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A Candle Trigger for Market Bottoms

Thursday, May 02, 2013

Published: 5/2/2013
By Tom Aspray, Senior Editor, MoneyShow.com
MoneyShow.com
Tickers mentioned: XLE, BAC, FAZ, GOOG, HD
Candlesticks have become a popular analysis tool for spotting early signs of change, and here,
MoneyShows Tom Aspray highlights one of its most revealing patterns, which could help pinpoint
optimal entry and exit points.
In the last trading lesson, I discussed the low close doji formation (LCD) that was created by trader
John Person which is in his book Candlestick and Pivot Point Trading Triggers.
Of course, John also taught me about his high close doji (HCD) trigger, which I have found equally as
valuable as the LCD, particularly when it is confirmed by the volume analysis. Since I was first exposed
to this technique, there have been numerous times when I looked at a market that has dropped
sharply or risen strongly only to realize that a LCD or HCD had been triggered at the turning point.
In this article, I will look at the HCD trigger in-depth and show how the use of multiple time frame OBV
analysis can confirm the price action.

Click to Enlarge
Just as the case with most technical methods, the signals from the monthly data are often the most
powerful. They can often help one catch moves that last many months or even a year. This first chart
of Bank of America (BAC) has two excellent examples of LCDs, as well as a HCD that formed in early
2012.
In April of 2012, BAC made a high of $19.86, a low of $17.41, and closed at $17.43. The following
month (point 1), BAC closed at $15.41, which triggered a LCD. Over the next six months, BAC declined,
and eventually reached a low of $10.91. This was a drop of 29.2% from the May close.
BAC closed higher in December 2010, but the next month, formed another doji, point 2. The pattern
of the OBV was much different as this doji was at the 2010 high, the OBV had also made a new high,
so there were no negative divergences. Two months after the LCD was confirmed, the OBV dropped
below its WMA.
As the doji was forming in January 2011, the OBV was just rallying back to its declining WMA (point 3),
which is typically a very negative formation. The close in March 2011 was at $13.33, which was below
the January low of $13.40. This therefore confirmed a LCD.
BAC closed December 2011 at $5.41, which was a drop of over 59% from the March close. That month
BAC formed a doji with a monthly high of $5.95. In January BAC closed at $7.13, which triggered a high
close doji or HCD. The risk was to under the December low of $4.92.
The monthly OBV formed a slight positive divergence at the lows and by the end of February had
clearly moved above its downtrend, line a, and its WMA (see circle). At this point, the stop could have
been moved to under the January low of $5.62.

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Lets look at this same time period for BAC on a weekly basis. The chart shows that in the final week of
2011, BAC formed a doji (line 1). Over the prior six weeks, the OBV had been forming higher lows (line
b) while prices had formed lower lows (line a). The OBV moved above its WMA a week before the doji
was formed (point 3).
The doji high was $5.58, and the next week (point 2), BAC had a close of $6.18 and therefore triggered
a weekly HCD. The stop would have been under the doji low of $5.27, making the risk much more
favorable on the weekly HCD signal than it was on the monthly.
NEXT PAGE: Examples of HCD
Of course, this method like the LCD can work on any market and by traders or investors. This daily
chart of the Direxion Financial Bear 3X ETF (FAZ) provides quite a few good examples but I will focus
on just two. On March 29, FAZ formed a doji as it had fallen from a high of $219.76 in November 2011
to a low of $79.80.

