Technical Analysis Series — Article #4: Introduction to Candlestick Trading
In previous articles, we’ve discussed that one should not buy or sell unless there’s more than one signal. But what other types of signals could you use to increase the likelihood of the trade favoring you? In this article, we’ll be discussing Candlestick Trading.
Released to the public in 1755 by Munehisa Homma, candlesticks help represent price action for a specific time period. These are one of the essential aspects to being able to read charts, and chances are that you’ve already seen them before.
In the figure above, we see a candlestick indicating that price went down on the left, and a candlestick indicating that price went up on the right. The wicks represent the extreme highs and lows for the price, while the start of the body represents the price at which the market opened, and the end of the body represents the price at which the market closed. If the price closed at a higher price than that at which it opened, it would typically be a green candlestick, while if the price closed at a lower price than that at which it opened, it would be red.
Are there patterns that exist to help find when price action may reverse? There is, and the figure above represents multiple bearish and bullish candlestick patterns. However, candlestick patterns are very subjective and must be used alongside other signals. If you see a pattern, the main idea is to let it be one of the factors to help with your analysis.
Let’s look at some examples:
Examples
In the daily timeframe for a BTCUSD index above, we see a spinning top candlestick, combined with the Relative Strength Index (RSI) indicator going into the oversold. Using these two signals, you could place an entry order somewhere above the high of the candlestick (acts as a resistance level) so you would enter the trade when price action breaks above that level. A stop loss would be placed somewhere below the low of the candlestick (acts as a support level).
In the same asset above on the daily, we see another similarly shaped pattern on October 24th. Here we see a bullish divergence, where the RSI makes higher lows, while price action makes lower lows. Using these two signals, you could place an entry order near $7550 above the resistance level of the candle’s high. A stop loss would be placed somewhere below the low of the candlestick (acts as a support level).
In the weekly timeframe for XAUUSD above, we see multiple bearish candlesticks making new highs, giving a signal that the market may reverse. Pair that knowledge with the multiple green candlesticks that occured beforehand suggesting that a correction is needed, and you have two signals that the next move may be to the downside.
Looking at the same section but in the daily timeframe, we see a bearish divergence occurring with higher highs on the price, but with lower highs on the RSI. This would give a third bearish signal, once again indicating that the next move would be to the downside.
Sounds Easy?
Don’t be fooled. Trading is not as easy as this, and is a discipline that requires extensive learning. The truth is that 90% of traders lose money. However, with proper training and money management, you are able to be in the 10% that do not. Always have a trading plan, use stop-losses to cut your losses and move on, and never overtrade.
This is the author’s perspective and is meant to be used for educational purposes. This is not financial advice.
Written by Fahim Ahmed, Writer for the Junior Economist
Originally published on November 15th, 2019
