How to Identify Tower Top and Bottom Candle Patterns

Tower Tops and Tower Bottoms

Tower Tops and Tower Bottoms are clear reversal patterns—clear in the sense that they are easily recognized by a quick glance at a chart. The Tower Top is formed after the market has been in an uptrend.

In the Telecomp PCS Inc. chart, seen in Figure 6.12, a long white candle or a series of white candles appear. The long white body or series of white bodies form an upmove that is substantial and distinguishable from the rest of the advances and decline slopes of the normal trends. When the ascent slows decidedly and signs of selling appear, the Tower Top is completed with large black candles taking the prices down hard. The formation of long candles resemble a tower structure, thus the name. Some Japanese writings refer to the Tower Top as a Turret Top.

The Tower Bottom is obviously the opposite scenario at the bottom of a market trend. After the appearance of a long black candle or series of long black candles, the descent flattens out. Then one or more white candles appears. There are long candles on the way down and on the way up. Again, as in the Tower Top, the Tower Bottom formation stands out compared to the normal trading. It is a noticeable pattern.

c As seen in Figure 6.13, representing Tripath Imagining Inc., the long black candle and the long white candle are approximately the same length. Both are substantially longer than the normal daily trading range. This formation is extremely useful for the long-term investor. A monthly chart having this formation has a great probability of being at the bottom of a long uptrend.

Cup and Handle Formation

A common formation, sometimes incorporating the Fry Pan Bottom, is the Cup and Handle Pattern. This pattern is a Western charting pattern. However, the setup for its formation is visually clear after it has occurred. The Candlestick analysts can profitably exploit this formation, benefiting early in the formation's development. The Western chartist is waiting to see if the price breaks through the handle's peak to commit funds into the trade. Upon breaching that level, a breakout should occur. The Candlestick investor has double potential from the same formation. Upon witnessing the forming of what could be a handle and seeing that the downward trajectory of the next decline is forming a bottom, the Candlesticks provide a valuable tool to gain two sets of profits from this set up.

First, if it appears as if a bottom of the cup portion is forming, Candlestick buy signals will identify when the cup formation is starting up the other side.

The returns can be easily calculated. If a purchase is put on at the bottom of the cup, the level of the first major resistance will be the peak of the handle. That move could produce a return of 8 percent, 12 percent, or more. Not bad for a two-week investment. As the price approaches level that would act as the resistance or the breakout, Candlestick analysis provides additional indications of profit potential. Examination of stochastics indicates how much buying force remains at the point of breaching the resistance area. If stochastics are well into the overbought region when approaching that point, one should be prepared for signs of a Candlestick sell signal. Any sign of weakness can get the investor out at the best profit-taking point. Should the stochastics have strength remaining when approaching the critical price level and no Candlestick sell signals are appearing, this produces an additional profit situation. Knowing that a new burst of buying will occur when it breaches that level gives reason to add to the position.

The chart for American Medical Systems Holdings Inc., seen in Figure 6.14, illustrates the Cup and Handle formation. As the price moves up after bottoming in the cup portion, the targets become the peaks of the handle. Candlestick formations, correlated with the stochastics, provide the information needed to decide whether the past peaks are going to act as resistance levels or not. Note how the candle, before the candle that breaks through the first level, does not give any indication of weakness. Stochastics show no signs of turning back down even though they are in the overbought area. The candle that does break through the most recent peak, Point B, forms another strong candle formation with no signs of selling. This makes the next higher peak, Point A, the next likely resistance. As seen in Figure 6.14, that level is blasted through. The strong candle created from that breakout level indicates that price will go much higher.

The chart of ITXC Corporation, seen in Figure 6.15, demonstrates a fizzling at the Handle peak. A close above Point B wasn't as strong a close, even though it had a run up that day. Stochastics appear to be getting stretched. The Shooting Star of the following day does show weakness in the trend, indicating that the bulls had run out of steam at a well-watched area, Point A, at the peak of the handle. The fact that this weak signal was forming near the end of the trading day could have gotten the Candlestick investor out at a good exit point, the close that day. Other technical trading methods would not have indicated a failure of the trend until the open the next day or even lower.

Scary Moves

There are some common price actions that occur during trends. Not being familiar with them can scare you out of profitable trades. Learning how prices react once the trade and/or trend have started will keep you from being juked out of good trades.

One common occurrence is the "last-gasp" buying day. This is seen after the third or fourth day of a reversal in a trend. Notice in Figure 6.16, representing Infosys Tech Ltd., how strong buying came in three days after a relatively solid sell signal. The top was identified by the Spinning Top. The next down leg was instigated by the lower open after the Hanging Man signal. This would have been a comfortable short in view of the stochastics direction. If the short position had been established on the open the day after the Hanging Man, notice how the third day after that would have been a testy period. Prices had come up through the entry point.

If the analysis has been performed, you've witnessed the signal, and you saw the downward movement of the stochastics, the best investment strategy is to wait it out. As scary as it will be, a basic rule for Candlestick trading is to let the end of the day form the signal. What happens during the day should not influence the trading decision. The Japanese spent many years identifying the results of the signals. The percentages are in your favor by honoring the indications of the signals.

Waiting to see what the formation will be at the end of a time period is important. Figure 6.17, representing Integrated Circuits System Inc., demonstrates exuberant buying at the top. The Harami the next day shows that the buying had stopped, confirmed by the black candle the following day. But notice the third day after the Harami how the buyers brought the price back up to the top of the second black candle. This eats up a major share of the profits. However, the stochastics are in the middle of their downtrend. The buying is a function of the last gasp bulls thinking that the price had moved back to bargain prices. They run it up before the weight of the dominant trend pushes the prices back down.

