Have you ever wondered how you can use that Japanese Candlestick knowledge that you have learned to make money in the stock market?
Today we will be taking a look at a trading strategy that use the daily bottoming tail candlestick pattern.
Before that, let us deal with some of the problems that beginners might face:
He or she does not have a trading strategy
He or she does not have a a solid plan on how to enter and exit stocks
Too busy and distracted to really day trade
If any of the above problems describes what you might be facing today, then I think this trading strategy will help you to overcome that.
There are so many people who would like to have a piece of the stock market action but they are too busy with things in their life to be able to do so.
It could be a day job, it could be family commitment. Therefore it does not make sense to day trade.
You need to find a trading strategy that enables you to do your homework and scan for stocks during the evening.
You also need to have a trading strategy where you do not need to look at the stock market every single day.
This is where the bottoming tail at rising daily 20 MA trading strategy can help you.
The Bottoming Tail Japanese Candlestick Pattern
We will be using the bottoming tail candlestick pattern to find a trade. The bottoming tail is also known as the hammer.
If you take a look at the picture of the bottoming tail below you will notice that it really does look like a hammer.
The solid part is called the body. The long lower shadow or wick is called the tail.
For the benefit of those who are new to candlestick chart pattern, the body is where the stock opens for the day.
The wick or lower tail shows how far the stock has traveled during the trading day.
The upper limit of the body is the high of the day which is also where the candle closed for the day.
So in one single candle, it tells you the open, close, high and low.
This is a lot of information and can actually tell you about the psychology of traders.
A candle can represent one day. Or if it is in an hourly time frame, it can represent one trading hour.
For our purpose, one candle represents one trading day.
The Psychology Of The Bottoming Tail
In order for you to fully appreciate the power of this trading strategy, you need to understand what the stock goes through in the entire trading day.
The left represents the bottoming tail for a single day's trade. on the right we can break down the price action.
So what actually happen during the day is the stock sold off only to recover all the losses and closed higher.
This tells us that despite the bearishness during the course of the trading day, the bulls eventually took back control and pushed the stock price up.
This kind of a situation can always happen when the stock drops to a significant area of support.
Here is something that you should know.
There are quite a number of variations of the bottoming tail. The first one is the one that I have just showed you.
The second one is where the open, high and close is the same. Therefore, it has no body. It has a long tail to tell us that the stock declined through the entire day only to move back up higher towards the end of the trading day.
The one on the right is where the stock opened higher and closed lower. During the trading day, it also went down a lot but still manage to close back up higher to form a bottoming tail candlestick pattern.
So it does not matter how the bottoming tail looks like. Green, black or red. What is important is:
It has a small body or no body
It has a long tail
The long tail is significant because it tells us where once there was bearishness, the bulls have now taken over.
We want to enter stocks that are turning bullish.
The Rising Daily 20 MA
Now, I will introduce you to the next technical concept that plays a big part in this trading strategy.
A moving average is the average price of the stock over a period of time. So if it is a 20 period moving average then it is 20 days price added together and divided by 20.
As the calculations are added up everyday, it produces a smooth line on the chart.
The chart above shows the S&P 500 futures.
It is a Japanese Candlestick chart and if you click on it you can zoom in and see the many candlestick patterns that are available. See if you can spot a bottoming tail in the chart.
The red line on the chart is the 20 period moving average.
Notice how it moves up and down.
It rises and fall and price will sometimes be above or below the red line.
Here are some principles that you should learn and make it your own:
When the stock is above the 20 MA, it is bullish short term
When the stock is below the 20 MA, it is bearish short term
For bullish short term trades, it is best if the 20 MA is rising
Print the above out and stick it next to your computer.
This principle works the same in the daily chart and also many other timeframes.
The next time you want to take a short term trade, consider whether your stock is above or below the 20 MA.
In the chart above, you might perhaps notice a bottoming tail at the rising 20 MA. I have put an arrow pointing to it so you can spot it easily.
That is the kind of setup that we are looking for.
Criteria And Setup For The Trading Strategy
Criterias for a trade are very important.
This is because we want to filter the best possible candidates for trading. If you have don't have criterias, you will be jumping all over the place.
