Introduction to Technical Trading and Candlesticks
Welcome to the exciting world of technical trading! If you’re new to this field, don’t worry, we’ll guide you through every step of the way. In this first chapter, we’ll introduce you to the basics of technical trading and candlesticks, and explain why they are essential tools for traders.
A. Definition of Technical Trading
Technical trading is a method of analyzing securities prices and market trends to make informed investment decisions. It involves using charts and other technical indicators to identify patterns and make predictions about future price movements. Technical traders use this information to buy and sell securities, hoping to profit from short-term price swings.
B. Overview of Candlesticks
Candlesticks are a popular form of charting used in technical trading. They provide a visual representation of price movements, and are an effective way to identify patterns and make informed investment decisions.
A candlestick is comprised of four parts: the body, the upper shadow, the lower shadow, and the wick. The body represents the difference between the opening and closing prices, with the color of the body indicating the direction of the price movement. The upper and lower shadows represent the highest and lowest prices for the period, while the wick represents the difference between the closing price and the highest or lowest price.
C. Benefits of using Candlesticks in Technical Trading
Candlesticks are a valuable tool for traders because they provide a quick and easy way to analyze market trends and make informed investment decisions. By using candlesticks, traders can identify patterns and make predictions about future price movements. Additionally, candlesticks can help traders avoid emotional decision-making and make more objective investment decisions.
By the end of this article, you’ll have a solid understanding of the basics of technical trading and candlesticks, and be well on your way to becoming a successful trader. Let’s get started!
What you'll learn:
⓵ Understanding candlesticks
A. Origin and History of Candlesticks
Candlesticks have been used for technical trading for centuries, originating in Japan during the 1600s. They have since been adopted by traders all over the world and have become a staple tool in technical analysis. The simplicity and effectiveness of candlesticks have made them a popular choice for traders of all levels, from beginners to advanced traders.
B. Anatomy of a Candlestick
Understanding the anatomy of a candlestick is the foundation of technical trading. The anatomy of a candlestick consists of four key components: the body, the wick, the shadow, and the tail.
The body of a candlestick represents the difference between the opening and closing price of a stock during a specific time frame, such as a day or an hour. If the closing price is higher than the opening price, the body of the candlestick is typically drawn as a hollow rectangle, and is referred to as a “bullish” candlestick. On the other hand, if the closing price is lower than the opening price, the body is filled, and is referred to as a “bearish” candlestick.
The wick, shadow, and tail of a candlestick represent the highest and lowest prices of the stock during the same time frame. The wick is a thin line that extends from the top or bottom of the body to the highest or lowest price, representing the range of prices during that time frame. The shadow is a longer line that extends from the top or bottom of the body to the end of the wick.
By studying the anatomy of a candlestick, technical traders can gain insights into the market sentiment and price movements of a stock during a specific time frame. They can also use this information to make informed investment decisions based on the patterns formed by multiple candlesticks over time.
C. Basic Candlestick Patterns and their Significance
Candlestick patterns provide valuable insights into market sentiment and can indicate potential changes in trend. Some of the most common and significant candlestick patterns include the following:
Bullish patterns
Bullish Hammer
This is a bullish reversal pattern that is formed after a downtrend and signals a potential trend reversal to the upside. It’s called a hammer because the pattern resembles a hammer with a long lower shadow and a short body near the top of the shadow. The pattern is considered bullish because it shows that the selling pressure has diminished and buying pressure is increasing.
Bullish Engulfing
This is a bullish reversal pattern that signals the potential end of a downtrend and the beginning of an uptrend. It’s formed when a small red candle is completely engulfed by a large green candle, showing that the buying pressure has overwhelmed the selling pressure.
Bullish Harami
This is a bullish reversal pattern that is formed during a downtrend and signals a potential trend reversal to the upside. It’s formed by a large red candle followed by a small green candle that is contained within the range of the red candle.
Bullish Rising Three Methods
This is a bullish continuation pattern that signals the continuation of an uptrend. It’s formed by three consecutive green candles that each have higher closes and higher opens than the previous candle.
Bullish Three White Soldiers
This is a bullish reversal pattern that signals the potential end of a downtrend and the beginning of an uptrend. It’s formed by three consecutive long green candles that each open above the previous candle’s close and have higher closes than the previous candle.
Bearish patterns
Bearish Hanging Man
This is a bearish reversal pattern that signals the potential end of an uptrend and the beginning of a downtrend. It’s formed by a small green candle with a long lower shadow and a short body near the top of the shadow. The pattern resembles a hanging man and shows that the buying pressure is diminishing and selling pressure is increasing.
Bearish Engulfing
This is a bearish reversal pattern that signals the potential end of an uptrend and the beginning of a downtrend. It’s formed when a small green candle is completely engulfed by a large red candle, showing that the selling pressure has overwhelmed the buying pressure.
Bearish Harami Cross
This is a bearish reversal pattern that is formed during an uptrend and signals a potential trend reversal to the downside. It’s formed by a large green candle followed by a small red or doji candle that is contained within the range of the green candle.
