Now consider some specific examples of dramatic price movements that follow common Black-Down-Black and White-Up-White patterns. By September 15, 2008, American International Group (AIG) was already spin-ning wildly out of control. In December 2000, AIG peaked at more than 2000. By the beginning of 2002, AIG had fallen below 1500. For about the next 5 years, AIG traded in a range roughly between 1000 and 1500.
AIG closed February 2008 below 1000 for the first time since February 2003. By mid-May, AIG had fallen below 800. AIG’s steady decline throughout the sum-mer of 2008 is shown in Figure 5.1.
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FIGURE 5.1 Daily stock chart for AIG, May 8–October 7, 2008
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The stock was in free fall. On Friday, September 12, AIG fell from about 300 to close at 234.52. On Monday, September 15, it opened with a gap down of more than 30% and closed down 60.8% from the September 15 close, forming a Black-Down-Black. On September 16, AIG opened at 37, down dramatically from the previous day’s close of 95.20. But, September 16 turned out to be a dramatic reversal with the stock closing at 75—more than a 100% increase in one day!
People who say that the stock market is boring just haven’t looked closely enough. Take Jammin Java Corporation (JAMN) in May 2011, for instance. If the company’s name and ticker symbol make you think of Bob Marley and reggae music, there’s a good reason.
Jammin Java was founded by Rohan Marley, son of the late Bob Marley and a star linebacker at the University of Miami in the early ’90s. On January 10, 2011 JAMN’s total volume was a whopping 500 shares and the price was 51 cents. On May 12, the stock gapped up with the price hitting a high of 6.35 per share and clos-ing at 5.42 on volume of more than 20 million shares (see Figure 5.2). The rise was meteoric going from about 1 per share in March to the high of 6.35 in less than 2 months.
But, on May 13, things began to unravel with four consecutive black candle days. The stock fell from an opening price of 5.59 on the 13th to a close of 1.52 on May 18, experiencing an intraday low of 92 cents on the 18th. JAMN’s price movement provides an example of what the results in this chapter suggest is a typical price movement after a White-Up-White pattern occurs.
Investors who purchased JAMN at the open the day after the gap would experience negative 1-day, 3-day, 5-day, and 10-day returns.
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FIGURE 5.2 Daily stock chart for JAMN, May 26–June 1, 2011
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On June 14, 2011, JAMN fell below 2; it closed the year at 27 cents per share. What caused this wild ride?
The answer isn’t clear, but in September there were news reports that the SEC was investigating a possible illegal online pump and dump scheme. The company issued a statement on September 9 saying that they had become aware of some unauthorized Internet stock promotion in May and that Rohan Marley strongly condemned such actions. The company vowed to coop-erate fully with the SEC investigation.
JAMN wasn’t the only coffee company with a wild ride in 2011. Coffee Holding Company, Inc. (JVA) began the year at 3.85 and ended the year at 7.84, an increase of more than 100%. However, that was noth-ing compared to what happened in between those dates.
On July 11, 2011, the stock hit a high for the year of 30.98, gapping up on a White-Up-White pattern (see Figure 5.3). An investor who saw this pattern might have reasoned that the stock’s tripling in price over the prior month was an unsustainable uptrend. Thinking this was an exhaustion gap, the investor might have shorted the stock at the open on July 12 at 29.54 and enjoyed the fall that same day to a close of 22.37. The next 2 days were also black candle days with the stock closing at 18.89 on July 14.
119and Previous Price Movement Created with TradeStation
FIGURE 5.3 Daily stock chart for JVA, May 14–August 1, 2011
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Summary
Gaps have generally been thought of as signaling a strong directional price move. Traditionally, traders have looked for breakaway gaps as a signal that a new trend in the direction of the gap has occurred. In addi-tion, measuring gaps signal that the trend is going to continue in the direction of the gap. Among those who practice Japanese candlestick charting, the adage is “go in the direction of the window.”
The results show that price movement does tend to continue downward when a down gap occurs, but only for about a day. You might think that spotting a black candle followed by another black candle that gaps down would be an ominous sign; this might mean that downward price movement is gaining momentum.
However, the results show that when a black candle on Day –1 is followed by a gap on Day 0, price movement tends to reverse to an upward direction on Day 1, and this upward movement continues for at least 30 days.
This suggests that the downward gap was an overreac-tion and the price fell too far.
Likewise, you might think that an up gap, especially when it occurs in a White-Up-White pattern, suggests strong upward price momentum. Again, the results bring this traditional reasoning into question. Stocks tend to reverse direction and have negative returns for a couple of weeks following an up gap.
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