Hello traders! This week’s newsletter will be a short lesson on candlestick stock charts and how to use them for hints on your trades.
First of all, Japanese candlesticks were first invented in Japan hundreds of years ago to try and predict the future price of rice. The interpretation of candlesticks is very fast and efficient, which is why they have remained so popular even in this day and age. There are dozens and dozens of different patterns that exist in the world of candlesticks. I plan on giving you an easy way to interpret the very basics of them to help with your trading.
Every candlestick shows us four data points, the open (first trade in the time period), the high (highest trade in the time period), low (lowest trade in the time period and the close (last trade in the time period). Of these four data points, each is important in its own way, but for this technique we are more interested in the close.
In the following image, you can see that I’ve marked two different candles with blue arrows, One and Two. I’ve also broken down these candles into five equal parts – quintiles. I look at where the candle closes within this range of quintiles to give me a bias of, from very bearish to very bullish.
If the candle closes in the highest quintile, that is very bullish (meaning a strong bias to higher prices).
If the candle closes in the next lower quintile, that is bullish (meaning a bias to higher prices).
If the candle closes in the middle quintile, the bias is neutral.
If the candle closes in the next lower quintile, that is bearish (meaning a bias to lower prices).
If the candle closes in the lowest quintile, that is very bearish (meaning a strong bias to lower prices).
So, on the candle labeled One, it closed in the top quintile giving a very bullish bias/hint for what will happen in the next candle. Lo and behold, the next went up as well! As you look at each of the following green bodied candles, you can see that bullish bias held until the move was nearly complete.
On the candle labeled Two, it closed in the lowest quintile, giving a very bearish bias/hint for what will happen in the next candle. Lo and behold, the next candle went down as well!
Notice the following large red candle closed near the very bottom of its range as well, but the next candle obviously didn’t continue down. Location on the chart is more important than the shape of the candle. What this means is that a very bearish candle after a long move down is much less important than after a long move up! On the other side of the coin, a very bullish candle after a long move up is much less important than after a long move down!
So how can we use this information? On the following image, I have put on two charts of the USDCAD. The chart on the left is a daily chart with the very bearish candle from September 3 marked in.
Notice we already had a move up from about 1.3020 to 1.3380 over a period of six weeks or so. The upward trend seems to be getting tired, the Sept 2 and 3 closing prices are indicating a bearish bias. On Sept 4, price traded below the Sept 3 low, indicating the bears are finally taking over. The plan would be to then go short in a smaller time frame supply zone.
The breakdown is, look for a bearish close after a move up into supply, drill down to a smaller time frame to find a supply zone for a short entry. Look for a bullish close after a move down into demand, drill down to a smaller time frame to find a demand zone for a long entry.