Bearish Falling Three Methods
This is a bearish continuation pattern that signals the continuation of a downtrend. It’s formed by three consecutive red candles that each have lower closes and lower opens than the previous candle.
Bearish Three Black Crows
This is a bearish reversal pattern that signals the potential end of an uptrend and the beginning of a downtrend. It’s formed by three consecutive long red candles that each open below the previous candle’s close and have lower closes than the previous candle.
It is important to note that while candlestick patterns can provide valuable information, they should not be relied upon solely for investment decisions. They should be used in conjunction with other technical analysis tools and market data to make informed investment decisions.
D. How to Read Candlesticks: An Introduction
Candlesticks are a visual representation of a stock’s price movement over a set period of time, usually a single day. To read candlesticks, it’s important to understand the anatomy of a candlestick, including the body, wick, and shadow.
When reading candlesticks, the body represents the range between the opening and closing price for a stock. If the closing price is higher than the opening price, the body is typically drawn as a hollow rectangle (often white or green) and is referred to as a “bullish” candlestick. On the other hand, if the closing price is lower than the opening price, the body is drawn filled (black or red) and is referred to as a “bearish” candlestick.
The wicks, or shadows, represent the high and low prices for a stock during the time period represented by the candlestick. The upper wick represents the highest price the stock reached during the period, while the lower wick represents the lowest price.
By combining the information from the body and the wicks, candlesticks provide valuable insights into the overall market sentiment for a particular stock, as well as potential trends and reversals. As you gain more experience reading candlesticks, you’ll be able to identify more advanced patterns (more on this later on) and make informed investment decisions.
⓶ Advanced candlestick analysis
Candlestick patterns can be divided into two categories: bullish and bearish (reversal or continuation).
Reversal patterns
Bullish reversal patterns indicate that a downtrend is about to reverse and a new uptrend is about to start.
Bearish reversal patterns indicate that an uptrend is about to reverse and a new downtrend is about to start.
Bullish Morning Star
A bullish morning star occurs when a bearish trend is about to end and the market is about to reverse direction.
Bearish Evening Star
A bearish evening star, on the other hand, indicates a potential bearish reversal from a bullish trend.
Bullish Abandoned Baby
A bullish abandoned baby occurs when a gap up appears after a downtrend, signaling a potential reversal.
Bearish Abandoned Baby
A bearish abandoned baby happens when a gap down appears after an uptrend, indicating a potential bearish reversal.
These bullish reversal patterns can be very helpful in identifying potential reversals and can provide traders with an opportunity to enter long positions.
Continuation Patterns
In addition to reversal patterns, there are also continuation patterns. These patterns indicate that the current trend is likely to continue.
These patterns occur when a price moves in a specific direction and then consolidates before continuing in the same direction, indicating a continuation of the trend.
Bullish Meeting Lines
A bullish meeting lines pattern occurs when two or more candlesticks form with the same high and low, indicating that the bullish trend is likely to continue.
Bearish Meeting Lines
A bearish meeting lines pattern happens when two or more candlesticks form with the same high and low, indicating that the bearish trend is likely to continue.
Bullish Breakaway
A Bullish Breakaway occurs when the price of an asset suddenly spikes upward, breaking through a resistance level, and indicating a possible uptrend.
Bullish Flag
A Bullish Flag is a pattern that forms after a sharp upward move and resembles a flag on a pole. It signals a pause in the upward trend before it continues.
Bearish Flag
On the other hand, a Bearish Flag is the same pattern but occurs after a sharp downward move, signaling a pause in the downward trend before it continues.
Bullish Pennant
A Bullish Pennant is a triangular pattern that forms after a sharp upward move and signals a continuation of the uptrend.
Bearish Pennant
A Bearish Pennant is the same pattern but forms after a sharp downward move and signals a continuation of the downtrend. These patterns can be useful for traders to identify potential entry or exit points in a trend.
C. Doji and its Significance
The Doji is a very significant candlestick pattern that can indicate a potential reversal. It is formed when the opening and closing prices are the same or nearly the same. This can indicate that the market is indecisive and that a reversal is likely to occur. The Doji can be bullish or bearish depending on the previous trend and the candlesticks that follow.
D. Dark Cloud Cover and Piercing Line Patterns
The Dark Cloud Cover and Piercing Line patterns are two reversal patterns that can indicate a potential change in trend. The Dark Cloud Cover is a bearish reversal pattern that is formed when a bullish candle is followed by a bearish candle that opens above the previous close and closes below the midpoint of the previous candle. The Piercing Line pattern is a bullish reversal pattern that is formed when a bearish candle is followed by a bullish candle that opens below the previous close and closes above the midpoint of the previous candle. These patterns can be very useful in identifying potential reversals in a trend.
☞ By understanding these advanced candlestick patterns, traders can get a better understanding of market sentiment and make more informed trading decisions. It is important to keep in mind that while candlesticks can provide valuable information, they should not be the sole basis for a trading decision. It is always important to consider other factors such as market trends, economic data, and news events when making a trade.
