What are candlestick patterns and how to use them to trade stocks? - part 4


What are candlestick patterns and how to use them to trade stocks? - part 4

This is the last part of the series and we will be learning today the applications of candlestick patterns using the T.A.E. framework as used by the exceptional trader Rayner Teo. 

What is the T.A.E. framework?

The T.A.E. framework includes 3 aspects:
  1. The trend: First of all, it is important to know how the market is moving, which can be tracked by 200MA (a usual standard). 200MA is nothing but a 200 days moving average of the price of the particular stock. It is very easy to understand with the help of moving average whether there is an uptrend or a downtrend. If the price is above the 200 days moving average, you will have a long bias. A long bias means that you aim to purchase the stock in expectation of prices to rise and sell at the higher price. In similar fashion, if the price is below 200 days moving average, then you will have a short bias i.e. you will be selling the stock prior with the expectation that prices will fall and then you can buy at a lower price later.
  2. The Area of Value: It is crucial to trade from an area of value. When you trade, you pay transaction fee on every trade. You need to therefore, trade in such way that don't end up getting losses and also paying transaction fee. What can be an area of value? An area of value can be:
    1. A support/resistance: Support refers to that stock price below which the company rarely goes and resistance refers to that stock price which the stock is not able to overcome in uptrend and usually there is a reversal at that price.
    2. Moving Average: The moving average is a simple way of technical analysis wherein a 20-30 period moving average can be used in order to trade in short term and a 100 plus period can be used if you are a long term investor.
    3. Trendline: Trendlines also known as bounding lines connect the highs or lows in the stock's price history, which makes it easier to identify the current trend and predict the future prices of the stock.
    4. Channel: A price channel  is a chart pattern that graphically depicts the peaks and troughs of a security's price over a period of time. If there is an observable symmetry in the oscillation, then it is considered to be a valid price channel that can be used as a tool for analyzing stocks.

  3. The Entry Trigger: These are the triggers that show up in the market, which helps us to identify when to enter in the market and when to exit. It is at this place we use the different candlestick patterns like engulfing pattern or the top and bottom tweezers.
Once you understand the above 3 aspects, you can trade keeping all of the above 3 aspects in mind, instead of haphazardly trading with just candlestick patterns alone.

Before we get to examples, You must know 1 thing, it is not possible to have 100% winning trades. In real-life scenario, if you do well, you will have somewhere around 50-60% winning trades and 50-40% losing trades and that's just the part of the trading game.

Let's get started:

Example 1:


In the above candlestick chart of Reliance Industries, let's use the T.A.E. framework to make a winning trade. Let's first analyze the trend. Is it upward or downward? Upward right. The area of value can be the trend line. If you draw a straight line with the lows in the stock price's history, you will observe there is an uptrend. Now you need to look for an entry trigger. Observe closely in the encircled area, there is a formation of hammer curve three times, which is a strong indication of rejection of lower prices by the market and therefore, it is the right time to enter the market to make some serious gains by selling at higher price later.

Example 2:
This is the candlestick chart of Dr Reddy's Laboratories. Observe at the top of the graph, I have drawn a line, which represents the resistance level. The stock price has touched the resistance level 5 times but has not been able to overcome the resistance level. Now look closely inside the encircled area. This a an engulfing pattern which represents that the sellers are in strong control of the market and the market is bearish. Also observe the wick of the green candlestick in the encircled area. It shows that the buyers increased the price till the resistance level but sellers came in and prices were dropped, which shows resistance of higher prices again. A short bias is what you should be expected to have.


I hope you enjoyed this series and I look forward to you guys making use of these techniques to trade stocks in real life.

Thanks for reading!

For the latest updates follow @rdhmfinance on Instagram!

Comment on any query you had like me to address.

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