Easy Methods for Finding and Learning the Signals

FINDING AND LEARNING THE SIGNALS MADE EASY

"To learn is a natural pleasure, not confined to philosophers, but common to all men." 

The impression that learning the Candlestick patterns is difficult has been the biggest deterrent for the method to be widely used in the United States. The stigma of trying to memorize all the signal patterns may have had some basis in fact until recently. The advent of the computer has made the learning process simple, and experienced tutors are now more widely available.

Computers make searching and viewing Candlestick formations an easy process. The development of excellent search programs provides an invaluable service. Candlesticks can be located and learned in a rapid process.

Fortunately, the same human emotions that the signals exploit—fear and greed-act as the best learning catalyst. Our own greed for making gains will instill the effectiveness of the signals into our mind. Learning the signals has been one of the major reasons that investors have not taken advantage of Candlesticks. It has been thought that understanding and remembering each signal was too much of a task. In addition, until now, there have been few places or people to confer with to verify whether one is understanding and learning the signals correctly.

This book, as well as Web sites such as www.candlestickforum.com provide the Candlestick student with places to refer to when trying to master this trading technique.

Following a basic premise of the Candlestick system, common sense, some of the processes for learning the different signals become simple: Where is the best place to buy? At the bottom, of course. Where is the best place to sell? Obviously at the top. When trying to learn the signals, most investors begin with this basic thought process. If the signals are effective, then they should be easily seen at the turns. This may sound too elementary, but it is the most effective method for remembering the signals.

"Learn as though you would never be able to master it; hold it as though you would be if fear of losing it." 

The desire to be in a position at the lowest point and selling at the highest point produces a quick method for identifying the signals. As you read at the beginning of Chapter 2, the "Signals" chapter, you were advised to become familiar with the signals on the first go through. It was not necessary to memorize them all from the start. There was good reason for that advice. Seeing the signals or what you may think you remembered as a signal, at a turning point, will ingrain itself into your memory much faster than trying to memorize them.

Learning the Signals

The process for learning and remembering the signals is much easier than most people expect. The following process is a step-by-step procedure for becoming acclimated to the signals in a very short period of time.

Step one is easy. On your computer, go to a Candlestick chart. Most software services provide them as an option along with bar charts and line charts. If you do not have an investment information provider, there are free charting services. www.bigcharts.com is a good chart provider. Once you have pulled up the candlestick charts, most charting services allow you to customize indicators. Set stochastics to 14, 5, 5. Or 12, 3, 3 for the swing trader, with two to five day holds.

Now the learning process becomes as easy as viewing and studying the charts. Look at the bottom reversal points. Is there a signal there? If some formations look familiar, leaf back through Chapter 2, the "Signals" section to see if you can locate them. Also take notice of the location of the stochastics. You will find that a vast majority of the reversal signals occur when the stochastics are in the oversold or overbought area.

Notice the easy-to-see oscillations in the Dell chart in Figure 5.1? Dell is an example of a good chart to trade, based on the Candlestick signals. If you run through the chart history of Dell's stock movement, it is easy to see the reversal signals. Most of the signals coordinate with the stochastics at the bottoms and the tops.

Through this exercise, you have now learned two important lessons. First, you will quickly remember what signals appeared at points that you wish you had bought (the greed factor once again). If your purpose for reading this book is to make money, then remembering those signals becomes an automatic process. It is much easier to remember what occurs at a bottom or a top when it results in money in your pocket. Secondly, witnessing a buy signal, occurring at a bottom, when the stochastics clearly indicate that the stock was oversold, will dramatically start changing your investment psychology. Why buy a stock when all the stars do not line up?

 

Fortunately, the number of signals you need to learn for successful investing is small. Of the thirty or forty Candlestick signals, approximately six to 10 of them will be more than what you need. These signals provide enough supply of excellent buy or sell positions each day.

The major signals that you will most often witness are as follows:

1. The Doji
2. The Hammer and Hanging Man
3. The Shooting Star
4. The Bullish Engulfing Pattern
5. The Bearish Engulfing Pattern
6. The Dark Cloud Cover
7. The Piercing Line
8. The Harami

These signals probably provide more than 75 percent of all the reversal situations. They are also the obvious Candlestick signals—obvious in the sense that they visually depict a change of direction. The Engulfing Patterns have a different colored body that stands out against the color of the current trend. The same can be said for the Dark Cloud Cover and the Piercing Line.

