Last updated on November 12th, 2016
Japanese Candlesticks Are Not Just A Pretty Color
When new potential traders enter the trading world, one of the first things they are exposed to is an indicator. Cruise any forum where someone has an indicator on the chart and usually one of the first question is “what is it and what are the settings”. It is not as if an indicator moves the market!
After beating their heads against the wall, a few traders look at what the market is….a battle between bulls and bears. No, not the animals (although some traders can be quite aggressive) but real people with real emotions and thoughts about the market and current price. If you can zero in on what the masses are thinking/feeling, you certainly have an edge in your trading. Now, this is not something you can learn in a month or two. This is something that takes a long time and time in the market to get a handle on. I live and breathe trader psychology and am still working through it. It is a never ending process but is an amazing ride.
To show an example, I am going to use a simple candlestick, why it formed and what the expectation can be.
Here we have a daily hammer candle marked #1 at the top of an uptrend. You can clearly see it is green which simply means that the day closed higher than it opened. The bulls (longs) eventually won on this day.
But what else does this candle tell us?
While price closed above the open, it fell during the trading day. Wait! This was an uptrend on the daily and by the looks of the bottom shadow, price fell pretty far. As a matter of fact, that shadow is bigger than the body.
Let us put our thinking caps on.
If the bulls were solidly in charge, we would not expect such a long shadow. Sure, they pushed price back up to close up on the day but to absorb the shorts, it clearly took a lot of work. IF the trend was strong, the bulls would not have to come in at such an extreme to push it back up and STILL close off the high of the day.
This is a clear sign that the trend is in danger of ending. Astute traders would understand this and perhaps make a case for getting ready to sell this market. I say perhaps because they would take it in the context in which it presents itself. Is it near support/resistance? How were the candles that came before this one? Each trader would have their own way of looking at it. I know one trader that when faced with this type of candle on the daily chart, will put in a trend line on the daily and look for the break and trade the retrace on a lower time frame chart.
The key take-away is don’t just look at candlesticks as pretty colors on your chart. Look at them as a summary of how the day unfolded and then draw your conclusions on what that could mean using logic.
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