As soon as I saw a candlestick chart, I was hooked. Percentages and numbers are great, but a picture paints a thousand words…cliché? Yea, but it’s true. You can read a candlestick chart from across a room. Yep, I love candlestick charts.
Candlestick charts are an important and valuable tool of technical analysis. Many traders use candlesticks to help identify turning or continuation areas on a chart. Some traders execute trades based purely on candlestick setups.
In this post, you’ll learn how I successfully use candlestick charts. You’ll also learn, not all candles are equal. One, in particular, has a very special skill.
Reading A Candlestick
Okay, I know you probably know how to read a candlestick. But understanding what the color, real body, and wick means are all mission-critical. If you’re foggy about what any of these mean, you’ll miss the subtleties of the message later in this post.
So for those that have any doubts, this is elementary stuff, and you’ll be a pro in jig time. Here goes!
The Color – Candles employ two colors to convey price moving lower or higher. Most modern charts use Red (lower) and Green (higher). (Older charts may use black for lower and white for higher).
The color red means the price moved lower and then closed lower for the period. The color green means the price moved higher and closed higher for the period.
- Real Body – The real body is the colored body of the candle.
- The low of a green candle is the open and the high is the close.
- The high of a red candle is the open and the low is the close.
The Wick – The wick marks the high and low in the price for the period.
3 Important Candle Types
There are a ton of different candles. The truth is I don’t read them all. In my experience, three are more important than others. In this section, I’ll highlight the candles I use. I’ll explain what they tell me about price and how I use them to read charts.
Engulfing – The engulfing candle is as its name suggests. It’s a candle that overshadows the previous candle. The engulfing candle’s real body engulfs the previous candle’s real body and wick. This is a show of strength and is a sign momentum favors the direction of the engulfing candle.
Inside Candle – The inside candle is just the opposite of the engulfing candle. I told you this was easy! It’s a candle that’s contained by the previous larger candle. Color is unimportant. It shows consolidation, and several inside candles are often found grouped together. Each contained by the previous larger candle. This type of setup usually ends with an explosive type move.
Long-tail – The longtail candle is a very special candle. By far, in my experience, the most important and useful candle. Longtail candles are characterized by their long tails relative to their short bodies. The tail tells the tale of a struggle between buyers and sellers.
The candle plays out like this. The losing party lacks conviction. Their numbers dry up. This causes a vacuum for the greater number of winners to push prices in their favor. The result is a long-tailed candle and is important as it often marks the start of a new trend.
Longtail candles are powerful areas. You’ll often find the market turns or stumbles at previous long tail candles. This is the only candle I use to enter a position, but I don’t use it in isolation. See below.
If you need more info on the longtail candle checks out this post, “How to trade long tail candles.”
How I Use Candlestick Charts
I use longtail candles a ton. They help me identify areas of support and resistance and also make a buy or sell decision. I’ve been using them for years and have faith in their ability to mark an important area on a chart.
I don’t trade them in isolation. I wouldn’t find that comfortable. Traders come in many different flavors. We all develop our style of trading. That’s what makes a market.
I approach trading from the fundamental side. You know, I develop a mental model of where I believe we are in the economic cycle, who’s ahead, and who’s behind in the race if you like.
Having a baseline allows me to play things out and make estimations of what I expect could happen. This allows me to look for particular setups in the charts, and that’s where the candles get their chance to shine.
Here’s how I developed a basic trade idea.
Consider the following. News flow from country A’s economy is generally positive (less horrible) than other countries. Company earnings are solid, employment and retail sales are excellent.
Country A’s central banks had voted to leave interest rates unchanged. However, some central bankers had concerns about inflation as commodity prices had moved significantly higher. All things considered, country A’s economy was expanding nicely.
Consider this type of news flow and compare it against country B, whose economy shows little in the way of expansion, unemployment stubbornly high, retail sales flat, no sign of inflation. It’s not hard to imagine how country A’s currency would be worth more than country B’s.
You can easily make the argument that rates would soon start to move higher in country A, and that leads to an increase in the currency value.
I accept this is a simplistic view of the world and many more factors that affect a country’s currency, but you get the point. I develop a view of where I think the currency is going, and that’s important.
Support & Resistance
I’ll check the cross rates of countries A and B. I’ll mark the strongest support and resistance zones. You know how this goes, old highs/lows, round numbers, MA touches, and peaks/troughs. Marking all these zones will help highlight areas where trade may present itself.
Watching the chart, I pay special attention to longtail candles that develop around support areas. Longtails help me make an entry decision. Trading comes with no guarantees. Before I enter a trade, I have an exit zone in mind, both on the upside and importantly on the downside.
Longtails that develop around a resistance zone can help you exit a trade too.
Longtail candles are distinctive. You won’t need to measure the tail. As a rough guide, in my experience, if you are questioning it – then it’s not a long tail candle.
If you need more info on the longtail candle, check out this post, “How to trade long tail candles.”
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