If you want to be popular and respected among traders, call every reversal point accurately. Warn traders when the top is forming, and inform people to prepare for the bottom. If you can do that with pinpoint accuracy, I guarantee that you will be a star. You will be the most sought-after person in the trading community.
The Engulfing pattern, the Harami pattern, the Shooting Star, Morning and Evening Star patterns -- all these reversal candlestick patterns are supposed to be excellent ways of detecting important bottoms and tops. More than a few years ago, I read a report that said, "The candlestick charting technique does not have unfair advantages over other charting methods. The accuracy of candlestick charting technique is 50/50, or worse, depending on which market you are trading in." I'm not trying to discredit candlesticks. In fact, I encourage you to use them as part of your decision-making process. It is always wise to get as many confirmations as possible before committing your money. Remember, multiple signals are better than one signal.
Today, I want to talk about continuation patterns of candlesticks. As you know, strong stocks cannot go up forever without taking a rest. They have to pull back from their highs before resuming their uptrend. This is the main idea behind continuation candle patterns. They are designed to detect when strong or weak stocks are taking a rest. It is just like the popular 1-2-3-4. Let's begin with the Rising Three Method.
The Rising Three Method
On this daily chart of ASTRO Power (AWPR | Quote | Chart | News | PowerRating), I want you to focus on numbers 1 through 5. This is what the Rising Three Method looks like. For it to be effective, some traders insist that Day 5's close must be higher than Day 1's high, and Day 4's low cannot go below the low of Day 1. I don't think this is really necessary, and do not wish to restrict myself too much when I trade. Since this pattern consists of five candlesticks, I think some leeway should be allowed.
First, we need to confirm a stock is in an uptrend. The number 1 bar must be an up day with its open near the low and its close near the high. The numbers 2, 3, and 4 are pullback bars with small real bodies, and the color of the real body is not important. The number 5 bar is a bullish engulfing line that wraps almost entirely the previous down bars. A conventional buy entry will be made when the stock takes out the high of the number 5 bar. This is where I disagree. If you are a follower of the 1-2-3-4 method, you would be a buyer of this stock on Day 5. You can safely buy this stock when it trades above the high of the number 4 bar.
The Falling Three Method
The opposite of the Rising Three Method can be seen on this daily chart of Nabors Industries (NBR | Quote | Chart | News | PowerRating). I would like you to take a look at numbers 1 through 5. The number 1 bar has to be a down day with its open near the high and its close near the low. The numbers 2, 3, and 4 are pullback bars with small real bodies. Some traders demand that the color of the small real bodies be the opposite of Day 1. The number 5 bar is a bearish engulfing line that almost wraps all prior three bars. Your sell entry comes when the stock falls below the low of the number 5 day. Again, if you are a typical pullback player, you would not wait that long. In fact, you sell the stock when it trades below the low of the number 4 day.
I want you to be a flexible trader. In actual trading situations, as you know, textbook-perfect shapes and patterns rarely develop. Here is a daily chart of MDU Resources Group (MDU | Quote | Chart | News | PowerRating). As you can see, it appears to be forming the Falling Three Method, but if you count correctly, it has four small real bodies. The number 6 bar is a bearish engulfing line that almost covers all previous four small bodies. Don't be too textbookish. Rather, be flexible. After all, a textbook is a textbook.
By Tsutae Kamada | TradingMarkets.com
This pattern occurs when a stock rises very quickly out of a base and gets overextended.
Stocks in a Parabolic Move can double or triple in value in a very short period of time (usually less than two weeks).
As an investor you certainly don't want to be one of the last passengers on the train and get quickly thrown off.
Some examples of this pattern are shown below.
Notice the quick move upward in MCOM back in July. In 5 trading days it went from $20 to $57 for a gain of 185%. Also notice that on the biggest volume day (point A) that it gapped up strongly to $53 and then closed poorly around $41. This was the Climax Top Off the Parabolic Move. As an investor you should have sold this day if you had bought the stock in the $20's. Meanwhile you certainly should have not bought this stock this day. Notice how the stock eventually pulled all the way back to $20 by early August (point B).
Another example of a Climax Top Off a Parabolic Move is demonstrated by LWIN. This stock skyrocketed from $30 to $95 in 10 trading days for a whopping gain of 217%.
The Climax Top occurred on the 10th and 11th days of trading as the volume peaked (point A). The stock then sold off and retreated back quickly to around $42 by late November.
As you can see stocks that go up very quickly, in a Parabolic Move, can also come down just as fast.
My advice is if you buy a stock and it doubles or triples in value in a very short period of time (1 to 2 weeks) take your profits and congratulate yourself for a job well done. If you become greedy then you could lose most of your gains as the above examples indicate. Furthermore if your buying a stock in this type of move be very careful and watch out for the Climax Top if the stock is trading on its biggest volume day.
