Trading Programs

TRADING PROGRAMS

“Perfect discipline requires recognition of infallibility. Infallibility requires the observance of discipline.”

A disciplined trading program is important for producing consistent profits. Without it, maintaining profitability becomes extremely difficult. Just by having established a program, the initial step for successful investing has been accomplished. You had to put the effort into investigating methods or procedures for producing favorable results. Logic says an investor would not put together an established program from losing trade statistics. Everybody wants to develop a trading method that creates positive results. The results now become a function of how that program is maintained.

Unfortunately, other elements interfere with maintaining the proper discipline to achieve success. Once a trading program is altered, deviating from the discipline required to minimize losses and produce gains, it is hard to achieve the desired results of the trading method. Once the parameters for entering or exiting a trade have been circumvented by human intervention, the framework of the trading program disappears. Human emotions have an enormous influence on the completion of the trade. Emotions are the biggest hindrance for most investors to stay the course. These emotions, once controlled, become the source for producing profits from others who do not control their emotions. It was from these flaws of emotional control that the Candlestick trading method was developed.

If the downfall of most investors is fear and greed, and Candlestick analysis exploits those emotions, how can these emotions be redirected into a program that takes advantage of them? This is not a rhetorical question for the development of a perfect trading program; this is a question to eliminate the weaknesses that most investors experience.

The following investment program was developed over a 15-year period. It incorporates the knowledge of the Candlestick signals and the procedures described in the past few chapters. Use the rationale for the setup of this trading program to develop the trading program that best fits your schedule and investment capabilities. This chapter and the following chapters describe investment programs that use the advantages of Candlestick analysis to the fullest extent.

Optimal Trading

Trading on a consistently proactive basis and not on a reactive basis requires eliminating human emotion from the decision-making process. Maintaining a disciplined trading program, based on calculated investment procedures extracts much greater profits from the market than undisciplined or unthought-out methods. Having a method to produce consistent profits provides a compounding effect that extensively outproduces the buy-and-hold method, or the method of buying the next tout from your broker and hoping that it will turn into a big win while not having any exit program for the last four touts that he or she gave you.

The first step for developing a successful trading program is having confidence in the methodology. Assuming that the statistics quoted earlier in this book hold true, at least three out of every four trades are going to be successful. Following the profit maximization steps can push those statistics up to four out of five. With those statistics as the backdrop for putting on trades, you can reasonably expect a monthly return of at least 10 percent. Does this seem like a bold statement? Follow the logic and the process for obtaining these returns.

The optimal trading program requires a few basic elements for a successful outcome:

• Easy access to a computer screen during the day
• A discount brokerage firm with low commissions
• Subscribing to a search software program
• Access to a live trade feed

Know Your Trading Schedule

The trading strategy that optimizes the following procedures requires that the investor have reasonable access to the computer screen each day. Being able to use a computer is important. It provides the medium for researching the best trades and executing orders. The discipline described incorporates trades that exist for an average of two to five trading days. Fizzled trades that are liquidated the same day are included, as well as, trades lasting up to 10 to 14 days before a viable reversal signal presents itself. Having a search software program, such as TC2000 or Telescan, simplifies the search process down to a matter of 5 to 10 minutes a day. Both programs also provide the ability to customize searches.

There will be periods in all market cycles where one set of formations is working better than the others. This does not pertain to the Candlestick signals specifically. It is directed more toward the conditions of the market. For example, after the indexes have had a period of uptrend followed by a period of pullback and are now resuming the uptrend, J-hook patterns may be producing better gain potential versus stocks that are in their initial bottoming stage. Having the ability to analyze each area of formations in the matter of minutes creates a clear comparison of which group of stocks to be concentrating on.

Research can be done anytime before, during, or after market hours. But access to the computer screen during the first 15 minutes of the market open and the last 15 to 30 minutes before the market close is vital. This will be explained further when discussing trade executions.

Low Commissions

The advent of the discount brokerage firms furnishes a mechanism for trading the number of times required to achieve maximum returns. As discussed in Chapter 9, it is expected that when a trade does not confirm a Candlestick signal, liquidation is executed immediately. There will be periods of choppy or reversing markets when entering and exiting trades a multitude of times prior to a direction is established. The lower the cost of getting in and out, the less effect that it will have on the equity of the account.

Do not be lulled into thinking that there are not significant costs associated with entering and exiting trades, even at $8 or $12 per trade. The investment brokerage industry is set up to try to profit from every trade that is made. Slippage will be present in every trade that you do. That is the case whether you are paying low commission rates or high commission rates. You can reduce severe execution slippage by exercising common-sense practices when getting into or out of trades.

Expect the slippage. It is part of reality. The Candlestick method of trading has been developed to reap excessive gains from the market. A bad fill on a trade should not be the criteria for making or not making a trade. The potential gain on a trade should have been analyzed to produce at least a 10-percent potential return—or the trade should not have been made in the first place.

Fund Allocations

Once everything is in place for putting on trades, the account is funded, access to a research software program is established, live feed for viewing the market movements and stock prices is in place, and it is time to allocate funds to positions. For the sake of this example, a $100,000 account has been established. What is the best way to allocate funds for each trade? The optimal number of positions on at any one time is between 7 and 10. Any more than this number starts to diminish the time needed to evaluate each position daily and keep a clear mind when executing trades. Any less than this reduces the probabilities of being positioned in a trade that moves dramatically in the direction that the signal indicated.

For example, start with an eight-position portfolio. The trade positions should be allocated to $12,500 per position or reasonably close. Buy lots of stocks that round out to the nearest 100 shares. If buying 900 shares of a stock costs $12,800 or $11,300, go ahead and execute that amount. You do not want to be waiting around for odd lot orders just to keep the dollar amount exactly at $12,500.

What is important is not to have some positions skewed too large while others are too small. The reason is simple. When all eight positions are implemented, all with fantastic signals, the probabilities still will produce mostly winners and a few losers. Nobody can predict with 100-percent accuracy which of the signals will produce a big winner and which trades will fizzle. Over-weighting one position over another allows the element of emotion to creep into the investment decision. The fact that more funds were put into one position and not another implies that your investment prowess stated that one stock was going to do better than the less invested position. If you are that good, you didn't need an investment plan in the first place.

Divide positions as evenly as possible. A bad trade will thereby be offset by a good trade elsewhere in the portfolio. Having equal positions keeps the decision-making process as mechanical as possible. The historic statistics of putting on Candlestick trades will provide positive results scattered across evenly funded positions. There is no need to put yourself in a situation of having to second-guess yourself.

Starting the Positioning

Producing above average returns embodies some simple compounding facts. It is easier to compound returns from a base amount plus additional funds (profits) than it is from a base amount minus funds (losses). This may sound elementary but it is usually not taken into consideration by most investors starting out. The compound effect is dramatically altered by how the initial funds are used. In our example, the account is starting with $100,000. The rate of return is based upon the profits produced from the inception of the trading program.

How the first transactions perform has an immense effect on the total return down the road. For instance, all the steps have been taken to establish trades. As described in Chapter 9, you have analyzed the market direction, analyzed the sectors that showed the best potential, found a multitude of excellent Candlestick buy signals, and are ready to commit funds. The next morning, you buy eight positions that all open in the manner that demonstrates continued buying. However, at 1:33 P.M. that same day, Alan Greenspan crosses his eyes the wrong way in front of the House Ways and Means Committee hearing. The market turns around and heads south. By the end of the day the account is down $8,000. Not your fault and not the signals' fault-just one of those facts of life. Even though the results of the positions that were put on were statistically in line, three were up slightly, two were flat, but three were down big, the results are that the account is down. No great concern. Liquidating the bad positions and/or putting on new positions, long and short over the next period of days, weeks, or month makes up the losses. But the make up of those losses has to be done from a smaller base of investment funds; $92,000 of equity had to make back the $8,000 to get back to even.

Two dynamics were at work that slowed down future gains. First, it took a higher return being produced to gain back the losses. Secondly, once the account was back to even, that time had been expended. It does not seem like that should be a big deal, but in the calculations of compounding, it can have large ramifications out in the future. The following illustration demonstrates what a one-month delay in profits cost the investor 12 months down the road.