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For both the LCD and the HCD, the most valid signals come after significant rallies or declines. Three
days later, another doji was formed at point 1 with a high of $83.56. The OBV had already moved
above its WMA, and the following day, FAZ opened at $84.28 and closed at $85.20, so a HCD was
triggered.
Four days later, FAZ hit a high of $95.12 before it reversed course. By May 1, FAZ had a reached a low
of $80.20, which was just above the late March lows at $79.68 and $79.80. Since there was no new
low in price, a bullish divergence in the OBV was not possible but the OBV was acting stronger than
prices as indicated by line c.
During the three days after the HCD was formed, FAZ rallied to a high of $95.20. But then, just two
days later, it closed back at $85.84. Anyone who has traded these triple leveraged ETFs should accept
that they are not for the faint hearted. If one is fortunate enough to get a double digit profit in just a
few days, those profits should definitely be taken.
On May 2, another doji was formed (point 2) with a high of $85.64. The next day, FAZ closed at
$86.08, so a HCD was again triggered. The OBV had moved above its WMA, and a couple of days later,
it also moved through its downtrend, line b.
Just 11 days later, FAZ hit a high of $116.20 as the OBV was acting very strong. After a six-day
correction, FAZ again moved higher and briefly exceeded the 127.2% Fibonacci retracement target
from the correction which was at $119.91. This also corresponds to chart resistance from March 2012,
line a. The OBV did not confirm those highs as it formed a negative divergence, line d.
Click to Enlarge
On this weekly chart of Google, Inc. (GOOG), I would like to concentrate on the doji that formed the
week ending April 22, point 1. GOOG had corrected from its high at $642.96 in early January and had
dropped down to form the doji between the 50% and 61.8% Fibonacci support levels. This was also
well above the uptrend, line a. The doji high was at $530.88, and the following week, GOOG closed at
$544.10 triggering the HCD. The stop would have been under the doji low at $519. But what is missing
from this analysis?
NEXT PAGE: More Examples of HCD
I hope that many of you noticed that in the prior commentary there was no analysis of the OBV. This is
a good example of why I find the OBV to be such a valuable tool in determining the strength of both
LCD and HCD triggers. Oftentimes, but not always, the OBV will help you identify the most worthwhile
signals. The chart below also includes what happened in GOOG in 2011, as well as detailed analysis of
the OBV. It should have been apparent that while GOOG was making a new high in 2011 (point 2), the
OBV was forming lower highs, line a. Weekly divergences in technical indicators like the OBV are
generally quite significant.
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The weekly OBV broke important support, line b, in early March, which confirmed the negative
divergence. This is highlighted by vertical line c. The lower lows in the OBV (point 4) confirmed that it
had started a new downtrend.
As GOOG was rebounding in the middle of April (line d), which was just two weeks before the doji was
formed, the OBV was acting very weak and making new lows. These were a series of strong warnings
that this HCD was not going to work out. The stock dropped another $50 per share before it bottomed
in June.
Home Depot, Inc. (HD) has been one of the bull markets big winners rising from a 2009 low of $17.49
to recent high of $71.45. In 2009, HD was making a gradual series of higher highs and in December
2009, the OBV finally broke through its long term resistance at line a.
Click to Enlarge
The OBV has been in a solid uptrend for some time as HD closed in December near the years highs. In
January 2010, HD declined forming a doji at the end of the month, point 1. The doji low at $27.19 was
just above the 50% Fibonacci support at $26.88, which made it a high probability entry level.
The doji high was $28.09, and the following week (point 2), another doji was formed with a close at
$27.98 but a high of $29.05, so no HCD was triggered. The following week (line 3), HD closed at $29
triggering the HCD from two weeks earlier. A stop should have been used under $27.19, which was
the initial doji low. The OBV also had broken its short-term downtrend, line c, which supported the
bullish case.
The following week, point 4, prices started to accelerate to the upside. At the end of April, HD peaked
at $37.03. The OBV had peaked two weeks earlier and therefore formed a negative or bearish
divergence, line d, at the highs. Three weeks later, the OBV dropped below its prior low, which
confirmed the bearish divergence. Over the next ten weeks, the stock eventually dropped below the
late January lows.
As regular readers know, I closely follow the Select Spyder ETFs and write about them frequently Best
Sector Bets For New Year. When I see that a sector has bottomed out using both the OBV and relative
performance analysis, it becomes a sector that I focus on for individual stock picks.
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In the summer of 2010, the Select Sector SPDR Energy (XLE) was making lower lows, line a, as it
reached $48.56 in early July. The OBV bottomed in early June and was forming a positive or bullish
divergence, line c. On the first rally off the lows, a doji was formed (see circle) with a high of $54.72.
NEXT PAGE: Implementing LCD & HCD in Your Analysis
The next week, XLE closed at $55.64, completing the HCD with a stop under the doji low of $53.23.
The OBV just barely made it above its WMA on the rally before it reversed the next week as the stop
would have been hit. This doji might have been excluded as it was formed after a three-week rally
from the lows, not after a protracted decline.

