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In this post, you will learn the construction of the candlestick and a simple candlestick trading strategy you can use to trade candlesticks successfully.
Price action and candlestick strategies are the best trading strategies and techniques you should focus on in your trading.
Develop a strategy with price action in its core and you will profit and become better at market timing.
Do not worry if you don't understand everything at first. After all, every successful trader was a beginner at some point. You too can learn these skills.
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Candlesticks are a way to represent price in a security. It is a type of price action trading (naked trading, no indicators).
Compared with a simple line charts which only give you the closing price for the session (week, day, hour, minute…), candlestick charts give you much more information; closing, open, high and low price for the session.
Line Chart
Candlestick Chart
Candlestick charts are great for improving your market timing.
Candlestick charting has a valuable aspect. It is visually easy to see patterns and the overall trend in the charts. This is an essential part for any technical trader to master.
In today’s trading environment you need to have a clear plan and rules on how you will trade profitably. Fortunately, the graphic picture that candlestick charting express makes it easy to take profitable actions.
One of the biggest advantages of candlestick charts is that candlesticks can be used in all time frames and when trading stocks, futures, forex and every other market that have an open, close, high and low.
The power of candlestick patterns is that they are created by the change in sentiment and crowd psychology. A green candlestick (candle) after a red candle shows that for now, the bulls are in control. A red candle after a green candle shows that in that moment, the bears are in control.
Green Candlesticks Show That Bulls Are In Control
Red Candlesticks Show That Bears Are In Control
Having the insight of change in sentiment and how traders react to price movements provides the candlestick trader with a powerful advantage.
Candlestick charting makes it easier for you to deal with the psychology of trading and feelings like greed and fear and I think candlestick trading is the best tool to achieve improvements that result in more profits for both swing and day trading.
Candlesticks techniques and strategies will give you:
- An edge in the market
- Simple and easy to understand charting
- Powerful buy signals
- Powerful sell signals
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Candlesticks can be used in all time frames and when trading stocks, futures, forex and every other market that have an open, close, high and low. If we look at a daily time frame, one candle (session) represents that day’s trading range.
Bearish And Bullish Candlesticks Explained
Above you can see how the candlestick is constructed and looks compared to a bar chart. The painted section is the candle body. The candle body is green or white if the close is higher than the open. If the close is lower than the open, the candle body is red or black.
The lines above and below the candle body are called tails or shadows. The top of the upper shadow is the session’s high and the bottom of the lower shadow is the session’s low of the day.
A sessions where the open and close have the same price, is called a doji candlestick, illustrated below.
Doji Candlestick
The doji is a candlestick where neither the buyers nor sellers control the session and, therefore, should alert us that the former trend may lose its momentum, or that the momentum is pausing and will later increase again.
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In an up or downtrend, the Doji is either an indication that the trend is about to end if traded as a reversal or an indication that the trend is only taking a pause.
Candlesticks, where the body is one-fourth of the high-low range of the candle, is a doji in our opinion, some use other names depending on where in the range the doji’s open and closing price occurs, but we recommend you keep it simple as we do.
In this strategy, we trade shorts low and cover lower, or if trading long, buy high and sell higher. We go long when the high of a doji breaks in an uptrend and we go short when the low of a doji breaks in a downtrend.
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Simple Candlestick Strategy Short Setup Before
Simple Candlestick Strategy Short Setup After
Short trades, so for us to have a setup you want:
- A doji with low at the lowest price for the recent ten candles
- The doji’s lower shadow is as long or longer than the upper shadow
- Entry when price breaks the low
- Place your stop above setup doji
- Place your target that gives you a 1:1 risk reward
Simple Candlestick Strategy Long Setup Before
Simple Candlestick Strategy Long Setup After
Long trades, so for us to have a setup you want:
- A doji with high at the highest price for the recent ten candles
- The doji’s upper shadow is as long or longer than the lower shadow
- Entry when price breaks the high
- Place your stop below setup doji
- Place your target that gives you a 1:1 risk reward
Price action and candlestick strategies are the best trading strategies and techniques you should focus on in your trading. Develop a strategy with price action in its core and you will profit and become better at market timing.
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Remember that there is no holy grail out there. There is no strategy or method that will always work, you will not earn money to take a trade when the MACD crosses, or stochastic are oversold if you do not learn how to read the market dynamics and naked charts (charts with price only) first.
Learn to read the market dynamics, i.e. the relationship between buyers and sellers and you will not need indicators to guide you. Spend your time to learn to read the market, and not mass indicators. Keep in mind that every single person can read an indicator, hence will not give you any further edge in the market.
When starting out trading, you should always learn how to read the candlestick chart first (price action), and then add indicators if you feel they help.