$100,000 Compounded 12 Times

The effect of a one-month delay cost this account $28,531 at the end of one year, the difference between Month 11 and Month 12. A more conservative approach can be taken when initiating the beginning positions. Of the best positions, put on three trades the first day. If an unexpected surprise crunches the market that day, losses should be minimal. The positions can be reevaluated and the next day adjusted to the new indications of the market. More than likely, if everything followed the expected results of the day, hopefully two of the three positions showed profits and the third showed a slight loss. The account over all was up. That could lead to adding another one or two positions the next day. Theoretically, the majority of the positions should show profits each day. Some of the profits will be offset by the losses in a minority of the positions. This should produce a net profit the majority of the trading days. After a few days, all eight positions should be on. At that point, a daily cultivation process keeps the best possible profit situations in the portfolio and eliminates the weak ones.

Cultivating the Portfolio

Once the investment funds are fully allocated, the portfolio can be maintained with an effective profit-maximizing process. Each position should be evaluated daily. Some of the positions may have been on for one day, some on for two, three, and so forth. Each position is evaluated as far as what is the remaining upside potential, what is the downside risk, is there any indication of weakness showing up in the move (that is, weak candlestick formations), and what is the condition of the stochastics? The evaluation process may show that Position 3 is getting toppy, and Position 7 would be a sell if it opens weaker the next day. And/or Position 6 has run up 14 percent over the past two days, indicating it might be preparing for a profit-taking pullback. The remaining positions all look solid for further profits.

The evaluations are now compared to the results of the latest search. Two signals may have been found that are compelling buys under the current market conditions. The availability of a constant supply of excellent trade situations creates the opportunity to shift funds from a good trade potential to a great trade potential. If the evaluation of Position 3 is that it has already made a good move and still has the possibility of continuing a few more percentage points, the decision might boil down to whether it is worth sitting in this position to make another 6 percent after moving up 12 percent or should the funds be moved to a new position where the upside appears to be 15 to 20 percent. This is a good problem to have. When the search program produces a constant supply of excellent trade situations, existing positions constantly have the capacity to be upgraded.

This supply of excellent trade situations is the stimulus for a basic rule for this style of trading. When in doubt, get out. If there is a situation where staying in a position has some doubt to it, get out. If there isn't a good place to put the funds immediately, there will be the next day. The search software programs, able to scan 10,000 stocks instantly, will always produce at least one or two high-potential trade situations each day. Why expose investment dollars to any questionable situations when they can easily be moved to low-risk, high-profit probability situations? An illustration of this situation is demonstrated in Figure 10.1, representing Marvel Technology Group Ltd., and Figure 10.2, representing Bell Microproducts Inc.

If Marvel Technology Group Ltd. was bought at the bullish Engulfing Pattern, it would have more than a 100-percent gain. Stochastics are in the overbought area. The question has to be how much more upside potential is left. There have not been any signs of selling. This chart should now be compared to what the latest search produced, Bell Microproducts Inc. Stochastics are just coming up out of the oversold area. A Morning Star signal appeared followed by continued buying. This looks like a good buy situation. But the account is fully allocated.

This is the dilemma that the Candlestick investor wants to always have. Now the decision boils down to which is the best place to have your investment dollars. The evaluation becomes simple. What is the upside potential of both positions? Marvel could keep heading higher. Bell seems likely to be able to fill the gap of a few weeks ago, taking the price up to $10, approximately a 25-percent gain from the $8.25 price. Could Marvel hit $26.50 to $27 in the same amount of time? Maybe, but at this point the chart on Bell Microproducts appears to be much more compelling chart. The first logical target, $10, seems to be with $12 not being out of reach. To be stated more simply, "If there were money available to invest today, which position would I invest in?" That should be the primary question each day.

This process will dramatically alter the investor's mental state. Having an abundant supply of potential profitable trades each day creates the opportunity to eliminate emotional attachments to any one trade. This line of thinking, combined with the single-figure portfolio management practice (discussed in the following section in this chapter), will eliminate emotional involvement in investment decisions. The decision to stay in or get out of a position is not predicated upon how much higher can the existing position go. The important question remains "Where is the best upside potential weighed against the downside risk?" It directs the Candlestick investor to analyze the best potential for producing the maximum profit for the account versus maximizing profits from specific positions. The effect of this cultivation process is always having funds placed in the best potential positions. The risk of squeezing out the last profits from a good trade, being exposed to elevated prices, and the possibility of extensive pullbacks is dramatically reduced.

