Contributor Since 2011
Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT Press); and "Options for Risk-Free Portfolios" and "Options for Swing Trading" (both Palgrave Macmillan). Thomsett also writes for www.TheStreet.com and the StockCharts.com Top Advisor Corner
Most candlestick patterns, especially those with three consecutive sessions, are easily identified as bullish or bearish, depending on the color of the candles. In other words, if you see three white sessions, it's probably bullish; and if you see three black sessions, that's almost always a bearish trend.
But not always.
One of the patterns running contrary to this is the bullish squeeze alert. Although it is bullish, it contains three consecutive black sessions in its purest form. (The pattern can contain white sessions as well, but the all-black three-part indicator is the strongest. More important than the color is the pattern itself.
The squeeze alert has three sessions, each one closing within the real body of the previous one. As a result, each session opens lower and closes higher than the previous one. The other important feature in this pattern is this shrinking range, which includes hidden gaps. So for example, the three sessions might involve opening and closing prices of:
session open close
1 $63.50 $58.00
2 61.90 59.25
3 60.00 59.50
There are gaps between each session's close and the next one's open. This is a subtle but important feature of the bullish squeeze alert. The larger the real body and the gap, the stronger the signal. The example about covers a very small range, but it still counts as a bullish squeeze alert with three consecutive black candlesticks.
One crucial aspect of this bullish signal is that it must show up after a downtrend. If there is no downtrend to reverse, there is no signal. In this situation, the squeeze is merely an interesting pattern. So if you see a bullish squeeze alert during an uptrend, it either serves as a continuation indicator or it has no special meaning. When a bullish squeeze alert shows up after a period of sideways movement, it probably is bullish, but you need to confirm the indicator separately, through changes in momentum indicators, volume spikes, or tests of support, for example. If you do not find such confirmation, it probably is not wise to assume it signals a new bullish trend.
One thing all candlestick indicators have in common is this need for confirmation. You cannot rely slowly on candlestick signals to time entry and exit, but they do provide excellent initial signals of what might be able to take place. Candlesticks may also confirm other traditional charting signals.
The candlestick indicator of any kind, especially squeeze alerts, is going to be the strongest when it appears right at the support level (or if a bearish squeeze alert, at resistance). Because the test of the trading range often leads to lost momentum and reversal, candlestick reversal signals in conjunction with other signs (like gapping action, double bottoms or inverse head and shoulders, for example) are valuable methods for gaining confidence in the timing of your trades.
To gain more perspective on insights to investing observations and specific analysis, I hope you will join me at ThomsettStocks.com where I publish many additional articles. I also maintain a virtual portfolio of stock at ThomsettStocks.com. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site to learn more.