. The opening is higher than the first candle’s real body, and the close is below the first candle’s middle portionof the body (Figures 7.27 and 7.28).
FIGURE 7.27
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FIGURE 7.28
• The bearish falling three methods is a bearish continuation patternoften associated with a bear flag formation. The three little candlesusually remain within the range of the first dark candle, which includesboth the real body and the shadow. Some argue that it works with justtwo candles in the middle, but the actual textbook classification isthree white candles. The last portion of this formation is that the nextlong dark candle closes below the first dark candle’s close (Figures7.29 and 7.30).
FIGURE 7.29
FIGURE 7.30
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• The bullish rising three methods is a bullish continuation pattern withthe same characteristics as in the bearish falling three methods, butjust the opposite. During the beginning stages of an advancing pricetrend, an unusually long white candle is preceded by three smaller darkcandles. Again, it can even be just two candles, but the textbook version is that three smaller candles need to stay within the range of thefirst long white candle. The last white candle shows a powerful, advancing white candle that should open above the previous session’sclose and should close above the first long white candle’s close as well(Figures 7.31 and 7.32).
FIGURE 7.31
FIGURE 7.32
• The tweezer tops or tweezer bottoms is a double-top or double-bottomformation that can be disguised by a few variations. The tweezer topforms after an uptrend and then two consecutive time periods makingequal highs. This signals that there is strong resistance and a shortterm top is in place. One variation is that the first period usually consists of a long body candle with a higher close than open (positive).The second day is usually a small real-body candle that has a highequal to the prior day’s high. It can be a positive or a negative openclose relationship; but it is more consistent and a better signal that a reversal is forming when the second candle’s color is the opposite of thefirst candle’s color. A tweezer bottom would be the exact opposite ofthis formation.Other variations have been called “equal and opposite” or “chopstick” patterns. In Chinese, it would be called the yin (black or red negative close candle) and the yang (white, hollow, or green positive closecandle).In Figure 7.33, the tweezer bottom looks more like a pair of fatchopsticks and is almost equal in size and in direct proportion to thereal body’s shape. However, the colors are opposite, which indicates astrong reversal.
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FIGURE 7.33
FIGURE 7.34
In Figure 7.34, the tweezer top also resembles a pair of fat chopsticks, but the dark candle exceeds the first candle’s real body and engulfs it. That is evidence that a top is in place.The equal and opposite formations occur with false breakoutsand key reversals. They are powerful signals that should be respected.Figure 7.35 shows a bar chart to compare to the candle chart in Figure 7.36.
FIGURE 7.35
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FIGURE 7.36
TRADING TRIGGER STRATEGYForex traders note that these candle patterns show up frequently in the currency pairs. Since many times the currency markets trade between the European and U.S. sessions, we see periods of low volatility; and the foreignexchange (forex) markets move in sideways channels, otherwise known aslonger-term intraday consolidation periods. We often see false breakdownsand breakouts, which create the equal and opposite formations. Therefore,a trigger to enter a position would be if the market price is near an important pivot point support level: Buy on the close of the second candle’s timeperiod or on the open of the immediately next time frame. Place a stop twoticks (or PIPS) beneath the double-bottom low. You should see immediateresults as the market moves higher. Adjust your stop accordingly.Chapter 8 goes into more specific trading rules on entries based onthree highly effective and frequently reoccurring patterns. Dojis form moreoften than not at pivot point support and resistance levels. With that said,the pivot point support and resistance levels will usually be either the exacthigh, the exact low, both, or darn close to it, which is why I wanted to getstatistical information on the doji, the hammer, and the shooting star patterns. Also, I wanted to answer the following questions that apply for themost active day trading markets in futures and forex.
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How many lows of the day are formed by a doji candle pattern?How many highs of the day are formed by a doji candle pattern?How many lows of the day are formed by a hammer candle pattern?How many highs of the day are formed by a shooting star candlepattern?
