Bulkowski’s Tall Candle Setup

Written and copyright © 2007-2010 by Thomas N. Bulkowski. All rights reserved.

Research shows that a tall price bar (candle line) indicates that the stock will reverse direction between 67% (uptrends) to 72% (downtrends) of the time, plus or minus one day. This finding is invaluable for swing traders, and other traders can profit from the knowledge as well.

Details

Research I conducted shows that tall candles (price bars) often, but not always, indicate a short-term trend change, that is, they tell when a minor high or minor low is forming. Traders can use this information to help time their trades. The method will not detect all trend changes nor will it signal perfectly. Nevertheless, knowing when price may form a minor high or minor low can help prevent you from trading just before a reversal.

Here are the recognition rules:

Recognition Rules

1. Look for price trending upward (for minor highs) or downward (for minor lows).
2. Determine if today shows a tall candle by computing the average height of the preceding 22 trading days (do not include today’s candle). That is, subtract the low price from the high for each of the past 22 days and average the result. This is the average candle height. I tested the 22 day period and found it worked best among 3-5, 10, and 22 days. Verify the 22 day lookback period works best for your security.
3. Compare today's candle height (high-low range) with the average candle height. If today’s height is more than 146% above the average candle height, then you have a tall candle. Tall candles are more likely to appear within a day of minor highs and minor lows (that is, one day before to one day after the tall candle). The 146% number is the median height of all tall candles found by research. You might want to test different values.

Trading Minor Highs

• Find a tall candle in an uptrend as described under Recognition Rules. The following methods assume you will sell short.
• The stop location is the same for all 3 methods. Place a stop above the highest of the three candles, meaning the higher of the day before to the day after the tall candle.
• Method 1 (best): Place an order to go short a penny below today’s low. If a higher high occurs before the order fills, cancel the trade. This method works 68% of the time and it shows the highest profitability.
• Method 2: Short if price opens lower tomorrow (you can place an order a penny below today’s low) but don’ worry about a higher high (but do have a stop in place). This method works 54% of the time but is not as profitable as Method 1, and yet it is slightly better than Method 3.
• Method 3: Short at tomorrow’s open. This method works 51% of the time and has the worst profitability trend of the three methods.

Trading Minor Lows

• Find a tall candle in a downtrend as described under Recognition Rules. These methods assume you will go long.
• The stop location is the same for all 3 methods. Place a stop below the lowest of the three candles, meaning the lower of the day before to the day after the tall candle.
• Method 1 (best): Place an order to buy a penny above today’s high. If a lower low occurs before the order fills, cancel the trade. This method works 73% of the time and shows the highest profitability.
• Method 2: Buy if price opens higher tomorrow (you can place an order a penny above today’s high) but don’t worry about a lower low (but do have a stop in place). This method works 58% of the time although it is not as profitable as Method 1.
• Method 3: Buy at tomorrow’s open. This method works 55% of the time but it has the worst profitability trend of the three methods.

-- Thomas Bulkowski

Copyright © 2007-2010 by Thomas N. Bulkowski. All rights reserved. Air is water with holes in it.