Figure 8 – Mercury Interactive Corp
Quite often you will witness a big volume day during this three-day period. It is most effective if it occurs on the indecision day, showing an inordinate amount of stock moving from the weak traders to the strong traders. The big volume day can still occur on any of those days. What is most important is to see this big amount of stock change hands at this bottom period.
When the stock price gaps back up after the indecision day, this illustrates the sellers are now finished and the bulls have taken control. Again, measuring gaps are seen in this example, creating the opportunity for the trader to make 73% in about two weeks.Example after example can be given on how a gap up at the bottom can produce big profit opportunities. But just as gaps tell you something as they occur at the bottom moving back to the upside, they are just as informative for preparing the investor to see when a downtrend is ready to reverse.
Reviewing some of the observations that Candlestick analysis reveals, as found in “Profitable Candlestick Trading”, the Japanese could not only identify when a reversal was occurring, they could describe the trading environment that would anticipate the reversal. For example, using candlestick formations, it was clearly obvious that after an extended downtrend, the fear and panic would start to exaggerate. The daily trading range would expand as more investors panicked and liquidated their positions. This series of events would forewarn the Candlestick investor that the bottom was getting near, and to be vigilant for a buy signal. The most informative signal at the bottom of one of these declines is the gap.For example, a stock has been in a downtrend for weeks. The talking heads on the financial stations are all expressing their opinions about how this company/industry is in the trash can. There is no reason to own this stock. Finally the last holdouts cannot stand the pain of owning that stock anymore. They get out at any cost. The price gaps down the next morning. Once this gap is spotted, a variety of profitable trading procedures can be put in place.
What can happen from this point? The price has gapped down after weeks of a lengthy decline. If it is a mild gap down, the price may keep declining. You may start seeing a dramatic increase in volume. The price is showing another big down day. However, the aggressive Candlestick investor realizes that the gap down was a blow-off signal. Upon seeing the price decline finally hit bottom and appear to stabilize, the aggressive investor can start to accumulate stock. Knowing that the gap was part of the panic selling gives the candlestick investor the confidence to step in when there is still panic in the air.
If the gap down is severe, the panic may all be built into the opening price. A severe gap down open after an extended downtrend may be a good opportunity time to buy. Watch how the stock price reacts after the open. If it appears to be stabilizing at the open level,with a little downside move that seems to be immediately bought up, it is time to start establishing a position. At the end of that day, you want to see a white candle, a close much higher than the open. This illustrates that all the sellers have been washed out. The buyers have taken over. This is the advantage that Candlesticks have over other charting techniques. It is much easier to see what is happening in a stock price when the color of the bodies can be viewed. A stock price that opens down and continues to go lower has a completely different strategy. The purchase of that position may be a few days or weeks down the road.
Next...... Measuring Gaps