To find the answers, I conducted a back test using Genesis Software(visit www.nationalfutures.com for more details) with its head programmer, Peter Kilman. Pete came to a seminar I was giving on Advance Trading Tactics for forex markets in Houston in January 2006. It is interestingthat, at the time, I was unaware of his preliminary test results when he offered to share them with the audience. In fact, he had thought that he ranthe test wrong when the results popped up, so he ran it three times. Peteran the test from the preceding 255 trading days on a 15-minute time periodfor each market. Because there are about 255 trading days in an averageyear, I felt this was a pretty good sample of information. Most people wantto see longer-term studies; for some applications and specific studies, thatmay be a novel idea. However, I would say the markets in 2005 generatedenough volatility, with macroeconomic and geopolitical events combinedwith the Federal Reserve tightening interest rates. Moreover, energy priceswere on the move; and we were faced with global terrorist attacks, such asthe heinous bomb blast in London that shocked the world in mid-July 2005.That event sent a tremendous price shock to global equity markets. In addition, there are more independent online traders and a new crop of supertraders known as hedge funds trading in the markets. So with thesevariables and market influences, I would say 2005 was a good representation of a more modern historic test period for determining what influencedmarket prices.A 10-year back study would not take into account the more active online trading vehicles or the popular spot foreign currency markets. Even ifthis were a 2-, 5-, or 10-year study, risk disclosure and the government stillwould require me to state that past price history is not indicative of futureresults. So, my study was a back-test study to determine the validity of finding out if dojis, hammers, and shooting stars were really forming at majorturning points or were making the actual highs or lows in the more activeday trading markets and how often. Here are the parameters Pete and Iused to determine the back test and the results of the findings: If a doji iswithin three ticks of the low, we count it. It could be the low itself, or itcould be within one, two, or three ticks of the low. In the same sense, wewill include when a shooting star is within three ticks of the high. To createa percentage, we take the number of days when we are within three ticks ofthe low and divide that by 255.
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For example, we found that on 132 of the past 255 days, a doji camewithin three ticks of the low on bonds. We took 132 and divided by 255, getting 0.528, which is 53 percent. We also found that the hammer pattern waswithin three ticks of the low 36 percent of the time on bonds. We added thetwo pattern totals together and found that hammers and dojis formed thelow on bonds 88 percent of the time, either making the exact high or coming within three ticks. We must keep in mind that there are many days thathave multiple dojis or hammer patterns.Some days may have four doji patterns where only one of these dojipatterns formed the low, while the other three gave false signals. For gold,we used four ticks. For e-mini–Standard & Poors (S&P) 500, we used fourticks (each tick is 12.50, so four ticks is one full point). In the ChicagoBoard of Trade (CBOT) mini-Dow, we also used four ticks, which may explain why the resulting difference is a lower percentage of occurrences forhammers, stars, and dojis forming at tops and bottoms in the Dow. As youcan see, the results are staggering that the highs and lows are formed bythese three patterns. If you just focus on when these patterns form, lookingfor a shift in momentum or the turning point, you may improve your profitability and frequency of winning trades as you may develop a better levelof confidence armed with these findings (Figures 7.37 to 7.40).
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FIGURE 7.37
Bond Lows and HighsUsed with permission of GenesisFT.com.
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FIGURE 7.38 Gold ComexUsed with permission of GenesisFT.com.
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FIGURE 7.39 Mini–S&P Lows and HighsUsed with permission of GenesisFT.com.
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FIGURE 7.40
Mini-Dow Lows and HighsUsed with permission of GenesisFT.com.