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Another doji was formed on the week ending August 27, point 1, with a high of $52.72 and a low of
$50.33. The following week, XLE closed at $54.20 triggering the HCD with a stop under $50.33. The
OBV completed its bottom three weeks later as the downtrend, line b, was broken confirming the
bullish divergence.
For the next nine weeks, XLE made higher lows and while it formed a doji in early December XLE did
not close below the doji low. In early March, point 2, another doji was formed with a low of $76.29
and a high of $79.08. The following week, XLE closed at $75.11 triggering the LCD. A stop above
$79.08 should have been used.
This, of course, could also have been used as a signal to exit long positions, even though the OBV had
confirmed the recent highs. After trading as low as $72.90, XLE rebounded sharply making a new high
at $80.97 in early April with a new closing high of $79.99. Therefore, the stop would have been hit.
Four weeks later, XLE had a closing high of $80.48, which was not confirmed by the OBV as it had
formed lower highs, line b. The following week, there was a bearish engulfing pattern on high volume,
which confirmed the divergence and dropped the OBV below its WMA. The following week, the OBV
made another new low confirming a downtrend and a major top. This was discussed in the May 2012
column Big Oils Big Top.
So how can you implement both the LCD and HCD into your analysis? There are several free services
on the Internet that will allow you to scan for dojis. What I have begun to do is to run weekly and
monthly scans for dojis as part of my watch list.

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One stock that showed up at the end of April was Procter & Gamble (PG) when it formed what is
called a gravestone doji as it opened the month at $76.85 and closed at $76.77 with a high of $82.54
and a low of $76.35. The monthly relative performance had formed lower highs, line a, which is a sign
of weakness. The OBV on the other hand did break its downtrend and is still above its WMA. Still, I will
be watching to see if PG closes the month of May below $76.35 and triggers a monthly LCD.
In my daily columns, I will be pointing out both the HCD and LCD when appropriate, and I hope you
will take the time on your own to see if it is something that can improve your results. I think it will and
recommend that you also read Johns article on HCDs, if you have not already, since he is the expert
on their use.
The High Close Doji Trigger

There are many trading methods one can employ to actively trade including various mechanical
trading systems and manual trading tactics. The constant changing of market conditions can
require system traders to adapt and update the parameters for the trading decisions. I often
prefer the hands on visual approach which is more of a manual method while employing
mechanical risk management techniques. The visual approach is aided by the use of candle
charts. The draw back is one must have a basic understanding of this form of charting to begin
with. The upside is once you learn the basics, a new meaning of how markets act may open up to
you.
It amazes me that candle charting was one of the first forms of tracking commodity prices some
400 years ago, today it has become more popular, however, relatively few Futures traders
implement it in their analysis. The myth surrounding this method is that it is a highly complicated
means of charting. The fact is it is a relatively simple method and enhances the visual effects in
charting. Candle Stick Charting is a basic building block method that immediately shows a trader
the important connection between the four most important aspects of price analysis. That is the
relationship between the Open, High, Low and close of a given session. It involves colors to
differentiate the relationship between the open and close referred to as the real body, it acts as
an immediate way to illustrate and help identify the current markets environment and the
current time frames acceptance or rejection of a specific support or resistance level in a clear
visual manner. If for example, on a given trading session prices move higher from the opening
price, and close near the highs, it shows strong buying interest. If after the open the market
trades up establishing the high and then fails, the distance formed from those points of interest is
called the shadow, which clearly shows rejection from that high price level.
There is one more formation, called a Doji where there is no main real body formation as the
market closes at nearly the exact level from where it opened. That is the focus of this article
In my Book Technical Trading Tactics: How to Profit using Pivot Points, Candlesticks and other
Indicators I demonstrate many powerful ways to anticipate support and resistance levels. The
most reliable and common method used to determine those levels is the mathematical based
calculations from Pivot Point Analysis. Through the years I have noticed that Doji formations form
more often than not at these pre-defined levels. That is the focus we want to concentrate on. The
markets behavior at support and resistance levels especially when Dojis appear. The key is
watching for confirmation for a transition to take place and to act when there is a shift in
momentum. We see a specific conditional change take place in the markets behavior, namely the
market makes a higher high but establishes a higher closing high above a Dojis high at the Pivot
Point support level.
In this article I want to share with you in detail this one specific trade setup and what it takes to
confirm the buy signal or whats known as a trigger to execute a trade.
This is the pattern I call the High Close Doji or the HCD method. It has dimensions of specific
criteria that need to fall in place, therefore helping to eliminate and filter out false signals. It is a
simple and basic approach that is a high probability winning strategy.
This setup may help you improve your trading performance and allow you to develop a consistent
winning trading strategy. Consider this your own personal trading system that is based off of
proven and powerful techniques. For a moment I want you to 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 with Pivot Points can give you that same result if you know
what to look for. The implementation of longer term analysis using Pivot Points will give a trader
a fantastic means in which to anticipate a point from where a trend change could occur, thus
helping one to not only prepare but to act on a trade opportunity.
The setup:
One can implement this set-up using different time frames besides daily analysis. You can include
weekly and even monthly Pivot Point calculations. Take for instance the Weekly numbers. They
are compiled from the previous weeks High, Low and Close. This method of analysis after
calculating the numbers will alert you well in advance of a potential Support and or Resistance
level. If you have your calculations figured out on the close of business on a Friday then you are
prepared before the weekend starts and now have a general guide of what may be the next
weeks potential High, Low or both.
In the setup process you heighten your awareness to enter in a long or short position against
predefined levels and wait for the trigger or market signal at those levels.
It can not only help you define or identify the target area to enter but also what you wish to
establish as your risk objective. Another event that occurs with this setup process is you now can
set up your orders to buy on your trading platform with the selected contract amounts. In other
words, prearrange the commands on the electronic order ticket. Now all we need is confirmation
so you can pull the trigger or click the mouse to establish an entry in the market and establish a
position.
The chart below magnifies what you are looking for, notice once the market closes above the
Dojis high we see an immediate reaction of positive momentum and a continuation of higher
prices.

