What are candlestick patterns and how to use them to trade stocks? - part 2


What are candlestick patterns and how to use them to trade stocks?

 In the previous post we learned about how to read candle stick. A candlestick will show you who is in control of the market, the buyer or the sellers. What you need to do is look at the body and the wick and the body relative to the wick. Now, I am gonna discuss about candlestick timeframes:

Candlestick time frames:

 In the above picture you will see a lot of green and red bars. Each bar represents the movement of stock price in a particular time frame. The time frame can be one hour or one day, depending on which timeframe chart you see.

Suppose you are seeing a 60 min candlestick chart, it means, one bar will give you information about the opening price at the start of that hour, the highest or lowest price of that hour and the closing price at the end of the hour.

However, when you see these charts, many times it doesn't make sense as to what is happening in the market and therefore, you might need to combine the candlestick patterns.

Combining candlestick charts:


The above figure represents how two candlestick patterns can be combined. The two candlestick patterns are made in 1 hour each and to gain more clarity we are combining the two candlesticks. Now observe closely, since the first candlestick is green, the opening price will be the lower part of the body of the first candlestick. The second candlestick is red, i.e. prices have fallen and therefore, the closing price at the 2hour session will be the lower part of the body of the 2nd candlestick. This, clearly shows us now, that the sellers are in full control and they are rejecting the high prices.

So you combine these charts to gain clarity of what is happening. The same process can be applied and we can make use of 4 hour charts, 8 hour charts. So the focus here is on understanding the big picture.

Now, you can't just trade with candlestick in isolation i.e. if you see three green candlestick, it doesn't mean the market is bullish, if there are red candlesticks doesn't mean market is bearish. So you can't go short or long in the market just by seeing candlestick by itself in isolation. So the question now is how to trade candlestick patterns. Well, there is a T.A.E. framework which i learned from Rayner Teo which means trend , area of value and entry trigger. Candlestick patterns are very powerful tool to gauge entry trigger to a trade. We will learn about this further, but let's first learn about some common candlestick patterns you should know about.

Engulfing Patterns:

The bullish engulfing patterns are very important to identify market reversals. In an engulfing pattern the body of the new candlestick engulfs the body of the previous candlestick and helps to identify which party has the sign of strength. In case one, you can see that the buyers came in the market and bought so much that they reversed the fall in prices sellers had made. Clearly in case 1 the buyers are in control. In the same way, in case 2, when the buyers increased the prices, suddenly sellers came into the market and kept selling that they reduced the price of the stock below the opening of previous candlestick, clearly in case 2 buyers took over the control. Scenario in case 1 and case 2 are called bullish engulfing pattern and bearish engulfing pattern respectively.

The hammer and the shooting star pattern


These patterns help you to identify the rejection of prices. The hammer and shooting star patterns are actually the opposite of each other. The hammer patten shows that the prices had fallen a lot but the buyers took control and the prices went back up, this shows the rejection of lower prices for the stock. The shooting star pattern shows that the buyers had increased the price a lot but then the sellers took control and sold so much that the prices ended up lower at the end of the session. The shooting star therefore, represents, that there is a rejection of higher prices for the stock. Take your time to absorb this info and I will be coming with part - 3 of the series on Tuesday.

Thanks for reading!

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Comment on any query you had like me to address.

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