Tag Archives: Candlestick Patterns

Better than Candlestick Patterns – Part One

The key learning point from candlestick patterns is that (assuming you’ve been taught correctly) it teaches you to read the sentiment within the pattern; how the battle between the bulls and the bears is playing out and which is the dominant force.

This concept is then applied to a dozen or so patterns. And provided the patterns are then considered within the context of the background market action, they can provide a good indicator of potential reversal.

Here’s the problem though… you only learn to apply this concept to those dozen or so patterns. If those text-book patterns don’t display on the screen, you’re lost.

A better approach is learning to read the sentiment of EVERY candle or group of candles.

We are not reliant then on fixed text-book patterns.

Let’s look at how I read the short-term sentiment of the current candle, or group of candles.

Let’s learn how to read candles in a way that I consider vastly superior to standard candlestick analysis.

(more…)

Candlestick Pattern Win Percentages

From time to time I receive a question at www.YourTradingCoach.com asking the winning percentages, or accuracy rates, for each of the individual candlestick patterns.

It’s a reasonable question. The trader is hoping that by establishing the probabilities of success or failure, they can then focus more on the higher probability patterns and minimise their exposure to losses.

In fact, I remember wondering this myself when I first learnt the various candlestick patterns.

The simple answer is that I don’t have any ‘percentage success rate’ figures which I can share.

However, the more accurate answer is a little more complicated.

Essentially, I believe the question is wrong, and any winning percentage figures that you may obtain through other sources have questionable value.

Let’s look at some of the factors which I believe render the data useless.

(1) Past samples of data are not necessarily representative of future samples of data. Of course, any fan of mechanical systems and backtesting may disagree with this, which is fine (the remainder of the factors discussed below should be sufficient to convince you that any published success rates are worthless)

This is a huge topic, certainly worthy of a full article on its own. For now though, let’s just consider this. Although the sample sizes used in producing these statistics are usually in the thousands, there will be significant variability in winning percentages between subsets of the sample. Break the sample into subsets of twenty trades, for example. All results will vary somewhere between the worst group of 20 and the best group of 20. And typically, this will be quite a range of results.

The reality of trading is that your first live sample of 20 trades for each pattern is potentially going to be worse than the average figure. Hopefully not at the lower end of the range, but certainly there’s a good likelihood of worse than average

I don’t know of many novice traders (actually, none) who would be willing to continue testing the concept beyond 20 trades, when results are not matching what was (in their opinion) promised.

The nature of the market is ‘uncertainty’. The historical probability of pattern success is unlikely to match the future probability. If you want to use published win percentage results, plan for worse performance in your live trading.

(2) What rules were used in defining the patterns? Although most sources use similar definitions, there are at times slight variations.

If your candle definitions do not match those used by the team who compiled the winning percentages, then the reported percentages will not be representative of your patterns. If you use any published figures, be sure that they also share the exact definition they used for each pattern. Most studies don’t appear to do this.

(3) Did the entry have to be triggered for the pattern to be included in the sample, or were all patterns considered, whether triggered or not?

If it had to be triggered in order to be included in the sample data, where did they define the entry? Did they use the closing price of the pattern? Did they use the open of the following candle (which may vary from the closing price if the market or timeframe often gaps)? Did they use a breakout of the pattern high/low? If they did use a breakout, was the entry triggered as soon as price broke the level, or on a close beyond the level, or on a breakout of the candle which closed beyond the level. All these different entry techniques will vary the results.

If we look at the following diagram, you can see that different entry methods result in different outcomes.

 

(more…)

Advanced Candlestick Analysis (Part 2 of 2)

 

Welcome to part 2 of our short article series on Advanced Candlestick Analysis.

If you haven’t read part 1, you’ll find a copy posted at this webpage: http://yourtradingcoach.com/trading-process-and-strategy/advanced-candlestick-analysis-part-1-of-2/

In the last article we reviewed some of the key concepts from basic candlestick analysis:

  • The importance of identifying the market context – where the pattern is happening within the market structure,
  • The importance of trading (primarily) with the trend – yes, a reversal pattern can also be applied at the end of a retracement, signaling continuation of the larger timeframe trend, and
  • The importance of understanding the probabilistic nature of the markets and the need for risk and money management to protect your downside.

 

We discovered that contrary to popular belief by those new to the industry, Advanced Candlestick Analysis (if there is even such a thing)* does NOT involve:

  • Better, and more secret, candlestick patterns, or
  • Some Holy Grail combination of western technical indicators and candlestick reversal patterns.

 

Instead, it simply involves seeing the flow of price in a whole new way.

