Reblog: Candlesticks – Forget Candlestick Patterns – This is All You Need To Know
Understanding candlestick patterns goes far beyond just remembering and recognizing certain formations. Many books have been written about candlestick patterns, featuring hundreds of different formations that supposedly provide secret information about what is going to happen next.
Truth be told, it will make no difference to your trading performance whether you know what the Concealing Baby Swallow, Three Black Crows or Unique Three River Bottom are.
What really matters is that you understand what the candlesticks in front you of you tell you about price structure, trend strength, buyer/seller dynamic and the likely path for future price movements.
The 4 elements of a candlestick
Step 1: The candlestick war
Before we start getting into the actual elements of candlesticks, it’s important that you are in the right mindset.
Let’s think about price movements like a war between bulls and bears. Every candlestick is a single battle in an overall war and the 5 elements of the candlestick tell us who is ahead, who is pulling back, who is in control and who has a better chance of winning the next battle.
Step 2: It’s all about context
It’s crucial to understand that candlesticks cannot be observed alone, in a vacuum. A candlestick always must be analyzed in the context of what has happened in the past. So, whenever we try to analyze a candlestick or a formation, we need to ask ourselves those questions:
- The current candlestick larger or smaller than previous ones?
- Is the size changing meaningfully or not?
- Is the change happening during an inactive trading period? For example, candlesticks on EUR Forex pairs tend to shrink in size during the quieter Asian session.
This is a good starting point because it helps us avoid the closed mindset thinking which limits many traders. Now we can start exploring the 4 elements:
Element 1: The size of the body
The candle body is a great starting point because we can get a lot of information from it.
- A long body is showing strength
- When bodies become larger, it shows an increase in momentum
- When bodies become smaller, it shows slowing momentum
The body shows how far price has traveled over the duration of the candle.
Element 2: The length of wicks
Wicks can show the volatility of price movements.
- Larger wicks show that price has moved a lot during the duration of the candle but it got rejected
- When candle wicks become larger it shows an increase in volatility. This often happens after long trending phases before a reversal happens. Or at major support and resistance levels.
Element 3: The ratio between wicks and bodies
Now can start slowly putting it together.
- Do you see longer wicks or bodies?
- In a high momentum trend, you can often see long bodies with small wicks
- When uncertainty rises, the volatility picks up and bodies become smaller while wicks become larger
Element 4: The position of the body
This is an extension of the previous point.
- Can you see a long wick with a body on the opposite side? This is often showing a rejection
- When you have a small body in the middle of a candle with long wicks, it means indecision
You can see that once we start combining the information that wicks and bodies provide, we can practically analyze all candlestick formations.
Now that we have covered the individual elements, we can put things together and see how we can use our knowledge to dissect price charts.
Let’s follow price in the chart below and I share what we are seeing here in the candlesticks:
- During the downtrend, the candlesticks are only red (bearish) and long with very small or no wicks >> this shows strength
- At the bottom, we see a rejection. This is not enough yet to call a reversal but on the next candle we then start seeing bullish candles
Below we see a typical range behavior and we can see how the candles tell us what is going on:
- Price trends lower on the left with strong bearish candles and no bullish candles in between
- Then suddenly the bodies become smaller and the wicks longer, showing that the momentum is fading
- Price trades back into a previous support and it now becomes resistance and we see a small rejection candle
- At the support of the range, we see that candles are becoming smaller and have more wicks, confirming the indecision. It also makes a break of the support unlikely
- Just before the support breaks, price is only starting to make bearish candles and we can see how momentum is picking up
In the final example, we can see a classic pattern at the end of a trend. This is also often one of the building blocks to the trading strategy which you can learn in our pro area.
- During the uptrend, the candles are very long and have very small wicks only
- Then suddenly we see two long wicks to the downside. This shows that price tried to push lower but it did not yet have enough selling pressure
- But the candles are becoming smaller and smaller after the failed sell-off attempt which indicates that the trend is running out of steam
- Then suddenly we see a strong bearish candle which confirms the new downtrend
Conclusion: No Need For Candlestick Patterns
With this article we want to show you that you do not have to remember any candlestick formation to understand price. Quite the opposite. It’s very important on your path to becoming a professional and profitable trader that you start thinking outside the box and avoid the common beginner mistakes. Learn how to understand how buyers and sellers push price, who is in control and who is losing control.
The original article appears on Tradeciety.com and is available here.