Bob Kleyla
Amateur-Investors.Com
A gap in a chart is essentially an empty space between one trading period and the previous trading period. They usually form because of an important and material event that affects the security, such as an earnings surprise or a merger agreement.
This happens when there is a large-enough difference in the opening price of a trading period where that price and the subsequent price moves do not fall within the range of the previous trading period. For example, if the price of a company’s stock is trading near $40 and the next trading period opens at $45, there would be a large gap up on the chart between these two periods, as shown by the figure below.
Figure 1
Gap price movements can be found on bar charts and candlestick charts but will not be found on point-and-figure or basic line charts. The reason for this is that every point on both point-and-figure charts and line charts are connected.
It is often said when referring to gaps that they will always fill, meaning that the price will move back and cover at least the empty trading range. However, before you enter a trade that profits the covering, note that this doesn’t always happen and can often take some time to fill.
There are four main types of gaps: common, breakaway, runaway (measuring), and exhaustion. Each are the same in structure, differing only in their location in the trend and subsequent meaning for chartists.
Common Gap
As its name implies, the common gap occurs often in the price movements of a security. For this reason, it's not as important as the other gap movements but is still worth noting.
Figure 2: Common Gap
These types of gaps often occur when a security is trading in a range and will often be small in terms of the gap's price movement. They can be a result of commonly occurring events, such as low-volume trading days or after an announcement of a stock split.
These gaps often fill quickly, moving back to the pre-gap price range.
Breakaway Gap
A breakaway gap occurs at the beginning of a market move - usually after the security has traded in a consolidation pattern, which happens when the price is non-trending within a bounded range. It is referred to as a breakaway gap as the gap moves the security out of a non-trending pattern into a trending pattern.
Figure 3: Breakaway gap
A strong breakaway gap out of a period of consolidation is considered to be much stronger than a non-gap move out. The gap gives an indication of a large increase in sentiment in the direction of the gap, which will likely last for some time, leading to an extended move.
The strength of this gap (and the accuracy of its signal) can be confirmed by looking at that volume during the gap. The greater the volume out of the gap, the more likely the security will continue in the direction of the gap, also reducing the chances of it being filled.
While the breakaway gap generally doesn't fill like the common gap, it will in some cases. The gap will often provide support or resistance for the resulting move. For an upward breakaway gap, the lowest point of the second candlestick provides support. A downward breakaway gap provides resistance for a move back up at the highest price in the second candlestick.
The breakaway gap is a good sign that the new trend has started.
Runaway Gap (Measuring Gap)
A runaway gap is found around the middle of a trend, usually after the price has already made a strong move. It is a healthy sign that the current trend will continue as it indicates continued, and even increasing, interest in the security.
Figure 4: Runaway (or measuring) gap
After a security has made a strong move, many of the traders that have been on the sideline waiting for a better entry or exit point decide that it may not be coming and if they wait any longer they will miss the trade. It is this increased buying or selling that creates the runaway gap and continuation of the trend.
Volume in a runaway gap is not as important as it is for a breakaway gap but generally should be marked with average volume. If the volume is too extreme, it could signal that the runaway gap is actually an exhaustion gap (discussed further in the next section), which signals the end of a trend.
The runaway gap forms support or resistance in the exact same manner as the breakaway gap. Likewise, the measuring gap does not often fill, and there's cause for concern if the price breaks through the support or resistance, as it is a sign that the trend is weakening - and could even signal that this is an exhaustion gap and not a runaway gap.
Exhaustion Gap
This is the last gap that forms at the end of a trend and is a negative sign that the trend is about to reverse. This usually occurs at the last thrusts of a trend (typically marked with panic or hype), but can also be the point when weaker market participants start to move in or out of the security.
The exhaustion gap usually coincides with an irrational market philosophy, such as the security being touted as "a can't-miss opportunity" or conversely as something to "avoid at all costs".
Figure 5: Exhaustion gap
To identify this as an exhaustion gap or the last large move in the trend, the gap should be marked with a large amount of volume. The strength of this signal is also increased when it occurs after the security has already made a substantial move.
Because the exhaustion gap signals a trend reversal, the gap is expected to fill. After the exhaustion gap, the price will often move sideways before eventually moving against the prior trend. Once the price fills the gap, the pattern is considered to be complete and signals that the trend will reverse.
Island Reversal
One of the most well-known gap patterns is the island reversal, which is formed by a gap followed by flat trading and then confirmed by another gap in the opposite direction. This pattern is a strong signal of a top or bottom in a trend, indicating a coming shift in the trend.
Figure 6: Island reversal pattern
Above is an example of an island-bottom reversal that occurs at the end of a downtrend. It's formed when an exhaustion gap appears in a downtrend followed by a period of flat trading. The pattern is confirmed when an upward breakaway gap forms in the price pattern.
