Better than Candlestick Patterns – Part Four

(Previous articles in this series: part 1part 2part 3)

So far, we’ve discussed:

  • A simple technique for classifying (or naming) candles and gaining a feel for short-term candle sentiment.

  • The importance of context – examining where the current pattern is occurring within the market structure in order to determine the technical and psychological impact of that pattern (how the pattern is interacting with key structural areas and the implications for future market bias).

So what? How do we use this information?

In order to answer that, let’s step back a bit and consider the purpose of our market analysis.

Market analysis has nothing to do with trading. It’s not about trade setups, entry or exit. They come later.

Our market analysis process is a tool for developing and maintaining situational awareness. It is a means of understanding the current environment within which we will be trading (structural S/R and trend) and projecting that forward in time to identify likely future price action (through assessment of strength and weakness within the current trend, likely areas of interaction with S/R barriers, and how other traders will likely act upon the human fear and greed caused by price interaction with those areas of S/R).

It’s about identifying scenarios for future price movement. It’s not prediction; at least not in the way that most people define prediction which involves a feeling of certainty of outcome. It is probabilities based. Considering probable future price action; considering how ongoing price will have to behave in order to validate our expectation; and where that would provide trade opportunity. Considering also, how price would behave if it was to invalidate our expectation. This way, if we’re wrong, we’ll very quickly know it and be able to adjust our expectations for future market direction.

Most traders are reactionary. Surprised by price action developments, they chase setups and entries after they’ve become obvious to the crowd.

Through our analysis process, we ensure our awareness is maintained ahead of current market action, so that our trading involves deliberate and premeditated actions rather than impulsive reactions to unexpected events.

The ‘YTC Price Action Trader‘ book has well over a hundred pages discussing the process of analysis; and that’s even before getting started on strategy. We’re not going to cover it here.

What we will talk about briefly though is a component of the process of ongoing analysis. Bar by bar reassessment of our future price expectations as new candles appear on the RHS of our screen.

Assuming we already have in place an expectation of future price direction and areas of future trade opportunity, ongoing analysis is simply a process of asking whether or not the new information still supports this premise.

  • Determine Candle Pattern Sentiment

  • Consider the Context

  • Does it Support My Premise?

  • Repeat

Determine Candle Pattern Sentiment  (Classify the candle pattern and determine the short-term sentiment of price)

  • Classify the candle pattern

    • High / Mid / Low Close

    • Bull / Range / Bear Candle

  • Determine the sentiment of the pattern

Consider the Context (Every pattern is unique and must be considered in the context of the background environment in which it occurs)

  • Where is the current price action in relation to key market structure features:

    • Support or Resistance / Trend / Swing Highs and Lows

  • What does this mean with respect to the sentiment of the pattern and the potential future price action?

Does it Support my Premise? (Is the market action continuing as expected, or is something indicating we’re out of sync with market flow?)

  • Does the current price action and sentiment support our previous expectations for future price action?

    • Yes – await further price information.

    • No – decide whether to hold for the next candle, or to reconsider your expectations from first principles.

    • Unsure – just wait for further price information.

Following this simple process will ensure we remain focused on price, maintaining our feel for market bias, and ready for action when price gets to our areas of trade opportunity.

We’ll work through a couple of examples…. (next article…sorry!…this one’s already long enough)

More to follow in Part Five…

Lance Beggs

Followup Articles:

Part 5 – http://yourtradingcoach.com/trading-process-and-strategy/better-than-candlestick-patterns-part-five/

 

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