Single-Figure Portfolio Management

Along with fear and greed there is one more major emotional element each investor has to deal with. Ego! Not the ego that everybody wants to go out and boast about how great an investor he or she is. It pertains to the self analysis that each of us goes through when putting on a trade. Nobody likes a losing trade—not so much because it lost money, but more that it went against our analysis. Being we each know that we are smarter than the average person, our egos get dashed when a stock purchase goes down. Our superior intelligence analyzed and decided that a stock was a good buy, but now we are wrong. Our egos step in. We are too smart to be wrong. This stock will come back. As it goes lower, our ego gets that much more out of whack.

At that point, the investment strategy becomes one of holding the position until it gets back to breakeven, and then selling it. The first question is why does this stock have to ever come back up to where you bought it? This is a prime example of most investors not having a credible investment program. This trade was put on for one set of reasons and it was kept on for a completely different set of reasons. The major reasons losing trades are held is because of ego. Unfortunately, holding on to losing trades does not maximize profits.

Implementing a discipline to maintain a set number of positions with an equal dollar amount allocation is the first step to eliminating emotions in investment decisions. The way to completely take emotions out of the process is to use a single-figure portfolio management program. That one figure is the bottom line. At the end of the day, there should be only one concern: What was the value of the portfolio? What was the total net gain or loss for the day?

This method of analysis eliminates the concern of the performance of each individual stock. At the end of each day the cost basis for each position held at the close becomes that day's closing price. This procedure eliminates any ego hang-ups. Emphasis is now directed to how the total portfolio did. If the concept of Candlestick trading holds true, the majority of the positions should have been up, a lesser number of positions down, producing an overall gain for the day.

The total value of the portfolio is calculated upon the gains or losses incurred on each position held, up or down from the previous closing price. Any stock positions bought or sold are calculated against closing prices. Stocks that were bought during the day are showing a profit or loss from where they were purchased compared to that day's closing prices. Any stock sold during that trading day will be calculated against the previous night's closing price.

This process removes the stigma of what the purchase price was for each position. On a nightly basis, each position can be objectively evaluated based upon the Candlestick signals, stochastics, and its status pertaining to its recent price movement. What was originally paid for the position becomes irrelevant. The important criteria becomes, "What is this position going to do tomorrow or the next few days to benefit the single-figure?"

Embarrassment

Analyzing all the factors, visually evaluating the probable potential of positions on the charts, helps eliminate another emotional trauma. Having a format for when to put positions on or take positions off alleviates the self-embarrassment process. As touched on in the introduction of this book, how most investors trade is predicated on what if somebody found out that I did this faux pas or that faux pas?

Why do investors stay in trades too long? Because it would be embarrassing to have somebody find out that Marvel was sold at $22 and proceeded to run up to $64. Or on the other hand, how you bought XYZ Corporation at $20, took your losses at $18 and it turned around immediately and went to $48. This embarrassment is usually self-inflicted. In the total scheme of things, who is ever going to know other than yourself?

Using the Candlestick signals helps in two ways. It forms a basis for putting on trades or taking off trades. If Marvel (as seen in Figure 10.1) is sold at $22, it is based upon the best investment decision for that particular time. If it proceeds to $64, the right decision was made for the right reason when it was liquidated. Too bad that a good run up was not fully exploited. However, the probabilities made better sense to take profits at that point and move the funds to another trade. There is nothing that can embarrass a person if he or she did the right thing at the right time. Another Candlestick rule is not to look back. The program is not to maximize profits on each trade; it is to maximize profits for the account.