In some cases indicators can add value, examples can be when you use a trend indicator like the moving average that acts as support or resistance for a security in trends and you can act on that, or when you use a momentum indicator to find momentum changes (divergences) which you act on and profit.
That said, almost all technical indicators are based off either price, volume or volatility. If you know how to read price, volume or volatility in a price action candlestick chart, you do not have to rely on indicators when trading.
Before we discuss price action vs indicators and each type of support and resistance level let us define the trend.
Rising Up Trend - Bull Trend
Falling Down Trend - Bear Trend
Definition of a trend:
- In a rising trend (bull trend) tops and bottoms are rising to higher levels because there is an imbalance between supply and demand where the demand is greater than supply
- In a falling trend (bear trend) the reverse is true, tops and bottoms are falling because supply is greater than demand
- In a neutral trend supply and demand is in balance and price bounce between same price levels. Securities move in trend between these and if new highs are created the trend is up
Trend analysis is mainly an analysis of support and resistance levels created by horizontal price levels and trend lines. A security does not move in a straight direction, it moves more like waves with smaller and larger waves with tops and bottoms reacting between these horizontal levels.
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Horizontal price levels are the most powerful support and resistance levels because everyone can see them cause they are visually easy to spot. Locals tops and bottoms in a trend can be viewed as support and resistance levels. Horizontal price levels that act as support or resistance doesn’t lose importance after broken.
Resistance Level
Support Level
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A common misconception when reading the literature about technical analysis is that support and resistance levels are exact. This means that you can draw a thin line at a certain price and expect an accurate bounce at this price.
The truth is often sadly quite different. Levels are not exact and should rather be seen as a zone. The more volatile a market is, bigger the distance between the upper and lower levels of these zones. Occasionally, we have low volatility and then the zones are smaller and more precise.
When we have high volatility, the respect for support and resistance zones reduces. Zones are those spots on the chart where the price has reversed more than one time. The general rule on the strength of a zone; the larger number of people who see a zone, more important it becomes.
The strength of a zone is determined by:
- Number of hits
- How accurate it is (distance between the upper and lower level)
- The speed of the market
- How close present hits are
- If it is close to an even number i.e. 1000
- Seen in many time frames (a zone we only see in a smaller time frame, say 5min is not as strong as a zone seen in the 4h, 30min, and 5min. The larger number of people who see the zone, more important it becomes.)
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Bullish Trend Line
Trend lines are used to get a visual overview in what direction the trend is going. The lines can be used to find support and resistance levels but we don’t recommend it since there are a million ways to draw a sloping trend line and, therefore, they will not give you an accurate price level other traders and investors look at.
They are however good to use to get a warning on potential trend reversals.
A rising trend line is drawn from left to right connecting rising bottoms. You need at least two bottoms where the second is higher than the first to draw a rising trend line. A falling trend line is drawn from left to right connecting falling bottoms.
There are some generalities on trend lines. The longer the trend line is valid the more significant it becomes, trend lines drawn over several years is viewed to be more significant than a trend line drawn over a few days since the second have a higher probability of being broken.
As with support and resistance lines, the more times the line is tested the more significant it becomes. The larger trend line in the chart below is still valid while the trend lines are drawn between fewer days often breaks.
Bearish Trend Line
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Trend indicators intended use is to identify the trend. The most used trend indicator is the moving average. You can in most cases find a link between a moving average and the security. An example can be that the security signals demand pressure when price reaches a moving average and supply pressure when it is extended.
The indicator determines the trend direction from the number of periods it is calculated on. If the price is above the moving average the trend direction can be defined as up. The choice of periods determines how sensitive the moving average is. The shorter period it is calculated on the more sensitive and faster it is and reacts to new price moves.
There are a number of ways to calculate the moving average, but the two most common ones are simple and exponential moving average.
Additional popular trend following indicators includes MACD, Channel indicators, ADX and more.
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Momentum indicators intended use is to identify securities overbought and oversold areas. The definition of overbought, according to momentum indicators, is when a security rises above a price of equilibrium and becomes expensive relative to the prevailing trend.
Momentum indicators are also used to analyze the strength or speed of the trends in securities. If a security is trending and the price rises but strength or speed of the price move decrease shown by a momentum indicator, indicates a divergence and that the trend might be over.
There are a number of different momentum indicators, and almost all give you exactly the same information. RSI and Stochastic are probably the most famous momentum indicators.
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If you use more than two indicators you will probably have a hard time making trade decisions since most indicators only act as noise, since indicators often makes your trading more complicated.
One indicator might give you a buy signal, but another indicator gives you a sell signal, I hope you get the picture, do not use indicators.
Most traders put indicators on the chart because it gives them comfort, a dangerous trap. Only add one or two indicators if you really feel they make a difference.
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