Keep these occurrences in the back of your mind. The nimble Candlestick investor can take advantage of these fast moves by using smart stop and reentry points.

 

For example, if a short position has been established and has a day or two of good profits, be ready for a reaction bounce. Being prepared for the bounce drastically reduces risk. Once any buying is observed, a safe method to stop out is placing a stop one-half way up the black candle of the previous day. The logic here is that if the price is brought up to that level, the buyers are present and will probably take the price higher. This protects some of the profits. Now a couple of reentry strategies can be put in place.

First, if the price advances a good amount higher and starts to hover at that high point, it may be time to short again. The reason is this: If the price had already moved up an inordinate percentage that day, how much further could it go? If it didn't start backing off before the end of the day, the trade could be liquidated with minor losses.

Second, once the price has gone through the buy-stop point and continued to higher levels, a sell-stop could be placed at or near the original buy- stop. If price came back down through that level, it would be demonstrating the lack of buyers to hold the price up. The downtrend should be continuing. This strategy stops out the trade as it moves up, protected the majority of the profits. If the upmove continues, no harm is done. On the other hand, if the bounce were nothing more than a bounce, as the prices came back down through the sell-stop, the trade would be reestablished. The cost of this protection was two commissions and maybe some slippage.

Trend-Lines and Trend Channels

Observe the obvious! Clear patterns can be seen on charts. They are easily seen by the inexperienced investor as well as the trained professional. Everybody that is observing them will have the same conclusions. If a support level holds, it is time to buy. If a resistance level holds, it is time to sell. The crucial word in these statements is if. Having the insight of the trend strength (stochastics) is an advantage. Witnessing a Candlestick signal at the point of support or resistance provides the head start to get in before the rest of the technicians. This extra lead time can make the difference between a good trade and a mediocre trade.

Anytime the obvious is going to work in your favor, use it. The trendlines will not be evident in the early stages of a channel, but the early peaks and valleys create an opportunity for a good trade or two at the end of the channel. As illustrated in Figure 6.18, representing Johnson and Johnson, a trade situation would not have become obvious until close to the end of the channel. Yet it produced a safe short trade.

Note in the Credence Systems Corp. chart, seen in Figure 6.19, how a trend-line drawn across the tops when the Spinning Top buy point would have created a parallel line to form at the bottom. This pattern, in conjunction with the Spinning Top occurring at the stochastics turn up point would have produced a credible reason to commit funds to the trade.

 

Additionally, a short position starting from the top trend-line, a few weeks later may have reentered the short side after the pop-up near the lower trend-line. The appearance of the Doji and Shooting Star with some downside juice left in the stochastics would have given more downside profits.

The play at this level would be to estimate that there was enough downside left to possibly breach the lower trend-line. If the lower trend-line did not hold, as in this example, a sharp downside move would have been anticipated. This is due to everybody watching the trend-line selling or shorting when they see that line did not hold.

Learning Technical Patterns

Having knowledge of some of the basic technical patterns is an added benefit. Though not necessary for pure Candlestick trading, being able to incorporate the criteria that many other technical investors are using to make their decisions enhances the effectiveness of the Candlestick signals. Wouldn't you like to know that a reversal has occurred while the majority of investors are anticipating that a reversal has occurred, getting in before the crowd adds that much more positive potential to your position.

Once you have identified successful patterns, initiated by your recognition of Candlestick signals, it becomes easy to remember them. You will remain familiar with potential pattern set-ups due to the best stimuli available, profits.

"I hear and I forget. I see and I remember. I do and I understand."

This chapter has exposed you to a few highly successful technical patterns. The more you study charts, the more you will become proficient in visualizing how profitable trades set up.

Having the knowledge of what formations precede a profitable move, enhanced with the appearances of Candlestick signals, produce a combination of investment insights. These insights will revolutionize your investment thought process. In-depth signal dissection illustrates investor sentiment. The Japanese added an element that the most sophisticated computer programs are not capable of performing: analyzing the thinking that produced the signals. You receive the fruits of an exclusive research methodology. Where else have you studied the thought processes of the investor? Elliot Wave and Pattern Recognition methods touch upon the fact that investment psychology produces oscillations, thus cycles in price movements. Fibonacci numbers demonstrate a way to measure the amplitude of the waves. But rarely will you find an investment method that breaks down each formation and describes what was occurring between the bull's camp and bear's camp. This information rewards the Candlestick investor with revolutionary investment advantages. The conventional investment methods become mundane. You will be provided with the ammunition to perfect investment strategies to maximize returns. You will use these skills for the rest of your life. You will take advantage of opportunities never presented to you before, mainly due to the fact that few in the U.S. investment community know how to extract the opportunities themselves.

Permanently Alter Your Investment Abilities

Your investment thought processes will be permanently altered—not because you have been exposed to a revolutionary new investment concept, but because you have been exposed to a revolutionary old investment program. Tested. Proven. Successful. And just now being properly taught in this part of the world. As mentioned earlier, this trading program was not being hidden from the masses. The Japanese never refused explanation of Candlesticks. The masses never asked to be taught. Your reading this book indicates that the wealth of conventional investment advise and programs are not fulfilling your expectations and you want more.

Chapter 7 illuminates investment basics that are inherent to the Candlestick signals, practices that are easily stated but never incorporated into most investor's disciplines. Adhering to the Candlestick lessons will produce profitable investment results that dissuade you from ever going back to the mediocrity of most investment programs.