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.
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:
Tall Candle Setup: Recognition Rules
Look for price trending upward (for minor highs) or downward (for minor
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 look back period works best for your
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.
Find a tall candle in an uptrend as described under
Recognition Rules. The following methods assume you will sell
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
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.
Tall Candle Setup: 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
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