When you look at a daily chart for a trade setup, there should be 2 criteria or things that you should satisfy:
There should always be a bottoming tail candlestick pattern
The bottoming tail should appear at the rising 20 MA
These are 2 powerful technical concepts that in itself is bullish.
When you combine two powerful technical concepts, this is where you start to build a high probability trade.
So in this guide, you are not only learning about a trading strategy. You are learning how to combine different technical concepts to ensure you have an edge.
Aren't you glad that you stumbled across this website.
First of all, the bottoming tail hints to us that the stock refuses to go down. Despite the efforts of the bears, the bulls came up on top and took control.
Secondly, the rising 20 MA points to possible continuation of bullishness in the stock price.
Coming back to the chart, look carefully at the daily chart of QQQ above.
You will notice that there were 3 times that the QQQ formed a bottoming tail at the rising 20 MA.
These 3 trading opportunities would have given you some nice profits.
A Trading Strategy That Is Suitable For Those Who Have A Day Job
Notice that they do not happen that often. So in a way it is good because you do not need to trade that often.
You can find other stocks that may form this setup and trade them. In a single week you might find one or two really good setups in the stock market.
Since it is the end of day candlestick pattern that we are looking at, you do not need to stare at the screen all day.
You can do your homework and look for stocks with this setup after your work.
When you find a setup, just key into your online broker and instruct the broker to buy the stock tomorrow when it breaks out higher.
You should also attached a stop loss order with the buy order.
If you do not know how, just ask your broker to teach you how to do it in the trading platform.
Next, Zoom In To The 60 Min Chart And Look For A Break Of Downtrend Line
In order to ensure that the trades that you take are high probability trades, you need to have more confirmation.
This is where some multiple time frame analysis comes into play.
Multiple time frame analysis simple means looking at the stock in different time frames.
If you are taking setups using the daily time frame, it is a good idea to zoom into the 60 min chart to get a closer look at what is happening.
There are other benefits when you zoom into the 60 min chart:
You can get a better entry
You know where to put a stop loss
You can ride the trend higher and learn how to take profits
Do you know what is a downtrend line?
If you do not know, then try to learn up a bit about the downtrend line.
Basically, the break above a downtrend line gives traders a hint that the stock wants to stop dropping and start moving higher and make a new uptrend.
That is why many traders rely on the downtrend line to analyze stocks.
How do you draw a downtrend line?
You draw the downtrend line by connecting as many swing highs as possible. The minimum will be 2
Drawing trendlines is a skill and it is subjective as well.
So don't beat yourself up if you don't know how to draw a perfect trendline. There are no perfect trendline. You need to practice drawing and looking at many examples to learn.
The chart above, is the 60 min chart of QQQ.
There are 2 downtrend lines that I have drawn and they represent the 2nd and 3rd trading opportunity that I have shown you in the daily chart of QQQ above.
Notice how the QQQ started to move higher when it breaks above its 60 min downtrend line.
The other thing that you should take note is the QQQ starts to be bullish after it goes back above the 60 min 20 MA.
This is where we create an entry:
Enter the stock when it goes above the 60 min downtrend line
If the trendlines is steep, enter when the stock goes back above the 60 min 20 MA
Once you enter, put a stop loss below the recent swing low
In both cases above, you can enter QQQ the moment it breaks above the downtrend line. The QQQ has already gone back above the 20 MA telling us that the trend is changing from downtrend to short term uptrend.
How To Take Profits Off The Table
There comes a time when every trader needs to know how to take profits off the table.
A trading strategy is no use if one does not know how to take profits.
This is where the 60 min 20 MA comes into play.
Take your first profit (1/2 or 1/3) when the stock drops below the 60 min 20 MA
Raise your stop loss to breakeven (purchase price)
The reason why we use the 60 min 20 MA is because a good trade setup will see the stock rise quite a lot before it drops below the 20 MA.
You can sell 1/3 or 1/2 of your position when it drops below the 60 min 20 MA. Raise your stop loss to breakeven to get a free trade.
The reason why you do not want to sell everything at once is because the stock is in a daily uptrend. Remember how the stock is trading above the rising daily 20 MA.
