Hello and Welcome to the ditto educational series that will provide you with the skills you need to become a forex trader!
Today we will be taking a deeper look into candlesticks and what their behaviour maybe interpreted as, this will help to aid in your market analysis and strengthen your existing knowledge surrounding the topic.
Candlestick chart analysis is dependent on your preferred trading strategy and time-frame. Different strategies attempt to take advantage of candle formations while others attempt to recognise price patterns.
How we Interpret single candle formations or Individual candlesticks can offer us insight into current market sentiment. Large market indicators like the Hammer formation, shooting star, and hanging man, offer glimpses as to shifts in momentum and potentially where the market prices range or trend.
As we can see here a Hammer candlestick formation can be indicative of a reversal in trend.The properties that make it a hammer candle formation are a long lower wick with a small body. Note as well that the closing price is above the opening price.
The explanation behind the hammer forming is, price attempted to decline but buyers entered the market which pushed the price back up. We perceive this As a bullish or buy signal to enter the market, additionally if we had short positions in the market at this time we may look at exiting or moving our stop losses tighter to ensure our profits against a potential reversal.
So with this in mind we can look to take advantage of the hammer formations by in this instance taking a buy trade once the hammer candle has closed. It must close in order to be a hammer candlestick as you may find the formation could change over time.
The advantages of trading this way are the ability to use a tighter stop loss as these formations are recognised by all traders as higher probability.
Price patterns in multiple candlesticks!
Candlestick charts help us discern price patterns that occur in the charts. Being able to identify patterns such as the bullish engulfing pattern or triangle patterns can aid us in identifying entry or exit signals in the market.
Here we have a bullish engulfing price pattern. The bullish engulfing is a combination of both a red candle and a green candle that engulfs the entire red candle. It is an indication that it could be the end of a currency pairs established weakness so a potential reversal is at hand.
A trader would take advantage of this by entering a long position after the green candle closes. Again we must wait For the second candle to close for positive identification.
Exactly like the hammer formation, we can now place a tight stop loss below the established pattern and use proper risk to reward ratios in our set up.
The two most common market behaviours are trending and ranging. Either we will have a range bound market with price bouncing off support and resistance like so or The other market behaviour we commonly see is markets trend with price showing higher highs and higher lows in an uptrend or the opposite is true in a downtrend.
Firstly we will want to identify which of the two we are looking at and then secondly we implement these important rules surrounding trade entry.
When in a range bound market, we want to focus on candlestick formations or patterns near support or resistance for entries, this is something we have discussed previously. Support and resistance can be identified by eyeing price action ceiling and floors or by adding indicators such as Pivot Points to our charts.
When in a trending market, we want to focus on candlestick formations or patterns near pull backs in the direction of the trend for entries. Something we have discussed surrounding Fibonacci and trend lines. Various moving averages can also be implemented including the popular 200 MA and candlestick behaviour around this should be keenly observed.
Wicks as an indicator!
Next we will look at wicks as an indicator. Note here how the market behaves surrounding the longer wicks. Also note that after the formation of a long wick, price will tend to move in the opposite direction of the established long wick. The moves maybe temporary or long term like in the continuation of a trend.
These extended wicks that are longer relative to other wicks on the chart, provide valuable indications for us as traders.
The explanation of the behaviour of market participants that result in long wicks is, sellers were able to push the price down significantly at one stage However, the seller’s numbers were not great enough to keep the price at that low level during the formation o the candle. The buyers were able to push price back up from that low level which shows strength. This rejection shows potential market strength and should be read as such.
When trading using long wicks we must first take note of the Daily trend. If the trend is bearish and we see a candle or multiple candles with long wicks on the top, this indicates a higher probability for price to move down in the direction that the market has been trending.
When the pair retraces against the trend and stalls at a level of resistance or a Fib level or any other indicating level, We will be looking for long wicks at the tops of the candles forming along that resistance line for two reasons.
Firstly the long wicks indicate the potential for the pair to trade to the downside back in the direction of the Daily trend. Secondly The tops of that extended wick or wicks provide us with a solid level to place our stop just beyond.
In summary candlesticks are a powerful addition to our trading analysis. To understand the behaviour of candlesticks is to understand the market participants and potential outcomes of market direction. Please take the time to analyse and contemplate what you have learned here today and as always contemplation is the key to learning.