Candlestick Gap up at the Bottom

A Gap up at the Bottom

A gap, appearing after a candlestick “buy” signal, has powerful implications. Knowing that a gap represents enthusiasm, getting in or out of a stock position becomes an easy identification process. The forewarning that a strong profit potential situation is about to or has occurred is established. Where is the best place to see rampant enthusiasm? At the point you are buying, near the bot­tom. Obviously, seeing a potential Candlestick “buy” signal, at the bottom of an extended downtrend is a great place to buy. In keeping with the concepts taught in Candlestick analysis, we want to be buying stocks that are already oversold, to reduce the downside risk. Evidence that buyers are very anxious to get into the stock is all that much better.

Reiterating the basics of finding the perfect trades, as found in the Article “How To make High Profit in Candlestick Patterns,” having all the stars in alignment makes for better probabilities of producing a profit. The best scenario for a high-profit trade is a candlestick “buy” signal, in oversold condition, confirmed with a gap up the following day. Illustrated in Fig. 4-1, the Bombay Company, Inc. chart, the uptrend was obviously instigated after a gap up and large bullish candle following a Doji. The fact that prices gapped up was clear illustration that buyers wanted to get into this stock with great fervor.

Unofficially, statistics illustrate an 80% or better probability that a trade will be successful when stochastics are oversold, a Candlestick “buy” signal appears, and prices gap up. (The Candlestick Forum will offer our years of statistical figures as “unofficial.” Even though over fifteen years of observations and studies have been involved, no formal data gathering programs have been fully operated. However, currently the Candlestick Forum is involved with two uni­versity studies to quantify signal results. This is an extensive program endeavor. Results of these studies will be released to Candlestick Forum subscribers upon completion. This study has been long and difficult, but results are expected sometime in the near future.)

Having this statistic as part of an investor’s arsenal of knowledge creates opportunities to extract large gains out of the markets. The risk factor remains extremely low when participating in these trade set-ups.

Many investors are afraid to buy after a gap up. The rationale being that they don’t like paying up for a stock that may have already moved 3%, 8%, 10%, or 20% already that day. Witnessing a Candlestick “buy” signal prior to the gap up provides a basis for aggressively buying the stock. If it is at the bottom of a trend, the 3%, 8%, 10% or 20% initial gap move may just be the beginning of a 50% move or a major trend that can last for months.

The strength of an uptrend can be better verified when the gap in price moves up past potential resistance levels. As illustrated in Fig. 4-2, the Merid­ian Gold Inc. chart, the price gapped up over the 50-day moving average, what had previously been acting as a resistance area. The strength of the buyers is clearly represented. The fact that the price breached the moving average, while still forming a bullish candle after the open price, illustrates that the buying sentiment did not diminish after the dramatic increase in price.

The more parameters in place, confirming an uptrend, the higher the prob­ability of being in a correct trade. Add to that the confirmation of excessive buying strength, a gap up in price, the higher the probabilities that a strong uptrend is occurring.

Fig.4-3, The Cleveland Cliffs Inc. chart reveals a Bullish Harami forming right on the 50-day moving average followed by a gap up in price. First, the Bullish Harami forming on the 50-day moving average became a good indica­tion that the moving average was going to act as support. The gap up the following day made it evident that many buyers felt the same way. If one gap shows enthusiastic buying, two gaps reveal that much more strength. The trend is your friend, an often the spoken adage. Gaps, when used correctly, are your best friends.

This is not a difficult analysis. Witnessing a candlestick buy signal fol­lowed by exuberant buying is exactly the type of trade an investor should be looking for.

Fig. 4-4, The Pride International Inc. chart illustrates how the enthusiastic buy­ing, after a candlestick signal, provides the confirmation that a strong uptrend is in progress. Notice how the Kicker type signal, a strong bullish indication in itself, precludes the strong uptrend. The next day it gaps up on a strong bullish candle. The gap up, followed by strong continued buying, reveals a number of bullish observations.

The gap occurs at what could be considered a mild resistance level. The price appeared to have trouble closing above the $16 level. When the price gapped up through drat area, it revealed that the $16 area was not acting as resistance any more. Next, the strong bullish candle went through the 50-day moving average. That average acted as a resistance level earlier. Witnessing price moving out of a trading range and through potential resistance should indicate that a new dynamic has come into the price trend.

Candlestick analysis can also be applied to what a price was doing before a significant buy situation. As seen in Fig. 4-5, the Premcor Inc. chart, August was a period of indecisive trading. There would not have been anything in the trading, during that time, that provided any reason to get excited about getting into that stock position. The gap up, out of the congestion area, now becomes a clear indication that new investor sentiment has entered this stock trend.

Once the gap up, followed by a strong bullish candle was observed, candlestick analysis of the prior month of trading becomes useful. Although the daily trad­ing ranges were relatively insignificant, they were showing small bullish candle­stick signals. Upon reviewing the trading during that time, it becomes obvious that it was forming a basing range. That information now becomes useful for analyzing the gap up.

The congestion area formed a resistance level at the $34 price. Once the price gapped up through that level, it became immediately obvious that the $34 level was not acting as resistance any more. Next, the large bullish candle went straight through the 50-day moving average without any problems. Obvi­ously, the 50-day moving average was not going to act as resistance. Being able to analyze what happened prior to the gap up allows the candlestick investor to better evaluate what was going on in investor sentiment. Although stochastics was now nearing the overbought area when the gap up occurred, the strength with which the buyers started entering into the stock price produces a different scenario. A breakout from the congestion area meant new enthusiasm was coming into the stock price.

A gap up occurring at a top of a trend, with stochastics in the overbought area, might have a much different conclusion. In this case, the gap up did not occur at a top of a trend. As observed, the trend was sideways prior to the gap up. This observation would put a different importance on the location of the stochastics.

Being able to analyze what the candlestick signals were doing prior to a gap up produces valuable information for entering high-profit trades. Preparing one’s eyes for successful and powerful price-movement setups aids an investor in being mentally ready to immediately exploit a high profit potential signal. This is a simple process. Having a mental picture of how a high-profit potential trade begins helps an investor enter that trade at a very early stage. This not only benefits the profitability; it also reduces loss potential. Entering a gap up situation in the very early stages of its development, provides more effective time and price entry levels to get in and out of the trade if it doesn’t reach full expectations.