That is what we are focusing on especially after a decline in price and when the market
approaches a predetermined support level based off of the Pivot Point Calculations.
Trading Rules for the HCD setup:
1. When the market approaches a key Pivot Point, buy on the close or on the next open once
a new closing high is made above the previous bullish reversal candle pattern especially a
Doji formation.
2. Place your initial risk management stop below the low of the lowest low point of the
bullish candle pattern. This can be on a Manual Stop Close Only basis.
3. Exit the trade on the close or the first open of a candle that makes a lower closing low
after a prolonged uptrend.
4. One can use a Filter or back-up process to confirm the buy signal against a major Pivot
Point number such as a bullish convergence stochastic pattern.
A bullish Candle pattern can be a Harami, Harami Doji Cross, Bullish Piercing Pattern, A Bullish
Engulfing Pattern or my favorite, but in most cases we want to act on a High Close Doji pattern.
This pattern works for most markets including Stocks, Forex and Futures. This is a high probability
intraday trading pattern however it works very well for position trading. There is a higher
frequency of patterns that develop for intraday trading.
This pattern develops on various time periods, however I do not use less than a 5 minute time
period. My favorite day trading time frame is using both the 5 and the 15 minute period. This
helps me to catch trend runs as they occur in the market.
The example below is the CBOT electronic Gold contract taken from September 28th 2005. The
first dimension we need is the Pivot Point calculations. So we take the prior days High, Low and
Close and applying the formula we derive at 466.50 as the first Support level known as S-1. Notice
the price action at the support level. The Doji Forms at the S-1 and two times periods later, an
engulfing green candle forms, which signifies the market closed above the open. Notice that it
also closes above the Dojis high.
I want to illustrate the flow of the market price action, notice we never see, until the end of the
trading session, prices make a lower closing low. The sequence of events that transpire is higher
highs, higher lows, and higher closing highs as defined by green candles, all the way up just past
the daily projected pivot Point R-1 of 472.50. This is a great example of a HCD trigger that results
in a 6.00 dollar gain in Gold.
In case you were wondering if this set-up can be applied to Forex markets the answer is yes. This
next chart is a spot FX British Pound from September 30th. If you apply the Pivot calculations
derived from the prior days data you will have a predetermined support of 1.7568. Notice how
the market bounces around and then the Doji forms. The trigger to buy initiates once the Green
candle closes above the Doji high and the same sequence of events takes place, higher highs,
higher lows and a continuation of higher closing highs all the way up until we hit resistance at the
R-1 of 1.7680. That equates to nearly an 80 PIP or point gain.