Secondly, whether taking profits or cutting losses, the Candlestick signals tell you when to get in and when to get out. If XYZ Corp. was shown as a buy at $20 and then looked bad, getting you out at $18 might have you back in at $21 on a better signal. Again, this could cause the ego/embarrassment dilemma. How hard it is to repurchase a stock that has recently given you a loss. Remember the single-figure does not care. A good trade signal is a good trade signal. Do not shy away from a stock just because it fooled you the first time. Remember, 99.9 percent of all the trades that you put on in your account will never be seen by anybody but yourself. Don't let your emotions be your own worst enemy.

Market Direction

As described in Chapter 9, knowing the direction of the market is important for placing correct trades. The majority of the time a trend will be obvious. However, there will be times when the markets are choppy and a direction is hard to decipher. Fortunately, this is the atmosphere in which the Candlestick signals will outperform other trading programs. The innate function of the signals is that they demonstrate where investment funds are flowing. In a nondirectional market, this becomes a priceless barometer.

Sometimes the markets just get too sloppy to trade at all. For example, if the market is oversold and still in a slow decline, every strong up-day may appear as a reversal signal. Longs are put on only to witness more downside the next day, producing small losses. If you cannot get a feel for the market, go to cash for a few days, until a better set of signals becomes evident. This does not happen often but it does occur from time to time.

Despite this type of action, there will still be good trades produced by the signals. Analyze the market action. This may be a period where successful trades are one or two days long versus three to five days long. It could also highlight a sector more clearly. If prices in general have been bobbing up and down, a sector may stand out due to a consistent move in one direction. Study that sector. Allocate investment funds according to procedures.

Identify the Sectors

The advantage of identifying a sector, moving in a particular direction, is twofold. First, it greatly reduces the search process each day for potentially profitable trades. Even though the search software can pinpoint many good trades in the matter of minutes, there is additional credence in finding good trade situations in a sector that is attracting investor attention. Secondly, the universe of the search is greatly reduced. What appears to be a redundancy in benefits has an underlying benefit. The knowledge that investment money is coming into a particular sector creates more time to fine-tune the analytical process for identifying the most compelling Candlestick signal.

Sector searches contain some double confirmation aspects. Being able to see where the big investment money is flowing produces strategic clarity that few investors use. This amplifies the practice of putting investment dollars in the most profitable situations. In a rising market, knowing which sector has the greatest upside potential enhances profit opportunities. All boats are raised in a rising tide. Identifying the Candlestick signals in sector indexes allows the investor to maximize profits. A strong signal during the rising market trend targets the sector that has an inordinate amount of investment dollars coming into it. This provides the opportunity to exceed the "rising tide." The more obvious benefit comes from being able to identify buying coming into a sector when the general market direction is down. Candlestick signals stick out like sore thumbs in this environment. If shorting stocks does not fit your investment profile, then identifying the sectors that can produce profits in a declining market atmosphere becomes an excellent supply of opportunity.

A residual benefit of participating in a sector trend is the further elimination of the false signal surprise. The news that affects an industry or sector is the result of fundamental elements that have made the sector attractive. The probabilities of a surprise adverse announcement is reduced. And by rare occurrence, if there is a surprise announcement that could greatly affect a stock price, the enthusiasm about the sector in general will moderate the price reaction.

Locating Candlestick signals in sector indexes is useful for maximizing long-term investment profits as well as pinpointing short-term trades. Candlestick signals on the weekly and monthly charts clearly illustrate when longer-term trends are changing.

Long-Term Investment Programs

For those investors who do not have the time or inclination to trade their portfolio daily, weekly, or even monthly, the Candlestick signals can be used effectively. As described earlier, the signals are the depiction of investor sentiment during particular time durations. Whether the time frame is one minute or one month, the signal created is the measurement of investor psychology during that time frame. A bullish Engulfing Pattern witnessed at the bottom of a monthly chart, corresponding with oversold stochastics, should act as the same alert to the Candlestick investor as the same conditions seen on a daily or minute-by-minute chart. The only difference becomes the time factor.

As seen in Figure 10.3, representing Stewart Industries Inc., the long-term trend was down for over one year. After trading flat for over another year, the long white candle, after the three months of indecision signals, along with stochastics coming up through the 20 line, gives a good indication that the long-term trend had changed. The appearance of a bullish candle when the stochastics have come up through the 20 line provides the long-term investor with a valuable timing tool. To confirm the reversal, the weekly chart can also be used to verify the change in long-term sentiment.