As we know, spot forex currency trading goes on 24 hours a day, without a centralized marketplace or exchange. There are many arguments onwhen the day ends and begins. For our analysis in calculating pivot points,I established that the forex trading day ends with the New York Bank closing at 5 P.M. Eastern time. From a market time period to run a study as towhat makes a high or a low, I needed a rigid sample test period with accurate and stable data. We wanted to find the highs and the lows of the daybased on trades and real trades. Forex data is not exchange based. Eachbroker has his or her own set of data. Although the data is parallel to thethat of the futures, as we discussed in Chapter 1 (known as the basis), theyare not trades; instead, they are bids/asks.To get a taste for the true highs and lows of the day from a centralizedmarket place that had actual time-stamped transactions (time and salesdata), we used the futures markets open outcry session, which is from7:20 A.M. until 2 P.M. Central time. This eliminates the possibility of the truelow being an extra few ticks away on the real exchange markets. Usingthis trading time period eliminated arguments over what time we shouldswitch from one day to the next based on the forex data. However, since,again, this is a test to find the candle pattern that formed when the marketmade highs and lows during a specific trading session, it is best to check onthe day-session-only highs and lows to avoid possible anomalies with regard to holidays, early bank hours, and market surges in the future (Figures7.41 to 7.44).
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FIGURE 7.41
Yen Lows and HighsUsed with permission of GenesisFT.com.
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FIGURE 7.42 Euro Lows and HighsUsed with permission of GenesisFT.com.
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47%
FIGURE 7.43
British Pound Lows and HighsUsed with permission of GenesisFT.com.
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FIGURE 7.44
Canadian Dollar Lows and HighsUsed with permission of GenesisFT.com.
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We can dig a bit deeper in the results and say that certain markets respond better than others with the psychological elements that dojis, hammers, and stars represent. Each market has its own character. TheCanadian dollar, for example, is a currency that highly correlates to commodities, which would be a good reason why it has a strong percentage ofoccurrences versus the British pound. The Canadian dollar tracks closer tothe moves in gold. In addition, the volume of trading is lower as comparedto the British pound, the euro, or the yen, according to the Triennial Central Bank Survey 2004. While most currencies are tradable, the five currencies, including the U.S. dollar (four currency pairs), that represent themajority of foreign exchange trading volume are the euro (EUR/USD), withthe majority of volume of 28 percent; the yen (USD/JPY), with estimated 17percent of market share; the British pound (GBP/USD), with 14 percent;and the Swiss franc (USD/CHF), with an estimated 5 percent share of overall volume activity. The Canadian dollar volume trades comparativelyspeaking about less than 4 percent.There are those who will take these statistics and show that there is noevidence that it is reliable information or that there was not enough backtest studies completed. In fact, statisticians and those who understandBayesian calculations will most likely dispute these findings. Well that’s alright, as I see these patterns form over and over and over; and the computerfindings substantiate that. In case you wanted to know what Bayesian theory is, it is from the famous mathematician Thomas Bayes. He was born inLondon in 1702 and died in 1761. One of the few works Bayes publishedduring his lifetime was a defense of Issac Newton against a bishop who hadattacked the logic of his calculus, according to the Encyclopedia Britannica. Bayes was successful enough as a mathematician to win election tothe Royal Society of London. He would have been long forgotten had it notbeen for his friend Richard Price, who inherited Bayes’s papers. Price, himself famous for devising one of the first actuarial tables, came across the“Essay towards Solving a Problem in the Doctrine of Chances” and helpeddevelop the Bayes rule. Statisticians have long recognized the rule’s importance, and some high school classes use it to solve straightforwardprobability problems. But once both data and beliefs enter the picture, themath can become unbelievably complex. Over the past 10 or 15 years, however, computers have become powerful enough to handle Bayesian calculations with relative ease; and the method has won a following. Bayes’sformula allows scientists to combine new data with their prior beliefsabout how the world works. It is an idea that amounts to heresy in much ofthe statistical world. After all, the method requires individuals to make subjective decisions about how strongly to weigh prior beliefs. The essence ofthe Bayesian approach is to provide a mathematical rule explaining how
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you should change your existing beliefs in the light of new evidence. Inother words, it allows scientists to combine new data with their existingknowledge or expertise.This rule applies to the statistics provided on hammers and dojisforming bottoms, as in the case of the Canadian dollar, saying “40 percentof bottoms are hammers” is not equivalent to saying “40 percent of hammers are bottoms.” The Bayes rule can be used to connect these two statements. Therefore, you must be aware that what happened in the past mightnot repeat with the same frequency or that this data is even reliable. However, the facts are the facts. During this time period, the results speak forthemselves.Now that you are armed with enough information to be dangerous inyour trading, let’s go over how to find certain setups and explain what triggers a call to initiate a trade based on these findings combined with whatwe have learned so far with pivot point analysis. In the following chapters,we will also cover the type of risk parameters to use and when and whereto exit positions.
CHAPTER 8
Setups andTriggersCombining Candles and Pivots
here are many methods you can employ to actively trade, includingvarious mechanical trading systems and manual trading tactics. Theconstant changing of market conditions can require system tradersto adapt and update the parameters for their trading decisions. I often prefer the hands-on visual approach, which is more of a manual method, whileemploying a mechanical trigger to both enter and exit a position with aspecific risk management technique. The visual approach is aided by theuse of candle charts.The triggers discussed in this chapter are based on the methodology developed from my 26 years as a trader. I have continually strived to findclearer signals and triggers for short- and even longer-term trade opportunities. I have been doing extensive research regarding the combination ofcandlestick formations and pivot points; some of the proprietary signalsthat I have taught traders at seminars and in my course, I am sharing in thisbook. This chapter details the triggers designed by me, based on my research joining both specific candle patterns and pivot point analysis.I am going to cover three setups: (1) the high close doji (HCD), (2) thelow close doji (LCD), and (3) the jackhammer. Each one has a special setof rules by which to initiate a trade and to exit a trade. These strategieshave done well in periods of both bullishness and bearishness, as well as intimes of heightened volatility and periods of low volatility.This is just a small sample of what is taught in my three-month intensive trading school. I have been asked why I would share such highprobability trading signals with the public. Well, I have taught these methodsto many people, including my own father and son. Just as they have differ-
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ent results with the same signals, you will, too, due to the very nature oftrading. Once my trading concepts are taught by the masses, I do not believe the signals will be diluted or absorbed in the marketplace.I believe not every trader will implement my methods in exactly thesame way as I do. For example, Larry Williams has his OOPS method, MarkFishers has his method, and Tom Demark had his method let out to the public. And all these systems, to my knowledge, are still highly effective strategies. So I do not believe letting you into my “black box” will hurt or dilutethe signals.There are various markets and various time periods in which to enter atrade, such as a 60-minute, a 15-minute, and a 5-minute time period forswing and day traders. These signals work for futures and stocks, and theywork amazingly well in the foreign exchange (forex) markets, as you willsee in the coming examples. The premise is to help keep the trader focusedon the now, to watch and study the current price action. The candle patterns give a visual confirmation of price momentum, and the pivot pointsforewarn you of what the potential turning points are. When you combinethe two methods, you have a solid trading program. This setup may helpyou improve your trading performance and allow you to develop a consistently winning trading strategy. This could be your personal trading systemthat is based off proven and powerful techniques. For a moment, I want youto envision the concept of epoxy glue: It requires two compounds. Separately, they are not very reliable or, in fact, a very strong bonding substance.However, when combined, a chemical reaction occurs and forms an amazingly strong and powerful bond. Using the methods of candlesticks withpivot points can give you that same result if you know what to look for. Theimplementation of longer-term analysis using pivot points will give a tradera fantastic means by which to anticipate a point where a trend changecould occur, thus helping a trader not only to prepare but also to act on atrade opportunity. One can implement this setup using different timeframes besides daily analysis. You can include weekly and even monthlypivot point calculations. This method of analysis will alert you well in advance of a potential support and/or resistance level. In the setup process,you will heighten your awareness to enter in a long or a short positionagainst predefined levels and will wait for the trigger or market signal atthose levels. It can not only help you define or identify the target area toenter but also establish your risk objective. Another event that occurs withthis setup process is that you now can set up your orders to buy on yourtrading platform with the selected contract amounts—in other words, prearrange the commands on the electronic order ticket. Now all you need isconfirmation so you can pull the trigger or click the mouse to establish anentry in the market and establish a position.In Chapter 7, we covered the importance of dojis and the statistical rel-
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FIGURE 8.1
evance of why I look for them at pivot point support targets. The primaryimportance in the study of the doji at a pivot is to understand that the dojiindicates indecision and is a significant sign that changes are coming. Incandle patterns, the morning doji star is one of the most reliable reversalformations that a trader can identify. The problem is that there are about 12variations, making it hard to write code to program in a trading softwarepackage. However, the main component about the doji is the trigger indicating when the next time period’s close is higher than the doji’s high. Thiscan be a subtle change by just two PIPs in forex or ticks in futures. It cannot be at the exact high of the doji; rather, it needs to close above the dojihigh. This is a very important point, so make sure you are crystal clear onit. Figure 8.1 demonstrates the definition of a close above the doji high.