This next example is the CBOT Mini-Dow contract, in this example notice how the Doji forms right
on the Pivot Point Support Line. Remember that Dojis form more often than not at Pivot Point
Support or Resistance levels. Here the candle right after the Doji not only closes above the dojis
high but see how it entirely engulfs the real bodies of the prior two candles of the Doji as well.
That helps signal the power behind the reversal formation. As you can see we have a great run in
the market testing beyond the R-2 number thus giving nearly a 100 point gain for the trading
session.
This is a pattern that should show an imediate positive change as the reversal takes hold. Also
notice that we see more green candles develop, which reflects the market closing above the
open, thus confirming buyers dominating the market with better bullish momentum.
The rules also state that we can use confirming indicators. In the chart below we have three
indicators, my favorite being Fast Stochastics, then MACD and CCI. As you can see Stochastics
indicates a bullish convergence signal, validating that prices were near an exhaustion phase and
ready to reverse, as the Doji formed.
The HCD trigger would have you long at the close or the open of the next candle near 10485.
However, notice the MACD triggers late and would initiate a position near 10520.
The trigger in the MACD would be verified from the moving average crossover as well as the zero
line crossover method. Notice how MACD does not form a Bullish Convergence either.
The CCI indicator is a 14 period setting. The Histogram feature does alert to a timely Bullish
Convergence confirmation, but notice when we line up the zero crossover feature it also would
trigger a buy at a much higher price entry similar to the MACD signal. One of the neat features of
CCI is that it incorporates the Pivot Point formula in its calculation; it has great validity as a
confirming indicator. It is non the less a lagging indicator and as the chart below shows signals an
entry later than the HCD trigger pattern.
No matter which indicator you are comfortable in using, when investors first discover Pivot
Points, most often their first impression is one of pure amazement. Mainly due to its ability to
predict what a specific time frames overhead resistance or support might be. Moreover, more
times than not the High, Low or even both are right on target as the exact number for that given
session. Make no mistake Pivot Point analysis is impressive. However, its real power and value
does not end there. Pivot Point Analysis deals with pin pointing not only price but in a specific
time period.
It is what I consider the Right Side of the chart indicator. It also gives you a method for
identifying the trend and how to determine the typical price or fair value of a given time frame.
After all, that is what the actual Pivot Point number is. If prices deviate too far from that point the
outer calculation numbers can help you determine at what point a market is most likely to turn.
One can also use this feature of the actual Pivot Point to develop a moving average system. But
when traders combine these calculations with the visual aid of certain candle patterns, it can give
you superior guidance as to when and where to enter and exit positions. Traders who want every
edge in their approach for the highest probability of success will benefit from this simple but yet
time tested method.
This is just one of the strategies that I wrote about in my book, A Complete Guide to Technical
Trading Tactics. Remember this technique works amazingly well for futures, commodities and
stocks; it also works especially in the FOREX markets.
The amazing fact is this pattern works equally well in market declines, therefore I call it a Low
Close Doji set-up. When I use pivot point analysis what I want to do is see how the market
behaves at or near a pivot point target number. I also include a special moving average approach
which is taught in my trading course that illustrates a conditional change in the market. Once we
identify that the current market price is turning direction we can establish a trading position as
prices close below a Doji low, a moving average cross over occurs and prices close below both
moving average values. I use a combination of a specific moving average of the pivot point
combined with a simple moving average. I stay with the initial position until those particular
conditions change. In bearish conditions I look for a series of events such as lower lows, lower
highs and lower closing lows to indicate a bearish trend. Once the market conditions change and
we have a series of opposite events occur I stay on the short side of the market.

In the chart above we have a Low Close Doji sell signal triggered at the pivot Point, prices close
below both moving average values and the moving averages cross signaling confirmation that a
trend change has occurred. The profit target is the first Pivot Point support target level. If you
notice that this method signals a short well before the MACD signal and even the Stochastics %K
and %D 80% line cross method. As you will notice the low is formed by a doji candle. In the
beginning of this article I stated the Dojis form more often than not at Pivot Point Support and
resistance levels. Here is another case in point. With that said, now you see why I focus on these
high frequently re-occurring patterns and teach these specific patterns in my trading course.
I went and took this observation one more step in my soon to be release book which is slated for
sale in October 2006. I cover more on statistical occurrences when Dojis, Stars and Hammers
form in certain markets. Here is an example of the frequency of these patterns, which was
independently back tested by Genesis Software. In the example below using the e-mini S&P 500
futures contract, the test results were based on the US open out cry session using a fifteen
minute time period. We ran these statistics on many markets; the best part is some markets had
even better results than what I am sharing with you now. Looking at this bar chart below we see
that 30% of the lows are established by a doji while 40% of the lows are made by Hammer
formations. Combined that accounts for a 70% chance that the low is made by a Doji or Hammer
based on a 15 minute time interval. At tops 36% of the time they are made by Dojis and 40% are
made by shooting stars, combined it accounts for a whopping 77% statistic.

The methods introduced here are used to help keep the traders focused on the now, which
means to watch and study the current price action. The Candle patterns give a visual confirmation
on price momentum, and the Pivot Points forewarn you what the potential turning points are.
When you combine the two methods you have a solid trading program.