December 16, 2017

Simple & Logical Candlesticks

Many people believe that using candlesticks as an approach to trading is outdated and it can’t possibly extract profits consistently from the markets. I’m not sure that I agree with this view entirely. Personally I don’t see candlestick charting as a direct trading methodology at all, but what I often see is that by taking the standpoint that they don’t work, traders miss out on the strengths which candlesticks offer. Many if not all traders at some point will look at a candlestick chart (or its bar chart equivalent), if not to identify specific candlestick patterns to trade from, then to use as a reference for price history. Whilst so many look at these charts, many traders by not a having a solid understanding of what candlesticks really tell them, are missing out on the extremely useful information which is staring them right in the face.

So what’s this precious information which they show? Apart from the obvious OHLC (Open, High, Low, Close) data for each and every candlestick, they offer a glimpse at how the market has moved. This really is the most vital aspect of candlestick charting and whether or not you want to trade the specific named patterns, it allows you to monitor how the market is moving compared with your expectations.

Let me give you an example. Certain types of candlestick or formation appearing in specific price zones can illustrate market intent. If say the market retests the recent highs, breaks out and yet somehow manages to close back below those highs, there’s likely to have been some strong selling present for this to have been achieved and therefore the market has every chance of a subsequent move lower. It’s market logic that’s of fundamental importance. This is what that logic might look like in the form of candlesticks:

You can even see that the bearish “dark cloud cover” formation is directly equivalent to a “shooting star” candle in this case. It may not be quite as bearish as it happens more slowly over two candles rather than one, but nevertheless it paints a similar picture. Yet these are two well-known examples of bearish formations. What happens if you don’t see these appear? Does it mean that bearish conditions don’t exist? Not necessarily. You wouldn’t have been aware in this particular case had you just been looking at a 5 minute chart on these two days:

However, understanding the principles behind what they’re showing means we can see that on the first it moves higher and rallies into close and then on the second day it opens higher, fails to push up much further and ultimately closes very near to the first day’s open. Realizing that this failure to push higher coupled with a strong reversal would alert a trader to the possibility of an impending reversal.

For me, the key to getting the most out of this centuries old charting method was the realization that formations are just the illustration of important market behaviors such as rejection, continuation or indecision. Specific candlesticks and patterns frame these behaviors very well and train the mind to be more aware of them, so that even when they don’t appear the logic is still clear. In any profession, a sound understanding of the tools at your disposal can be the difference between being quite good and excelling at something. Trading is no different. A trader with a solid understanding of candlestick charting is well positioned to read the rhythm and flow of the markets compared with a trader who simply applies indicators to the very same charts!

Trade well.