The Doji is unique in itself, a cross, with shadows as its predominant feature. The Hammers, Hanging Man, and Shooting Star have long shadows that make them stand out. Anytime a long shadow or shadows appear, investors should pay attention.

The remaining signals can be learned at a less aggressive pace. They will not occur as often; however, when they do occur, 400 years of statistical study has verified that they will probably produce a change of direction. Nevertheless, the learning process remains the same. Simply identify what happened at the reversal point. Is it a signal? And what was the status of the stochastics?

To reiterate, you will discover that the Candlestick signals can be observed an inordinate percentage of the time at the reversal points, with some qualifications. Not all stocks or trading entities will have clear trading patterns. Some are just "junky" traders. Leave them alone. There are thousands of stocks, commodities, and futures that work extremely well as far as providing good Candlestick signals.

For example, you can see in the Capital Federal Financial chart in Figure 5.2, there is absolutely no reason to be trading this stock. All stocks, no matter how volatile, will go through dead periods. If a chart starts going flat, leave it alone for awhile. There will be plenty of other places to put funds.

If you come across a chart that is hard to evaluate, skip it. There are 10,000 stocks to trade. You will have more excellent signals than you can handle. Go find those stocks and eliminate the sloppy trading stocks.

 

As you study the charts, the stocks that have easy-to-read reversal signals will become evident. Put those stocks on a list somewhere. Some investors may use the Candlestick signals to trade a limited number of stocks, going long or short, at well-defined signal reversals. This style of trading eliminates the extra few minutes each day doing searches for new buy or sell positions. Becoming well versed in the trading habits of a few select positions has its advantages. Support and resistance levels are better identified. Correlating Candlestick formations with these levels produces an extremely high prospect of profiting from pinpointing the reversals. The positions can be exploited both ways—by bullish moves and bearish moves.

You will be pleasantly surprised at how quickly you recognize and remember the important signals. Learning the signals can take as little as a couple of hours. A couple of hours of reviewing past reversal points on your charts will help you retain the signal's formations. That forceful emotion, greed, produces the impetus for retaining the signal images. The process of remembering the signals is now driven from the desire of producing profits, not a mechanical exercise. Wanting to remember what will make money produces a strong motivational factor.

The visual identification is the important aspect of learning the signals. Knowing the name of the signal or the psychology of why the formation works is not a necessity for using the signals profitably. However, eventually knowing the name and becoming more knowledgeable about the psychology behind the formations gives the investor more confidence. It aids in the evaluation of whether a trade is in trouble or not, after you have put a trade on.

Search Programs

Using search programs has two major functions. First, using a search program allows the investor to dissect the formations as a function of formulating the search parameters. It will implant the elements of each signal firmly into your mind. There are a number of excellent search software service companies: TC2000, Telescan, and Trade Station 2000, just to name a few. All have excellent search capabilities. The second function of a search software pro-gram is the fast execution for creating a list of the best possible trades.

The best software program for providing an easy-to-use format at a reasonable monthly fee is TC2000. It doesn't bog down your system, and it is easy to customize for Candlestick searches. It allows you to download all ten thousand or so trading symbols. From that list, the best buy or sell formations can be cultivated in a matter of minutes. Additionally, TC2000 has dozens of pre-formulated technical processes already built into its program. This permits the investor to tweak the searches for optimal trades by using the best combinations of technical parameters. TC2000 makes finding those eight or 10 highest-profit probability trades amazingly fast, once the search parameters are in place. Spending an hour formatting the signals, the ones most likely to produce the best profits (that is, the major signals), is the best procedure for learning the signals.

Putting a signal's pattern formation into formula descriptions creates the best method for mentally understanding each signal. TC2000's customizing process is simple to use. It can be set up to search the total universe of stocks or customized to search specific industries or sectors. It can eliminate all the small capitalization stocks or all the large capitalization stocks, depending upon your personal preferences.

The following is a method that has been most effective in searches for the best possible trades available with no industry or sector preferences. Not all stocks fit necessary basic parameters, which can be established for all searches. These basic paramenters are simple.

