Wednesday, February 07, 2007

Blow-Off Bottom

Here's a picture anyone who wants to can save to a file and put in their trading workbook (I trust everyone has one) of a Blow-off Bottom. I've heard that the stock market is a random walk and people are often fooled by randomness yet I see this formation every day in every time frame. Most often the result is the same - the stock goes up. I have no way of measuring the long term efficiency of this signal but I'm confident in it to return at least a 65% win rate.

I'm showing only the pertinent parts and will walk you through it.

It is always a three-candle sequence.

1 - The first candle in the sequence closes down. Volume doesn't matter.
2 - The second candle in the sequence closes down. If it rebounds as is shown here that is a stronger formation than if it just goes down and closes at the bottom of the range. But it doesn't have to rebound.
3 - The volume for the second candle in the sequence must be greater than the previous candle's volume. This is a key factor - it is what you should always look for in a declining stock. The bottom is almost always signalled by a strong volume. Not necessarily but it is an excellent tell.
4 - The third candle in the sequence must close up.
5 - The low of the third candle in the sequence must be higher than the low of the second candle in the three-candle sequence.

That's all there is to it - three candles, the first two declining, the second candle's volume greater than the first, the third candle closing up with a higher low than the second candle.

The buy point is after the third candle is formed and finished. Then if a blow-off bottom occurred it is time to buy. The exit is up to the trader - I let the candles and volume inform me of when to sell but you might decide to get out at a fibonacci range, or a specific pivot point or for any number of other reasons.

Always put a stop below the third candle in the sequence. How far down is up to you but some increment of the Average True Range(10) for the period being observed is usually appropriate.

This works on every time scale from a minute to a month. The longer the time scale generally the longer the run.

And I hope it is needless to say - there are no guarantees.


Bullish Jim said...

I love this setup and I learned it right here. It is one of two techniques I am trying for daytrading right now and it feels like a winner to me.

Marlyn- I think you'll be proud of me for one of my two daytrades today. I bought off a blow off bottom quite nicely. It wasn't a perfectly executed trade but not bad for a rookie. I'll post the chart later.

Thanks again!

Anonymous said...

Recently been reading your blog and have found it to be both educational and entertaining. Thank you for that. I've been paying specific attention to your BOB theory and, although I did not trade it today, I would have loved to have gotten Long into "NT" after the 11:30 BOB. Wow---nice move!


Anonymous said...

Thanks so much for the BOB setup intructions. I set up a doji alert and a hammer/hanging man alert in TradeStation's RadarScreen to assist me in finding setups.

Marlyn Trades said...

I repeat one more time - no guarantees and I did say 65% win rate at the top. That means 35% losers at least.

Keep a good stop in place - not too tight not too loose and if you aren't watching like I do - make it real.

Good trading to all.

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Nice charts