Computer software programs have provided investors with a multitude of stock trading programs. However, stock trading programs are only as effective as the percentage of correct readings for trend reversals. This may be overstating the obvious, but many stock trading programs may only work under certain circumstances. Candlestick signals allow investors to greatly enhance the percentage probabilities of identifying a reversal when added to other stock market indicators. They work effectively in all market conditions, mainly because they are produced by investor sentiment that create the market conditions.

A case in point is the first day of trading after the new year started. As witnessed in the NASDAQ index chart, many indicators showed that the NASDAQ had been trading in an overbought condition for a good while. At what point, will a pullback occur? Understanding the psychology behind what forms a Candlestick signal gives the Candlestick investor a huge advantage for determining that.

Knowing how Candlestick signals are formed allows a Candlestick investor to be prepared for potential reversals in a trend. The first trading day of January, 2005 started out with a gap-up in the NASDAQ chart. This should have immediately alerted the Candlestick investor that a potential reversal was in the making. A gap-up in an overbought condition is usually the first sign to watch for a Candlestick “sell” signal. In this case, once the gap-up occurred and by the end of the day, a Bearish Engulfing signal had formed. This should have been the confirmation of other stock market indicators that were indicating that the market was overbought and that a reversal could potentially occur. A Candlestick signal, when correctly identified, can reveal immediately when investor sentiment has changed.

NASDAQ

Using the Candlestick signals effectively acts as an immediate confirmation of other indicators. In Candlestick analysis, other technical indicators now become an alert that a reversal can occur and the Candlestick signals become the immediate verification.

Market Direction - Analyzing the market direction becomes much easier when analyzing both indexes, the NASDAQ and the Dow, at the same time. It could be observed three days before the end of the year where the Dow formed a small Hanging Man formation, followed by a couple of weak days after that. At the same time, the NASDAQ was forming little Doji trading days, three indecisive days. Both indexes had stochastics that were indicating overbought conditions. However, the uptrend that had continued for nearly two months had stochastics in the overbought condition most of that time. The fact alone that the stochastics were in the overbought area does not mean a reversal will occur.

The Dow

The potential for a reversal was turning when the Dow was backing off with stochastics starting to curl down and the NASDAQ trading flat, with some indecisive days producing a format for analyzing what the possibilities are for the existing trend. As stated often in Steve Bigalow's analysis of the markets, the longer a trend persists, the more convincing the sell signal needs to be to indicate a reversal. Additionally, when the reversal signal appears, it should be obvious in both indexes. This would signify that selling had come into the market in general versus one index over another.

The fact that the NASDAQ opened up very strong on the first trading day of 2005 should have provided an alert. The gap-up in an overbought condition would have meant one of two things to a Candlestick analyst. Either new strength was coming into the markets and taking the trend much higher, or the gap-up should have alerted us that a sell signal was about to occur. It became obvious after the first hour of trading that the buying was disappearing. The Bearish Engulfing signal, formed by the end of the day, was a severe indication that the sellers were now in control. Had the Dow shown any strength at the end of the day, it could have been assumed that the uptrend was still intact but money was shifting. As we witnessed, the Dow sold off, forming a Shooting Star-type formation which revealed weakness at the same time the NASDAQ was forming a bearish signal.

Simply stated, when both indexes are showing signs of weakness in an overbought condition, a change of investor sentiment has come into the existing trend. This was the time, as mentioned in our morning comments, to start taking profits. This is not rocket science. This is just utilizing the information that is provided in Candlestick signals that have worked effectively for centuries. Where most analysts try to project where they think the market is going, analyzing the Candlestick signals tell you where the market is going.

Where was the market potentially going to pull back? The first obvious support level was the 50-day moving average. As seen in this past week of trading, the 50-day moving average was tested. The stochastics have now gone back down into the oversold condition. The 50-day moving average becomes a level to start watching to see if Candlestick buying signals are going to appear at this level. At the same time, the Dow is approaching the 50-day moving average but has not gotten there yet. The stochastics being in the oversold area give the indication to start watching for Candlestick “buy” signals very soon.

Reversing positions - When a Candlestick “sell” signal appears in the market indexes, if you have the ability to short stocks, that is the time to look for high probability short trades. Especially when the market trend becomes doubtful, it is prudent to start hedging your portfolio positions by having both longs and shorts in the portfolio. When the markets indexes are getting toppy, there is nothing wrong with taking profits in stocks that also have toppy patterns or may not have moved like they should in the previous trend. The logic being that if the uptrend continues and the few short positions were put on during the toppy period, those short positions may still sell off or at least not move up with great strength in the continued uptrend, giving time to close out the positions.

As seen in the Gentex Corporation chart, there are many good indications for shorting the position. A Doji/Harami formed above the 200-day moving average with stochastics in the overbought area followed the next day by confirmation selling, producing a high probability short trade. A gap-down the following day revealed severe selling pressure. The downward target becomes obvious, the 50-day moving average.

GNTX

As the GNTX chart illustrates, a gap-down through an important resistance level after a Candlestick “sell” signal becomes a very powerful trend mover. Gaps have very important implications when analyzed with Candlestick signals. They produce the most powerful trend movements. Learning how to analyze and evaluate Candlestick signal and gap chart patterns will produce very strong profits. For more information on how to use gaps effectively, you might want to study the Candlestick forum video “Gaps at the Top with Candlestick Signals”.

Click here for information on "Gaps at the Top with Candlestick Signals"

It should be noted that the vast majority of our long positions were closed out based on the weakness early this week. Does that eliminate the possibility that some of them would go higher? No! But the probabilities told us it was time to close out positions. Was this pullback going to be short-lived or substantial? That, we did not know. However, the signals told us that there was a high probability that a sel loff was occurring. Why sit in positions against the odds? There is nothing wrong with closing out positions when they do not look good and buying them right back if they turn back up again. Remember, the point of investing is not to be right on every single trade, it is to maximize the profits for your account.

Spring Seminar Schedule - The spring seminar schedule is being put together this week. The schedule will be Chicago, Houston, and Orlando. Also, in May there will be an investment cruise in the Caribbean. These are very fun and entertaining events with Steve Bigalow, Dave Elliott, and Bill Johnson as the key speakers. Details will be put on the site soon.

Good Investing,

- The Candlestick Forum Staff

www. candlestickforum.com