First, liquidity needs to be addressed to be able to get in and out of trades. A small account might include the parameter that the daily average volume is greater than 200,000 shares per day. A larger account or an institutional account will probably eliminate all stocks that have less than a certain number of shares—for example, 500,000 shares to 1,000,000 shares per day. This will allow them to get into or out of a stock position without affecting the price radically.

The next parameter is the price range that reflects the investor's comfort zone. Because most brokerage firms do not margin against stocks trading less than $5.00 per share, you might make that a minimum parameter. Other traders make excellent profits trading stocks in the $2.00 to $5.00 range. They would set their parameters lower. Yet other traders are more comfortable trading stocks in the $20 to $70 price range. The parameters can be set to each investor's preference.

On the other hand, if you know that you will rarely buy stocks greater than $150.00 per share. Why bother evaluating those charts? Put on a maximum price parameter.

Once these basic parameters are put into the search function, you have reduced your universe of potentials down to approximately 3,600 stocks. Next, the search is oriented toward looking for longs or shorts. TC2000 makes it simple to segregate those stocks. If looking for potential long positions, a customized stochastics parameter is added. The TC2000 search program permits you to add or eliminate stocks by the level of the stochastics. In the case of searching for long positions, the search would be limited to all stocks that have stochastics below 20 that day. If you wanted to get more specific, it could be set up as stochastics below 20 and heading up. For the purposes of most searches, that extra tweak is not required.

Implanting the Signals in Your Memory

The exercise that will ingrain the signals into your memory is the next step. Describe each signal in formula terms. Going through the process of creating the formula for each signal is easy. The actual process of creating the formulas will make the development of each signal very clear. For example, how is the Bullish Engulfing pattern formed?

First, the open of today is below the close of the previous day. That formula would set up as:

 0<C1

AND the close of today is greater than the open of yesterday:

C>01

That is easy. Once you have done this simple process, visualizing a Bullish Engulfing Pattern should be clear from now on. It is now in your search program. You can name it "Bullish Engulfing Patterns." To further enhance the search criteria, you would add the stochastics parameter to find all Bullish Engulfing signals that occur in stocks where the stochastics are below the 20 level. Every time you update the data (depending upon the speed of your computer, this takes from one minute to three minutes), the scan list will show you how many stocks showed up in that particular search.

All the signals can be dissected this way. The Shooting Star would have the opposite parameters. Stochastics would be set to find stocks with the stochastics over 80. The open and the close are within the lower 33 percent of the daily trading range. This would make the upper shadow twice the size of the body. Obviously, it will not take more than a couple of times to pull up the Shooting Star search results to recognize a Shooting Star. The same can be done with all the signals.

Time and effort? With the simplicity of TC2000's system, it should not take any longer than 15 minutes, at most, to formulate each signal. In less than three hours you should have a search program that spits out all the major signals every day. At that point, your job will be to evaluate the best of the best signals.

Summary

Learning the signals is easier than what the public's perception has been. The number of important signals, or the signals that are most often observed, is less than 10. The remaining signals should be studied, but the time spent upon them is a function of keeping them in the back of your mind. When one of the other signals appears, you want to be able to recognize that it might be a signal. After a few times identifying and verifying a signal (reviewing the signal pages), the formation will remain with you.

Today's computer charting services make analyzing past charts an easy exercise. Recognizing the Candlestick signals at the reversal points of past price movements reinforces the memorization of the signals as well as confirming to the investor the frequency with which the signals occur. Not being familiar with the signals is the major reason for such a large percentage of investors not taking advantage of them.

The motivation of making profits will be the best stimulus for the learning process. Do not let the task of becoming educated on the signals be a deterrent. For the few hours required to become acclimated to their identification and meaning, the profits developed from their use will be expediently massive.

Profits are made easier when identifying Candlestick signals in a common pattern. Wouldn't you like to be able to prepare for the next potential trade setup? Knowing approximately when a Candlestick signal should be appearing, due to a common technical formation developing, multiplies your investment opportunities. Powerful investment fund allocation strategies can be properly scheduled. Trade implementation can be optimized. Your entry and exit decision processes will be reinforced when recognizing successful formations. Chapter 6 introduces you to a number of common patterns. Being able to perceive profitable trades, with proven results, increases the chances of timely trading strategies.