This use of the Candlestick signals enhances the Warren Buffet method: accumulating companies and industries that are in the unwanted stage and holding them for three years or longer until the cycle makes them the hot companies. Having the ability to see when the crucial buying is starting to come into companies or industries greatly multiplies earning potential. It reduces sitting in a stock while the price is in its bottoming stage. In the example of Stewart Industries, the Harami of mid-1999 indicated that the selling had basically stopped. However, there was about a year and a half of bottoming before the price started showing upward movement. Buying anytime before the first of the year 2000 would have resulted in flat returns. An accumulation period is fine if you are a wealthy client in the Warren Buffet program, but if you are trying to maximize returns, the timing aspect plays an important role.

You as an investor can use the Candlestick formations to enhance the establishment of a long-term position. You can put a simple procedure in place. Analyzing the monthly charts, as seen in Figure 10.3, will identify those stocks that are coming off bottoms. These bottoms can be the long gradual bottoming formations or the hard decline followed by an obvious

Candlestick buy signal. The advantage that the Candlestick signals provide is clear indications that buying sentiment is visually apparent. A signal on a monthly chart can be confirmed by corresponding signals on the weekly chart. Once you make the decision to commit funds to a long-term position, the daily charts provide a format for accumulating positions during the short term pullbacks.

Intermediate Investing: Buying Bad News

The longer the term of a trading-hold period, the more important the company's fundamentals become. As with all companies and industries, some economic environments are favorable and some are unfavorable. Rarely will the price history of a stock be straight up. Companies experience growing pains, some getting too big too fast. Or management changes. Or faulty management decisions are made. Yet, the one major analytical factor that most investors fail to consider is the ability of management. It is this factor that Candlestick signals help to exploit for producing extraordinary profits.

When a company is going through a bad period, it has usually been made evident by the reduction in the stock price. The further the stock goes down, the more emotion is brought into the price. The smart money got out of the stock at the beginning of the decline. They foresaw the results of what current economic factors or management decisions would do to the stock price down the road. The more complacent investor rode the decline all the way down. They got tidbits of analysts' opinions as to why the stock was going down by watching clips on the financial stations. Finally, the bad news is announced. An earnings warning, a loss of a major contract, the loss of market share—the reason for the suspected price decline over the past three months is finally made public. The investors who held their position through the decline finally acquiesce and throw in the towel. What has been publicized on the financial stations for the past month is apparently true. The stock price gaps down 25 percent on the open.

Is this the time to be buying or selling? The Candlestick formations created can answer that question. The particular candle formed on the day of the gap down holds an immense amount of information. It gives a clear signal indicating if and when that stock should be bought. It is a common phenomenon to see the price of the stock come back up to and exceed the price level of where the huge gap down occurred. It usually does so within the next three months if not sooner. The result is 25-percent gains or better in a three- month time frame. Those are not bad returns for any investment program.

Why does this program work? Emotion. The bad news has been speculated through the financial mediums for weeks and months. All the news is negative. The bad announcement knocks the price down dramatically. Nobody wants this stock anymore. Except, who is buying this stock when everybody is selling?

The buyers are the investors who anticipate the effects of good management. A company does not and will not remain in existence if there is not good management at the helm. Management is not a static function. Mature companies have qualified decision-makers. They did not get to upper management by chance. The term mature is crucial. Growth companies have the potential to succeed because of their product or service. The uniqueness of the company can sustain growth for a period despite the lack of management skills of the founders. As it matures, getting competition or expanding into less developed markets, management becomes more important. A well- managed company does not stay static in its thinking.

The same adverse factors, that induced the smart money to get out at the highs, should have been evident to top management. These factors should have set alert management on a course of corrective action. Even though there might not been anything that could be done to avert the negative news, changes would have been developed to solve the problems. When the bad news was announced, corrective actions were probably already well underway. The future should be different from the recent results. That is why somebody is buying the stock that the panic sellers are providing at a deep discount.

