How to Make Money Trading with Candlestick Charts

Why the Reversal Works
Consider a stock moving down for a period
of time. Investors start panicking at some
point. They want to get out and accept the
loss. Finally, as the sellers pile on the stock
starts selling off heavily during the day. But
then smart money moves in. They are able to
move the price all the way near where the
stock had opened for that day. This gives the
stock a hammer look. The Japanese call it
hammering out a bottom
. However, the
stock needs to trade higher the next day to
confirm that the bulls have actually reversed
the trend. The candlestick trader should enter
the market after seeing this confirmation.

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The following conditions can make the
Hammer signal a more compelling buy:
There is a gap down from the previous
day’s close on the day of the Hammer.
There is a spike in volume on the
Hammer day.
Stochastics are in oversold condition.
The longer the lower shadow, the better.
Figure 4.2
shows the chart of Bharat Forge
Co. Ltd. Notice the long-legged Hammer in
June 2006. The volume surged on the day of
the Hammer, indicating people were panic
selling the shares. The question is — who
was buying when these “novice” traders
were selling?

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Figure 4.2:
A Hammer in oversold
condition in Bharat Forge
Also note the fact that the stochastics were
near the oversold area. Another point to see
in the chart is the day before the Hammer
signal. That candle also had a long tail,
indicating buyers stepping in to absorb some

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of the selling. But it did not form the Hammer
signal because the lower shadow was not
twice the length of the body.
Consider 
Figure 4.3
showing the Hammer
formation in Punjab National Bank chart. If
you watch closely, the Hammer has a small
upper shadow. That is acceptable. Compared
to the size of the lower shadow, the upper
shadow is negligible. The stochastics are in
the right place adding credence to the signal.
Buying around the 
`
430 area after
confirmation and selling around the 
`
470
area (after the Bearish Engulfing signal)
would have given the candlestick trader
good profits.

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Figure 4.3: