upward 33 cents (D).
Exit time. Why? This is one of those situations where you get a feeling that it's time to leave, so I started my analysis. The height of the candle lines was diminishing, suggesting a trend change. The Commodity Channel Index (CCI, with default settings of 20 bars for the lookback and 5 for the DCCI line - dual CCI, a smoothing of the CCI), an indicator, was rounding over and looked as if the next day would produce a sell signal. In other words, upward price momentum was slowing. I didn't wan