Candlesticks provide the optimal time for accumulating the discounted stock. The formations created by the panic selling reveal valuable information. As illustrated in Figure 10.4, representing Plantronics Inc., the news that produced the big drop was met with immediate buying.

The white candle indicates that the extreme selling was done on the open. The subsequent buying was based upon somebody evaluating that the selling was overdone. It was time to look ahead to future possibilities. The white body illustrates that more buying than selling occurred after the opening price. In most cases, the low of that trading day when a white candle forms acts as the support level for future trading. Note that two weeks later an Inverted Hammer followed by a strong white candle creates a second opportunity to accumulate more stock. Approximately six weeks from the gap down day, the gap is filled and then exceeded. Buying stock in the $17 area produced a 27.5 percent return when the gap was filled on April 19—an acceptable return for a six-week investment.

The white candle formed on the day of the big percentage move down provided the Candlestick investor with a valuable insight. Buyers were stepping in after the stock price opened that day. This provides the knowledge that the selling is being soaked up, unlike the signal illustrated in Figure 10.5, representing Dollar Tree Stores, where after the open, the sellers were still dominating. This clearly illustrates that despite the big drop in price, the bad news was apparently more involved than what the market was expecting. A black candle reveals that the sellers overwhelmed any buying after the open.

The black candle is a clear signal that all the selling is not finished. In this example, the buying signal did not appear for another five trading days. 

The Harami indicated that the selling had stopped. The strong open the next day illustrated that the buyers were continuing their presence. Buying Dollar Tree Stores at the $16.50 to $17.00 area would have resulted in holding the position for seven to eight weeks before getting back to the levels where prices gapped down. May 4 filled the gap at $23.63. Holding to that date produced approximately a 29-percent return. The appearance of a black candle on the gap down day provided the awareness to not commit to this trade yet, more selling was evident. Identifying the buy signal a few days later, under the circumstances, made for an excellent, relatively low-risk transaction.

Finding these trades does not require a great amount of time expenditure. If one's schedule permits an investor to get to a computer screen once every week or two, this method of investing becomes a good program. The search programs can be formatted to identify these situations. The search parameters can be easily established:

• Stock prices that have declined X percent from their highest levels within the past 30 trading days.
• Stock prices that have gapped down greater 20 percent during the past 7 trading days.

These searches will produce enough situations, out of the universe of stocks, to keep six or eight positions fully funded at any one time. This type of trading program makes for low maintenance investing. The probabilities are extremely favorable that profits will be made. This is derived by simple rules. Fundamentally, companies work to get mistakes and/or bad economic factors corrected. Technically, the stock prices are usually in oversold conditions when the bad news is finally reported. The gap formed will eventually be filled. Using Candlestick buy signals pinpoints when buying starts coming back into the stock. The low point of any buy signal can be used as sensible stop-loss points. Again, the common thread of successful invest logic is incorporated into this trading program. The investor who does not have much time to devote to position analysis can produce excellent returns by holding trades for 3- to 16-week periods. The positions can be identified with 30 minutes of research every week or two. It does not take a rocket scientist to realize that positions that produce 20 to 30 percent returns every month to four months, rolled over into the next position, creates an exemplary compounding effect.

The visual aspects of Candlestick formations supplies investors with a powerful advantage for developing profitable trading programs. The program can be customized to fit every schedule. The most dominant aspect is the proficiency of the signals to recognize the change of trend direction. Whether that trend is months or minutes does not alter the function of the Candlestick signals. The signals measure investor sentiment occurring in the specified time increment.

Day Trading

The advent of the Small Order Execution Systems (SOES) trading was the result of the one-day market crashes over the 15 years. The SEC ruled that small investors should be able to have access to the markets on days that dramatic moves in the market make it impossible to get through to stock-brokers. The crash of 1987 was a good example. The Dow-Jones crashed over 500 points in one day. The phone lines to the brokerage firms were jammed. Only the institutions with direct lines to the floor traders were able to execute their trades. The average person had no way to facilitate an order.

That lack of access is what started opening up the trading options for the average investor. New avenues of getting orders executed were implemented. This created a new form of investment trading, day trading. The development of online investing expanded greatly with the new electronic trading capabilities.

