In this video, Stephen Bigalow discusses the major candlestick signals and how to use them when buying and selling.

Stochastics

As an aid to interpreting candlesticks, Stephen also uses a (Full) Stochastic Oscillator of 12-3-3 (12 = the look-back period %K, 3 = the number of periods to slow and so smooth %K , 3 = simple moving average). He says 80% of what he looks at are the price movements, and only 20% is Stochastic.

Moving Averages

Stephen uses a minimum of indicators. However, he does use the 200 SMA, the 50 SMA, and the 20 SMA – these are the SMAs that all the portfolio managers use when managing their portfolios.

The T-Line

Then there is the T- Line (the Trigger Line), which is the 8 EMA.

THE SIGNALS

The Doji

dojis

Probably the most powerful candlestick signal.

If you see a Doji at the top – SELL

If you see a Doji at the bottom – CONFIRM either a bullish reversal or whether the weight of the market continuing to push the market down

Always heed the appearance of a Doji – The trend will usually move in the direction of the open then next day after a Doji

After a long uptrend, he would look for a Doji at the top while the Stochastics are in an overbought position. That would be a Sell signal. If it opens lower in the next period, close out your position immediately.

If you see a candlestick Buy signal and a close above the T-line, you can stay in the trade until you see a candlestick sell signal and a close below the T-Line. This makes for a comfortable trading scenario.

The caveat is that, the further the price moves away from the T-Line, the higher the probability that it’s going to come back and test it. It you see this happening and get a signal (e.g. a Doji), it’s time to get out.

If you see a Doji following a gap up, it’s time to take profits (especially in the overbought area).

The bigger the signal (e.g. a long-legged Doji or multiple  long-legged Dojis), the greater the intrinsic indecision and the greater the likelihood of reversal.

Candlestick signals and Gaps

“Candlestick signals and Gaps are your best friends”: The Doji tells you there was indecision and the Gap tells you, with force, the result of that indecision and what the trend will be. Gaps show enthusiasm!

The “Abandoned Baby” with a Gap up to the Doji and then a Gap down, is a very powerful signal.

Dojis at the Bottom

While you should take profits with a Doji at the top, at the bottom, you need bullish confirmation (e.g. a move to the T-Line) that the Bulls have indeed retaken control.

You take the trade when the price has started to move in the direction that the Doji has suggested it will move.

 The Left/Right Combination: Bullish and Bearish engulfing signals

Bullish Engulfing

A Doji followed by a Bullish Engulfing signal (where the price opens below the previous days close and closes above the previous days open) creates a Left/Right Combo, a change of investor sentiment. It usually starts a strong uptrend. The same goes in reverse for a Bearish Engulfing signal. The bigger the body of the engulfing candle, the stronger the trend will be.Bearish Engulfing

With a  Bullish Engulfing signal, if the Bears come back and the price closes more than half way down the  Bullish Engulfing candlestick, then the Bears are still in control.

If you are in an Overbought situation and you see price Gap up and then start to rise, put a stop one tick below the open. If it goes up and stays up, then something good is happening. But, if it starts to go down through the open, it will create some kind of candlestick sell signal (e.g a shooting star, a dark cloud). If it Gaps up, but then immediately starts to trade down, put your stop at the close of the previous period.

Piercing Signal

Piercing SignalThe Piercing Signal is where, at the bottom of a trend, the price Gaps down, but then comes back to close in the top half of the previous candle. This shows that Bulls are starting to retake control. The bigger the movement, the stronger the signal.

Dark Cloud CoverDarkCloudCover

 

The Dark Cloud Cover is the reverse of Piercing Signal: At the top of a trend, the price Gaps up, but then comes back to close in the top half of the previous candle. This shows that Bears are starting to retake control.

The Hammer

With a Hammer, the lower tail is 2x longer than the body of the candlestick. The body can be either black or white. It tells you that the Bears have “hammered” out the bottom of the market and the Bulls have stepped back in. But, we want to see that the Bulls are participating the next day.

hammer and hanging man

The Hanging Man

The Hanging Man is similar to the Hammer, but it’s at the top of the trend. It basically shows that the Bears are starting to show up on the scene. If it is confirmed the next day with a lower open, then it’s time to get out.

The Inverted Hammer

The Inverted Hammer is the opposite of the Hanging Man. At the bottom of the trend, the Bulls have traded the price up, but the Bears have managed to wrestle it back down (so there is a long upper tail). But indecision has come into play.

The Shooting Star

shooting starThe is at the top of the trend. Again, this is where the tail is 2x longer than the body of the candlestick, but it is the upper tail.  Again, if it is confirmed the next day with a lower open, then it’s time to get out.

Bullish Harami (Inside Day)

The Bullish Harami is where, at the bottom, a candlestick opens above the close of the previous period, but closes lower than the opening of the previous period. Also known as an Inside Day. If this happens on a major indicator (eg. the 200 SMA), it shows big money have stepped back in to buy. Also look for a Gap up the next day to confirm sentiment.

If the next day the Bears pull the price back below the T-Line or take back 50% of the confirming candle, get out of the trade.

Harami

Bearish Harami 

Like the Bullish Harami, but at the top of the trend, this shows buying has stopped and it’s time to sell. Maybe you take 50% off your position and then look for an signal (e.g an indicator line) as to where you want to take all your money off the table.

Morning Star

The Morning Star is where you have a “dark” day at the end of a downtrend followed by a day of indecision (e.g. a long-legged Doji). The third day has to close positively and at least half-way up the body of the “dark” candle. The further the way that it closes up past the halfway mark, the better. If it Gaps up, even better. You would place a stop half way down the candle that was the indicator that the Bulls were back in control.

Bullish and Bearish Kicker Signals

These are the strongest reversal signals, where a candlestick opens higher or lower than the previous period’s high or low and then continues and closes the period in that same direction.

J-Hook Pattern

J-Hook Pattern

If you see a pullback from the top followed be a series of Dojis, it indicates there may not be conviction in the pullback and you could see the start of a new uptrend. In this case, this second uptrend could be as long as the first wave of the uptrend. This will help with profit taking.

Fry-Pan Bottom (Saucer)

The Fry-Pan Bottom pattern looks like a Fry-Pan or Saucer Bottom and can show a break-out even in overbought situations.

Cradle Pattern

The Cradle Pattern starts in a downtrend  with a long dark candle (the cradle’s footboard), then trades indecisively for 4-7 days, followed by a long light candle  (the cradle’s headboard). A strong uptrend usually follows.

Stops

Once you have your Entry price confirmed by a close of the price above the T-Line, the stock should not close again below the T-Line. It is not doing what the candlestick signals told you it should be doing. You don’t want to see it trade back through the signal,  so you need to get out of that trade and go on to one that is going to work in your favour. You do that by putting s stop below the T-Line.

If you’re in an uptrend with a green candle, but it is in an overbought condition, the Bears should not be able to trade it back to the open of the previous candle, nor should they be able to open below the previous candle. This is an incredibly Bearish signal. That’s where your stop needs to be.

Volume

Stephen Bigelow doesn’t spend too much time on volume. He says that seeing high volume supporting a candlestick signal is an added benefit. But, he says, “volume has nothing to do with price”.

Profits

If it’s time to take profits and you still think price will continue to trend, take off 50% of your position.