The Forex market can be an unforgiving environment even to the seasoned investor and experienced banker. It’s a business like no other in that every day is unpredictable and an emotional roller coaster. Candlesticks can help bring structure to this new business pursuit. If learnt how to wield masterfully, candlesticks can be one of the most important techniques in your trading arsenal.
What are Candlesticks
Candlesticks were first discovered by a Japanese man named Homma, who used the then-unrefined technique to speculate in the futures market, particularly in rice. Decades later, it was popularized in the Western world by Steve Nison, who specializes in using candlestick charting.
A single candlestick will consist of a vertical rectangular body with wicks or what’s referred to as “shadows” sticking out the top and bottom portion. The lengths of the wick will vary depending on the volatility or price action within that given time frame. The body will also be colored differently to denote whether price is increasing or decreasing.
Types of Candlesticks
There are several single candlestick forms and patterns you can find being used today by institutional and retail traders. The most common standalone candlestick is known as a Doji. A Doji is cross shaped, implying inactivity or equal strength between buyers and sellers during that period.
An example of a candlestick pattern is known as the Bullish Engulfing, which consists of two candles. Following a downtrend, the second candle of the pattern is considerably larger than the first candle and should appear as if it’s engulfing it. This signals a potential reversal unfolding due to exhaustion of the sell side and the subsequent start of an uptrend.
Last but not least is the Hammer candlestick. This standalone candle consists of a big wick at the bottom portion of the body and a small or nonexistent wick above it. It usually appears during a protracted downtrend, signaling a potential reversal favoring the bulls.
Other common patterns derived from candlesticks include Bearish Engulfing, which is simply the opposite of a Bullish Engulfing, Dark Cloud, Shooting Star, and Three Outside Down. Learn these basic patterns first before moving on to advanced patterns that are harder to spot but provide higher probability and win rate. These include the Island Reversal, Hook Reversal, Three Gaps, and Kicker patterns.
Benefits of Trading Candlesticks
Compared to bar and line charting, candlestick charting offered by AlfaTrade provides more data. Looking at a candlestick, you can identify an asset’s opening and closing prices, highs and lows, and overall range for a specific time frame. Candlesticks can also serve as a visual representation of which side is driving price action.
Candlestick charting is generally easier to comprehend, irrespective of a trader’s experience or skill level. It’s also very flexible and lets you combine it with other analytical tools and technical indicators to arrive at the best possible trading decisions. The technique doesn’t require months or years of practice to master. By getting a few hours of chart time per day, you can memorize the patterns relatively quick and capitalize on trade opportunities as they unfold.
Mastering candlestick charting actually gives you a tool that’s been around for more than 200 years. For a technique or practice to survive the test of time for more than twenty decades proves a lot about how reliable candlesticks are when it comes to speculation.
Tips to Trading With Candlesticks
On its own, candlestick patterns are incomplete when it comes to striving for consistent profitability in the Forex market. You have to learn how to integrate them with technical or fundamental analysis. This allows you to filter out low-quality and average trades and only take high-quality trades.
One other thing to keep in mind is that the market environment a candlestick or a candlestick pattern is placed in can impact the outcome of the trade. For example, a Hammer pattern is a bullish signal by default. However, if it appears atop a protracted uptrend, it may be signaling an impending reversal to bearish territory. This is why countless hours of chart time is crucial. Traders must intentionally train their minds to look at the big picture and identify which candlestick patterns and at what sort of market environments are best to trade with.
You also have to acknowledge the fact that candlestick charting still has inherent risk, similar to other tools and strategies the financial industry has come up with over the decades. If you accept early on that some trades will end up a loss, you set yourself up for long-term success.
Trading Forex with candlestick patterns should be thought of as a marathon, rather than a sprint. It won’t produce overnight results or make you a millionaire in 6 months. There are countless more advanced strategies and in-depth tips about candlestick charting, but the guide above should cover the basics you need to get started.