Forum Archive Index - July 2001

[Phaedrus <Phaedrus@techemail.com>]

A Simple Technique for Timing Entries and Exits, and Setting Stop-loss and 
Profit-Protection Stop levels.
 It is useful to start with a basic understanding of Japanese Candlesticks. 
These have been used for centuries, and are simply a graphical method of 
expressing the relationships between High, Low, Open and Close prices for any 
given period, most commonly one day. They may however cover periods ranging 
from 1 minute or less to a year or more. A day-trader might use 1, 15 or 30 
minute periods, a medium to long-term trader perhaps one week, while a very 
long-term trader might use one month. The body of the candlestick represents 
the Open and Close levels. If the Close is higher than the Open (an Up period) 
the candlestick body is hollow. If the Close is lower than the Open (a down 
period) the body is solid. The "shadows" at either end of the candlestick 
represent the Highest and Lowest levels reached in the period. Years can be 
spent studying candlestick patterns. If this specialty of technical analysis 
interests you, there are many books available - start with those by Steve 
Nison. 
  The following describes a simple entry/exit and stop setting technique, that 
can be used in any timeframe. It is not meant to be a stand-alone system, and 
should be used in conjunction with other indicators such as oscillators. It 
could be used to implement trades that have been determined by fundamental 
analysis, or some other method. The CWO chart below has weekly candlesticks, 
and so covers a period of 35 weeks. They could just as easily be 60 second 
candlesticks, and the chart cover 35 minutes. Only the X and Y axis scales 
would be different. The entry, exit and stop-loss points are determined by 
exactly the same technique in all cases.
  What we are looking for are the pivot points that are formed at a change in 
trend. Since a downtrend consists of candlesticks with lower lows and lower 
highs, the first candlestick with a higher high and a higher low is the first 
in a new uptrend. The candlestick with the lowest low forms the pivot point. 
Its high denotes the Buy trigger point (a higher high would have been formed) 
and its Low is set as our stop-loss, the point at which we would consider our 
entry to be wrong. If this is breached, a new low would have been formed, thus 
our tentative pivotpoint has been replaced by another with a lower low, and the 
downtrend has continued. We sell immediately. Some traders using daily 
candlesticks prefer to wait and only sell if it looks as though the Close will 
be below the Stoploss level. The end of the uptrend is marked by a candlestick 
with a lower high and a lower low, in other words, the first candlestick with a 
lower high to break through the Profit Protection Stop drawn from the low of 
the pivotpoint day. These Profit Protection Stops are drawn from the Low of 
every candlestick that has a new High as the uptrend develops.
   So, you have decided to buy XYZ by reason of fundamental analysis, or 
because it was recommended by your broker, or through technical analysis. So 
long as it is making new lows, you do nothing. When it moves above the high of 
the candlestick with the lowest low, you buy, setting your stoploss at the low 
of that period.  If it subsequently moves below the Low of the pivotpoint, you 
sell at a small loss. If the uptrend progresses, Profit-Protection Stops are 
drawn from the Low of each candlestick making a new high. When one of these 
stops is penetrated, Sell. As before, some traders using daily candlesticks may 
wait, and decide just before the Close. If the Close looks to be below the 
Stop, Sell. 
   Choose a candlestick period appropriate to your situation, and the stock in 
question. If you only want to look at your stocks once a week, use weekly 
candlesticks. Once a month ditto. As you might expect, the less frequently you 
monitor your stocks, the later you are getting in, and the later you are 
getting out, thus reducing returns. As the chosen candlestick period gets 
longer, the Buy price moves further above the Stoploss level, making it less 
likely that the stoploss will be hit, although losses will be bigger if it is 
hit. Longer time periods mean fewer trades, higher Buying prices and lower 
Selling prices. 
   This all sounds much more complicated than it really is. The chart below 
shows it more clearly than it can be described.  
                       Phaedrus.
This post was prepared at the request of Gerry Stolwyk for incorporation in the 
"Learning to Invest" series.



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