Candlestick
Fundamentals
Japanese
Candlesticks are a method of following market price
action and identifying market reversal points and trends.
Some people have tried to trivialize the technique -
but I believe the more you know about them, the better
you will become at trading with them. I explain it like
learning a language. If you only learn five words -
you won't be able to speak and understand the language
well - right? If you learn to speak and understand the
entire language base, then you will be fluent in it
- and thus be able to use it more effectively.
The
same thing applies to candlesticks. The more you know
and the more you practice, the better you will become
at using them. "Reading a candlestick chart"
is something that comes after much experience with them
- I call it the "Grasshopper Effect". After
sometime, my clients contact me and normally say "It's
Great! I see what you are saying now". This is
when they have achieved a level of understand that allows
them to "see the chart in TOTALITY" - they
are able to see everything and how it all inter-relates.
This is the ultimate goal of most traders - where they
will get the most out of using candlesticks.
To
get to this level, beginners must start with the basics
and build upon this foundation to achieve a higher level
of understanding. Let me start by explaing some of the
basics..
Candlestick Basics (for beginners) |
White
Candles are also called "Empty"
candles.
Black Candles are also called "Filled"
candles.
The open~close range is call the "Body"
of the candle.
The upper and lower wicks on the candle
are called the "Upper Shadow"
and "Lower Shadow".
Dojis are generall any small ranged bar
where the open~close range is equal or very
close to one another.
True Dojis are when the open = the close.
Dojis are a sign of
congestion/weakness in the markets.
The body of all Dojis are support/resistance.
Size, Shape and Location are key factors
when analysing candlesticks.
Size - shows the strength
of the move. A larger candle shows more
strength than a smaller candle.
Shape - different candle
shapes (patterns) provide clues as to the
potential future moves in the market.
Location - where the pattern
forms can help determine the potential future
market moves.
Candlestick patterns are the basis of the
Japanese candlestick technique. We use the
patterns as clues to the future of the market
movement. The trick is to NOT concentrate
on just one or two patterns, but to "read
the entire chart". For example, if
a BUY signal formed today, we would want
to review the entire chart (most recent
activity - 3 months or so) for other clues
to the potential future moves in this chart.
|
|
The
next level of analysis (for intermediate level users)
is to blend (or filter) Western Technical indicators
into the candlestick analysis. This process is somewhat
simple, it requires the users to be familliar with technical
indicators and their actions/reactions to price movement
on the chart.
Ideally,
when we find a potential "trigger" (buy or
sell), we should review the candlestick chart for other
patterns that help confirm or deny the current signal.
At the same time, we should look at the technical indicators
for signs of strength or weakness in this signal. We
want to find triggers that are "timed" well
with our technical indicator levels/conditions.
Another
important fact is to review a longer term chart (normally
a weekly chart for end-of-day traders), for other signs
of strength or weakness. For example, if the weekly
chart also shows a buy signal with good technical indicator
conditions, we may have found a really strong contender.
But if the weekly chart shows weekness or the technical
indicators are not "timed" with this buy signal,
then we may have only found a short-term "pop"
in the market.
Candlestick Theory for Intermediate
Level Users |
Identify
the candlestick pattern, then look for conditional
"timed" setups in the technical
indicators.
Remember to review the rest of the chart
for other clues.. Try to find support/resistance
(dojis) and other clues to help support
this signal.
Now, use the longer-term chart to provide
further confirmation of this potential.
Don't
try to force the trade. Let the trade come
to you - be patient.
|
|
At
this point, we are getting into some of the more advanced
topics of candlesticks. This is for people who already
have experience with them and have mastered most of
the basic skills. This next section is designed to help
those people who need more than the basics above.
These
advanced topics are partially from my own experience
with candlesticks and the markets.
Candlestick Theory for Advanced
Level Users |
Follow
the longer term charts
It is best to follow longer term charts
(weekly for end-of-day traders and 15, 30,
60 minute for intra-day traders) to identify
longer term trends. Then fall back to the
shorter time frame (Daily for end-of-day
traders and less then 15 minute for intra-day
traders) to execute trades. In other words,
never loose focus of the overall market
trends. The reason everyone needs to follow
the longer-term trends is simple - you need
to know what direction the market is moving.
The shorter term charts focus on the "mirco
trends". The longer term charts focus
on the overall trends. Blend the two together
for the best view.
Use
Risk Management to Protect Your Trades
Use
appropriate risk management when trading.
Don't trade out of fear or greed. Wait for
the trades to come to you and execute a
"smart" trading plan.
Know
what to do at all times
Know
what will happen before it happens. In other
words, know what to do if your decision
is correct and know what to do if your decision
is wrong. Have a plan and use it. The most
important factor here is "what to do
if you're wrong"
Identify
targets and have an "Exit Plan"
Identify
a profit target or projected target level.
If you buy a stock, know where you think
it will go, then plan an exit strategy at
(or near) that level.
Example:
Let's
say I purchased 500 share of XYZ at
$13 off a buy signal. I should know
exactly what to expect if I'm wrong
or right about this trade. If I'm
wrong, My $0.50 stop will protect
me from extended loss. If, I'm right,
my initial target will be $14.50 (where
I'll probably sell 300~400 shares).
At this target, I'll move my stop
above my entry price and continue
to trail the stop higher as the stock
trends. |
This
is the type of "plan" you should
have for all your trades. The only thing
you want to leave to chance is the price
action. You should know exactly what to
do in any event within your trade.
Time
your Entry Trades to Maximize Profits and
Minimize Risk
Time your entry trades. You don't have to
just use market orders to enter trades.
Let's say you see a buy signal on the weekly
chart, but see some weakness on the daily
chart (or market volatility - up and down
swings in price). You could enter a MARKET
order and your STOP to enter the trade,
or you could try to "time" the
entry using a LIMIT order and a stop.
Example:
Let's
say I wanted purchased 500 share of
XYZ at off a buy signal (say it closed
at $13). If I see some potential for
a better entry price (below $13),
I might try to use a LIMIT order to
enter the trade. Say I place a limit
order to buy 500 shares of XYZ @ $12.75.
If, I'm correct, I'll have cut my
risk in half and added $0.25 to my
potential profit target. If I'm wrong,
I might have to get in at a higher
price. |
You
can see how, if properly used, this technique
can help you maximize your potential. The
drawback to this is then you were right
and the market just runs. Then, you might
have to get in with a market order (after
canceling your limit order).
Don't
leave exposed profits on the table
If you entered a trade and it is moving
in your direction, use a trailing stop to
find the best place to protect your trade.
I like to use DOJIS and support/resistance
for these levels. Here are some hints...
After
my trades move in my favor, I try
to find the best place to move my
stop to breakeven or better. Normally,
you have to see a decent price move
before you can safely do this.
After
moving higher, I might try to move
my stop above breakeven (to try to
lock in profits).
If
the stock reaches your initial target,
liquidate 50+% of the trade (you've
achieved your goal - a profitable
trade). Now, move your stop to lock
in the rest.
At
the first sign of weakness (especially
if your target has been reached),
move your stop to protect against
a pullback. Think of it this way,
better to place a tighter stop and
lock in profits, than leave it unprotected.
So what if it gets stopped out, you
made a profit and will get the next
one.
|
|
|
CONTINUE
|