I like to think of it as being like the Magic Eye books, posters and prints (http://www.magiceye.com/3dfun/stwkdisp.shtml) that became popular back in the 90’s, where to the uninitiated the picture was just a blur of color and shape, but through a slight refocusing of our vision the trained observer is able to see a hidden 3D image.

Thankfully, Advanced Candlestick Analysis does not require squinting or changing the focus of the eyes.

All it takes is an understanding that candlesticks are a visual representation of the bullish or bearish sentiment within the timeframe represented by that candle, and then using the power of questions to compare the current candle with those preceding it, in order to sense the changes in bullish or bearish sentiment as price flows from one candle to another.

We finished up last time with a small collection of sample questions, to help you see the changes in sentiment:

  • Is the current candle able to push beyond the previous candle high/low, in the same direction as the previous candle? Is it able to close in this area, or was the candle breakout rejected?
  • Has the candle moved beyond the previous candle’s high/low, against the direction of the previous candle? Is it able to close in this area, or was the candle breakout rejected?
  • How far does the current candle penetrate within the body (or the range) of the previous candle?
  • How far does price extend beyond the previous candle body (or range)?
  • How does the current candle’s range compare with previous candles?
  • Is there a long tail at either the high or low of the candle, and what is the significance of this price rejection?
  • How has price acted on reaching any significant areas, such as areas of support or resistance, previous swing highs or lows, previous day’s high, low or close, today’s opening price or opening range (or any other areas you deem to be significant)? Did the market accept these prices, or reject the area?
  • Is the momentum of the current price swing increasing or decreasing, especially as it moves towards the significant areas listed above?
  • Has this candle trapped anyone long? Or short? Or trapped anyone out of a position prematurely?

 

These of course are just examples, and can easily be replaced by any others which allow you to better sense the shift in market sentiment.

Ultimately, your aim is to answer the following question – “Does the current price action confirm my previous bias? If not, how is the sentiment changing and does that change my bias?”

Confused? Hopefully an example will help…

(more…)

Advanced Candlestick Analysis (Part 1 of 2)

Do you remember the feeling of excitement when you first discovered candlestick patterns?

Simple textbook patterns which promised to get you into every market reversal, right near the beginning of the move.

If you’re like most of us traders, you bought a book on candlestick patterns, or scoured the internet for the best of the free candlestick information (it’s here by the way – http://www.youtube.com/user/YourTradingCoach).

You spent hours practicing – scanning through historical charts and learning the patterns until you could see them in your sleep. Surely the funds from the uninformed masses would soon be flowing into your account.

And you may have even taken great delight in showing off your new found knowledge to your non-trading partner or friends. “Look at this dark cloud cover. See how it makes price fall. And here’s a doji. And this one here is called a shooting star.”

It all seemed so simple.

Then reality hits…

Somehow, when you’re trading live at the right hand edge of the chart, the patterns are not so easy to see. They never quite look as picture perfect as they do in the textbooks.

And even when they do look perfect, and you summon up enough courage to enter, the trade just never moves like it’s meant to.

That textbook hammer, entered on the breakout of the highs, suddenly reverses to retest the lows and stop you out, before then moving north again without you.

How do I know you’ve been through this?

Well, firstly, because it’s a stage we all go through. But I also know this because a lot of traders contact me, frustrated with their lack of candlestick success. They’ve worked through my basic candlestick analysis videos and are now hoping I can share with them the secrets of ADVANCED CANDLESTICK ANALYSIS.

Usually I just reinforce some of the key concepts from the videos:

  • Reminding them of the importance of identifying the market context – “Where is the pattern happening within the market structure?”

  • Reminding them of the importance of trading with the trend – reversal patterns aren’t just for reversals, they also apply at the end of a retracement as it resumes the dominant, longer term trend.

  • And most importantly, reminding them of the probabilistic nature of all setups, along with the importance of risk management to limit our risk as we operate in the uncertainty of the market environment.

 

But there is more to it…

So, let’s have a look at what I call ADVANCED CANDLESTICK ANALYSIS (if there is even such a thing!!!)

(more…)

Real Traders Use Candlesticks… or do they?

Here’s an interesting observation – over the last week I’ve received half a dozen emails asking why I don’t use candlesticks.

While that’s fairly understandable, given the current series of price bar reversal videos, it led me to thinking that there’s probably a lot more people who are thinking the same thing but hadn’t bothered to email, so perhaps I’d better expand on this in the newsletter.

Actually, I even had one person who informed me that they had unsubscribed from the newsletter because of the fact that I don’t use candlesticks. Ok…whatever!

So, here’s my thoughts on the price bars vs candlestick debate, partly copy/pasted out of the email replies…

(more…)