The size of the trend reversal or the quality of the signal is dependent on the location of the island in the prior trend. If it happens near the beginning of a trend, then the size of the reversal will likely be less significant.
By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.com
As you may have noticed, chart pattern names don't leave much to the imagination. This is no different for the triangle patterns, which clearly form the shape of a triangle. The basic construct of this chart pattern is the convergence of two trendlines - flat, ascending or descending - with the price of the security moving between the two trendlines.
There are three types of triangles, which vary in construct and significance: the symmetrical triangle, the descending triangle and the ascending triangle.
Symmetrical triangle
The symmetrical triangle is mainly considered to be a continuation pattern that signals a period of consolidation in a trend followed by a resumption of the prior trend. It is formed by the convergence of a descending resistance line and an ascending support line. The two trendlines in the formation of this triangle should have a similar slope converging at a point known as the apex. The price of the security will bounce between these trendlines, towards the apex, and typically breakout in the direction of the prior trend.
If preceded by a downward trend, the focus should be on a break below the ascending support line. If preceded by an upward trend, look for a break above the descending resistance line. However, this pattern doesn't always lead to a continuation of the previous trend. A break in the opposite direction of the prior trend should signal the formation of a new trend.
Figure 1: Symmetrical triangle
Above is an example of a symmetrical triangle that is preceded by an upward trend. The first part of this pattern is the creation of a high in the upward trend, which is followed by a sell-off to a low. The price then moves to another high that is lower than the first high and again sells off to a low, which is higher than the previous low. At this point the trendlines can be drawn, which creates the apex. The price will continue to move between these lines until breakout.
The pattern is complete when the price breaks out of the triangle - look for an increase in volume in the direction of the breakout. This pattern is also susceptible to a return to the previous support or resistance line that it just broke through, so make sure to watch for this level to hold if it does indeed break out.
Ascending Triangle
The ascending triangle is a bullish pattern, which gives an indication that the price of the security is headed higher upon completion. The pattern is formed by two trendlines: a flat trendline being a point of resistance and an ascending trendline acting as a price support.
The price of the security moves between these trendlines until it eventually breaks out to the upside. This pattern will typically be preceded by an upward trend, which makes it a continuation pattern; however, it can be found during a downtrend.
Figure 2: Ascending triangle
As seen above, the price moves to a high that faces resistance leading to a sell-off to a low. This follows another move higher, which tests the previous level of resistance. Upon failing to move past this level of resistance, the security again sells off - but to a higher low. This continues until the price moves above the level of resistance or the pattern fails.
The most telling part of this pattern is the ascending support line, which gives an indication that sellers are starting to leave the security. After the sellers are knocked out of the market, the buyers can take the price past the resistance level and resume the upward trend.
The pattern is complete upon breakout above the resistance level, but it can fall below the support line (thus breaking the pattern), so be careful when entering prior to breakout.
Descending triangle
The descending triangle is the opposite of the ascending triangle in that it gives a bearish signal to chartists, suggesting that the price will trend downward upon completion of the pattern. The descending triangle is constructed with a flat support line and a downward-sloping resistance line.
Similar to the ascending triangle, this pattern is generally considered to be a continuation pattern, as it is preceded by a downward trendline. But again, it can be found in an uptrend.
Figure 3: Descending triangle
The first part of this pattern is the fall to a low that then finds a level of support, which sends the price to a high. The next move is a second test of the previous support level, which again sends the stock higher - but this time to a lower level than the previous move higher. This is repeated until the price is unable to hold the support level and falls below, resuming the downtrend.
This pattern indicates that buyers are trying to take the security higher, but continue to face resistance. After several attempts to push the stock higher, the buyers fade and the sellers overpower them, which sends the price lower.
By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.com
The Falling Three Method
The opposite of the Rising Three Method can be seen on this daily chart of Nabors Industries (NBR | Quote | Chart | News | PowerRating). I would like you to take a look at numbers 1 through 5. The number 1 bar has to be a down day with its open near the high and its close near the low. The numbers 2, 3, and 4 are pullback bars with small real bodies. Some traders demand that the color of the small real bodies be the opposite of Day 1. The number 5 bar is a bearish engulfing line that almost wraps all prior three bars. Your sell entry comes when the stock falls below the low of the number 5 day. Again, if you are a typical pullback player, you would not wait that long. In fact, you sell the stock when it trades below the low of the number 4 day.
I want you to be a flexible trader. In actual trading situations, as you know, textbook-perfect shapes and patterns rarely develop. Here is a daily chart of MDU Resources Group (MDU | Quote | Chart | News | PowerRating). As you can see, it appears to be forming the Falling Three Method, but if you count correctly, it has four small real bodies. The number 6 bar is a bearish engulfing line that almost covers all previous four small bodies. Don't be too textbookish. Rather, be flexible. After all, a textbook is a textbook.
By Tsutae Kamada | TradingMarkets.com