Since a trend in motion tends to stay in motion for quite some time, it is perhaps wise for us to sell only 1/2 or 1/3 and see what will happen.
You never know...
The stock may continue to rise and rise even more.
You can sell the remaining positions when...
The stock rises and drops below the 60 min 20 MA again
The stock reaches a significant resistance area
The stock drops below the daily 20 MA
Sure the stock may drop rapidly after that but since you have raised your stop loss to breakeven then you already have a free trade and don't need to worry about the trade.
Take a look at the chart of QQQ above again.
Notice how you can take profits off the table when it drops below the 60 min 20 MA. That is the power of using a simple trend following tool like the moving average.
Example - AKBA Forms A Bottoming Tail At Rising 20 MA
The example above is a very beautiful example of how this trading strategy works. It is still an ongoing trade at the moment of writing.
First of all, notice how the stock is above its rising 20 MA. It is already in an uptrend and since it is in an uptrend traders can look for buyable dips.
What better way than to look for a bottoming tail at a rising 20 MA?
Notice how the stock rose nicely after the presence of the bottoming tail. The 60 min chart below still have not shown any sell signal yet. So the trade is still ongoing.
The trader can do some support and resistance analysis to determine where is the best place to take some profits.
There is a previous high resistance overhead and in the event the stock rises to that area, the trader can perhaps take all the positions off the table.
So you see the importance of taking support and resistance analysis into account.
The chart above is a zoom into AKBA using the 60 min chart.
We can draw a downtrend line connecting as many highs as possible. Though it is not easy, I have drawn the 60 min downtrend line.
Notice how the stock trades above the 60 min downtrend line. The stock also broke back above the 60 min 20 MA.
It satisfies the 2 criteria.
But do remember to take into consideration the height of the bottoming tail in the daily chart.
A trader can buy the stock when it breaks above the 60 min downtrend line and the 60 min 20 MA but if the high of the daily bottoming tail is higher, then wait for a break above the highs of the daily bottoming tail.
The stock is still trading above the 60 min 20 MA. So at the moment there is no signal to take any positions off the table.
Example -ASB, A Great Reward To Risk Ratio Trade
The great thing about this trading strategy is you can often find a great reward to risk ratio trade.
It can often give you a 2,3 and even 5 r/r ratio.
That means if you risk $1000 on the trade you stand to make $2000-$5000 on that trade.
You already have a high probability trade because you employ the:
Rising 20 MA
Bottoming tail
Break of 60 min downtrend line
Rise above 60 min 20 MA
The above is all positive things going for the stock.
If you have daily support below, then that increases your chance of having a high probability trade.
In the chart above, ASB started to make higher highs and higher lows. This hinted to the start of an uptrend.
By using the trading strategy you will be participating in the stock just as it is starting to shoot up higher.
Notice as the stock rose it did not drop below the daily 20 MA. Only after a significant rise did it drop below the daily 20 MA.
That was the time for traders to sell off all the positions.
Not bad for a trade. It would have given traders an extremely good R/R trade.
As standard practice we will now zoom into the 60 min chart to discover how to enter.
As you can see the stock broke above a downtrend line. It also broke above the 60 min 20 MA.
The stock gap up and the way to trade it is to buy the gap up the moment the stock starts trading in the morning.
Yes you can buy a gap up provided the gap up is not too big.
Then place a stop loss below the recent swing low.
The stock did drop below the 60 min 20 MA the next day but for the first few days of trading try not to be bothered by the drop below the 60 min 20 MA as you need to give it some time to work.
That is why the stop loss at the recent swing low is important.
It is only when the stock has risen by quite a lot and after many trading days that you begin to employ the rising 60 min 20 MA as a guide to know when to sell your first profits.
Remember to sell 1/3 or 1/2 and let the other position ride higher.
Then zoom out into the daily chart and watch the daily 20 MA carefully to see if the stock drops below the daily 20 MA.
If it drops below the daily 20 MA, then you sell the remaining positions.
Summary
You have now learn a trading strategy:
That is easy to spot
That employ many technical concepts
It has a high winning rate (if you follow the rules properly)
It has a good reward to risk ratio
You also learn how to manage a trade
I hope this guide has open your eyes to the many possibilities of making money in the stock market.
Happy trading!