SOES trading firms produced a few years of flurry about the SOES bandits. Media hoopla investigated the aspect of the bandits creating new volatility to the markets. In actuality, the ability for day traders to cut into the hefty profits of the market makers led to the market makers getting favorable rulings for backing away from trades. This new flexibility was the cause of more volatile price movements. But that is neither here nor there. How to make money using Candlestick signals is the important subject.

The basis for most of a day trader's profits are the results of quick arbitrage situations or scalping short-term trend movements. Candlestick signals applied to a 1-, 3-, 5-, and/or 15-minute chart create excellent successful trade conditions. How the charts are used can enable a trader to develop multiple of successful trading programs. The most basic program for the trader who can constantly monitor each trade, the one-minute chart, can produce dozens of high-probability trades every day. As seen in Figure 10.6, the same parameters found in the daily charts are applied to the one-minute chart. A buy signal appearing when stochastics are in the oversold area represent a high probability of a successful trade.

In this case, the trade may last 3, 5, 7, or 10 minutes. Note that the arrows point out clear Candlestick formations, Morning Star signals, Evening Star signals, Bearish Engulfing Patterns. These formations can be acted upon with a high degree of confidence. This requires having fairly fast trade capabilities. It also requires a trading entity that is constantly liquid. Excellent trade signals become less valuable if the trading entity is difficult to get in and out of, the bid/ask spread is too large to overcome, or the slippage (execution price) is too exaggerated to produce profitable trades. The NASDAQ futures, the Standard and Poor futures, or the Dow-Jones futures provide the liquidity for successful day trading. They all have constant liquidity that makes immediate entry and exit of trades easy.

Note how the 15-minute chart, seen in Figure 10.7, was forming a Morning Star signal. This indicates that the longer-term daily trends may be changing. An analysis of the five-minute chart, shown in Figure 10.8, reveals that the trend is showing a few candles that indicate strength. The information conveyed by both of these charts would lead to the one-minute chart. The next bullish formation would act as a safe entry point for a trade that should last from 45 minutes through the remainder of the day, depending upon the appearance of a sell signal.

The day trader who can't or does not want to be tied to the computer screen every second that a trade is in place has alternatives. Statistical studies are easily implemented for longer day trading programs. For example, fewer but better success probability trades can be put in place when the 15- and the 5-minute charts both show Candlestick buy signals along with stochastics being in the oversold area. When both of these charts correspond, the one-minute chart can then be used to put on the trade at the most opportune time. Figures 10.7 and 10.8 are showing bottoming formations at the same time. This offers an opportune trade development the next time the one-minute chart produces a Candlestick buy signal corresponding with the stochastics being in the oversold condition. This trade now warrants a hold period until the 15- and 5-minute charts show a sell signal at the same time. A trade of this nature may last for a few hours at a time.

The length of trades will be a direct function of successfully combining chart patterns. Back testing may discover that the 3- and 10-minute charts acting in conjunction produces profitable trades 73 percent of the time while the combination of successful trades in the 5/15 combination works 67 percent of the time. Whatever statistical testing is done, the Candlestick signals provide a basis for testing. The signals act as the catalyst for effective testing. The favorable probabilities of a successful reversal is a built-in factor of the signal. This element, applied to other successful result characteristics, creates a trading program that makes identifying short trend changes visually easy and quick. The speed of recognizing a trend change in a day trading program is important. Executing trades after a trend has started and exiting after a profitable trend has shown a reversal will greatly reduce the potential profit. The position needs to be put on at the first signs of a reversal and exited upon the first signs of the trend ending. The Candlestick formations or the set up for a Candlestick formation allows the Candlestick day trader to anticipate when those signs may be forming. Getting in or out prior to the majority of the traders moving en masse greatly reduces the slippage generated when a trading entity is moving extensively in one direction.

Using the signals to establish trades reduces the guesswork of when a trade is about to reverse. Establishing a trading discipline using the signals as the framework for putting on a day trade gives the trader the statistical advantage. Knowing that a set of corresponding buy signals has a much greater probability of producing a successful trade induces the trader to move quicker, gaining execution advantage over the momentum traders. The visual clarity makes the day traders trade implementation an easy function of the trading program.