HIGH CLOSE DOJIThe most reliable and most common method used to determine supportand resistance levels is the mathematical-based calculations from pivotpoint analysis. Through the years, I have noticed that doji formations formmore often than not at these predefined levels. In Chapter 7, we have statistical information that backs up that observation. That is the focus onwhich we want to concentrate—the market’s behavior at support and resistance levels, especially when dojis appear. The key is to watch for confirmation for a transition to take place and to act when there is a shift inmomentum. We are looking for a specific conditional change to take placein the market, namely a higher closing high above a doji’s high at the pivotpoint support level. This is the pattern I call the high close doji (HCD)
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method. It has dimensions of specific criteria that need to fall in place,helping to eliminate and to filter out false signals. It is a simple and basicapproach to candlestick chart patterns that is a high-probability winningstrategy.
CharacteristicsWhen the market is in an extended trend to the downside and the marketcondition is oversold, a doji appears, indicating indecision and weakness ofsellers to maintain the downward trend. In addition, prices are near a projected pivot point support target level (Figure 8.1).When a doji appears, you should:• Buy on the close or on the next open after a new closing high is madefrom the previous doji candle high, especially when the market isagainst a key pivot point support target number.• Place stops below the lowest low point of the doji. Stops should be initially placed as a stop-close-only, meaning you do not exit the trade unless the market closes back below the doji’s low.• Sell or exit the trade on the close or on the next open of a candle thatmakes a lower closing low near a key pivot point resistance number.You can use a “filter” or backup process to confirm the buy signal, suchas a bullish convergence stochastic pattern or a bullish convergence onmoving average convergence/divergence (MACD).
Spot Forex TriggersNow let’s put these rules into practice by examining active trading markets,such as in foreign currency markets. Figure 8.2 shows a 15-minute time period candle chart on the spot British pound. Taking the data from September 29 and using the close from the 5 P.M. (ET) New York Bank settlement,we have a high of 177.04, a low of 175.92, and a close of 176.13. Once we calculate the pivot points, we have the first support (S-1) figured as 175.68.The first resistance (R-1) is 176.80.As you can see, the market trades for almost two hours at the pivot support; but at 4:30, a doji forms. Three time periods later, a close above thedoji’s high occurs. Note that the market closes above both moving averagevalues. In addition, the COMAS (Conditional Optimized Moving AverageSystem™) method shows the shorter-term moving average cross above thelonger-term average, confirming a trigger to go long. The trigger to enter along position would be on the time period’s close or the very next session’s
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FIGURE 8.2Used with permission of esignal.com.
open; the entry price would be 175.95. As the market blasts off into trendmode, the money-making sequence of events transpires—higher highs,higher lows, and higher closing highs.As the trade matures, watch the reaction at the pivot resistance R-1 of176.80. Observe the bullish momentum dry up; for the first time, there is alower closing low, and prices close below both moving average values. Themoving averages also form a negative cross, confirming a trigger to exitthe long position. As a day trader, you have completed your mission to capture money from the market. This example would have had you exit theposition at 176.57. For each full-lot-size contract, that would be a 62-PIPprofit or $620 gain. Granted, you did not buy the low or sell the high; butyou certainly did what you always want to do—capture a nice chunk of themiddle of a price move. If you understand that markets move from trendmode to consolidation (or congestion) phase, then you will realize that atthis time it is best to walk away and wait for the next setup because youare now vulnerable to getting whipsawed in the market during the consolidation phase. That is why most successful traders make their money andwalk away. Other less fortunate traders tend to make money early in theday and lose it by trading it away late in the trading session during the consolidation period.
