Learn How to Use Candlesticks to Stay Ahead of the Market
While many traders are using candles (which is gratifying considering all the expense and years of research I put into uncovering these “Secrets of the Orient”), from my experience many are using them incorrectly.
There are a lot of misunderstandings and misuses of candles. For instance one of the secrets to using candles correctly is that candles are a tool- they are not a trading system. Buying or selling on every candle signal – and this includes testing on only candle signals – is, as the Japanese proverb says, “like leaning a ladder against the clouds.”
With the above in mind, I will discuss one of the ways to enhance your use of candles by using trade management. Trade management includes risk-reward analysis, stops, looking at the overall technical picture and many other aspects that I detail in my more comprehensive educational resources. One of these trade management items is adapting to changing market conditions. This concept is the focus of this article.
As a chameleon changes its color according to its surroundings so traders should change their market stance adapting to what the market is telling us. Like the cartoon below there are some slow to adapt.
The most successful traders adapt quickly to the market’s clues. And candles, once you know how to read them correctly, will let you quickly and accurately read the “mood and manner” of the market so that you can often get into a trade before other traders jump on the new move. That is the power of the candles – letting you quickly adapt to the clues the markets send out.
As shown in the chart in early January of the cash S&P there was a classic bullish engulfing pattern in which a white real body envelopes a prior black real body (see exhibit of this pattern).
This relatively large white candle compared to the much smaller (almost a doji) black candle graphically reflected the bulls had overwhelmed the bears. Another aspect which underscored the importance of this pattern was the very long bullish shadows. These extended long lower shadows visually displayed a strong rejection of lower prices.
It’s amazing how much more information we get about who is winning the battle between the bulls and bears with candles than with a bar chart – although they both use the same open, high, low and close data!
Most of the candle patterns (but not all) can be used as support or resistance. And the lowest low of the two sessions that make up the bullish engulfing pattern is one of those patterns we can use as support (based on a close). And note how the lows of this pattern held at the green arrow in mid March.
Now here’s where being a market chameleon comes into play. On the day of the Bear Stearns collapse the S&P broke under the support of the bullish engulfing pattern- but what happened by the end of that day? Right – the bears couldn’t keep prices under that support. So the market was able to shrug off the extremely bearish news.
As Bernard Baruch said “It is not the news itself, but the market’s reaction to the news that’s important.” And this was an important sign of a potential major low since the market both shrugged off very bearish news and held the support, on a close, of the bullish engulfing pattern.
So for anyone who sold on the break under the support during the day of the Bear Stearns news should have adapted their stance by the end of the day to exit because the support at the bullish engulfing pattern held rock solid. And for those flat on that day it was a golden opportunity to buy using the lows of the Bear Stearns news as a stop and a target to the top end of the trading range (what the Japanese call a “box” range) near 1400.
So in this brief article we touched on how candles should not be used in isolation (this is why all the Western tools you learn can be added to candles), how we can use some candle signals as support, why the market’s reaction to news can be just as important, if not moresoe, than the news itself.
May the candles light your way to greater profits!
Steve Nison, CMT is the founder and president of www.candlecharts.com. Steve has the distinction of introducing the previously secret candlestick technique to the Western world. He is also an expert on Western technical analysis with over 30 years of real world experience. He has presented his trading strategies in over 20 countries to traders from almost every investment firm and been a guest speaker at numerous universities as well as the World Bank and the Federal Reserve.
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