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Let’s examine another trading setup in a spot forex market and seehow the HCD signal responds. Figure 8.3 is another 15-minute chart on theeuro currency with the two indicators stochastics and MACD. So far in thisbook, you have learned how to spot triggers and how to properly read theindicators. The HCD trigger signals to enter in a position earlier than theMACD does and is confirmed by the stochastics as the %K and %D bothclose above the 20 percent line. What helps keep you in the trade is the sequence of trading events, such as higher highs, higher lows, and higher closing highs. Note that the %K and %D stochastic readings do not closebeneath the 80 percent level until the end of the trend run. Also note thatonce the market closes below a prior time period’s low and a doji forms atthe top of the price peak, the stochastics does cross beneath and closesbelow the 80 percent line. The MACD also signals a zero-line cross. All theindicators lined up with an exit point.This signal generated a buy at 119.06. If you applied the combined technical tools covered in this book, it would have allowed you to stay with thetrade and to capture the bulk of the move as the exit triggered at 120.15. Per100,000 lot contract in the spot forex market, that would have generated ahandsome profit over $1,000 per position. All it takes is a few of those permonth to generate a tidy income.
FIGURE 8.3RealTick graphics used with permission of Townsend Analytics, LTD.
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Triggers on Futures MarketsLet’s tune our focus to the futures markets. Figure 8.4 shows a 15-minutechart on the Chicago Board of Trade (CBOT) mini-gold contract. Notice theHCD trigger and the small hammerlike pattern that forms on the pivot pointsupport. The trigger to go long is on the close of that time period or the nexttime frame’s open. If the market is to go into trend mode, which in this example it did, we should see the sequence of events unfold, such as higherhighs, higher lows, and higher closing highs. As a day trader, your exit is atthe least to be calculated by the end of the day; but until the market makesthe first lower closing low near a key resistance level, you stay with the position or at least scale out of partial positions at the first sign of a pause inthe trending condition.The long would be entered at 530.50, and the offset was triggered at538. That would be a $7.50 move per contract and would equate to $250 percontract.The example in Figure 8.5 is on a five-minute chart. We see confirmation of an HCD trigger with the fast stochastics closing back above the 20percent line. Here we have the same feature with higher highs, higher lows,and higher closing highs. The trigger to go long here is 11315⁄32, and the tradewas still going strong until we see a series of dojis at the top. In this case,
FIGURE 8.4RealTick graphics used with permission of Townsend Analytics, LTD.
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FIGURE 8.5Used with permission of esignal.com.
especially as a day trader, you may do several things: Liquidate your longsat the last price, 11330⁄32, which equates to a juicy profit per contract of$468.75 (each tick in bonds is $31.25). You would look to get out becauseyou know, based on the research covered in Chapter 7, that dojis form theday’s highs or lows in bonds a fair amount of the time; and that is what occurred in this example. Then when you see a doji form after a nice trend runor near a pivot, getting flat is good common sense. If you had multiple positions on, the scaling out of half to two-thirds of them would be another alternative (Figure 8.6).The trade example in Figure 8.7 shows a 5-minute chart on the CBOTmini-Dow contract. The daily pivot point support lines up at 10836. A dojiforms; and the cofirming HCD trigger, which was initiated at 10846, develops. I have three identical studies under the chart: (1) the fast stochastics,(2) the MACD study, and (3) a commodity channel index (CCI) using a 14period parameter setting. The stochastics closes above the 20 percent lineat the same time as the entry on