In today’s episode, you’ll discover the truth about candlestick patterns that nobody tells you.
So tune in right now…
Hey, hey, what’s up my friends? In today’s episode, I want to share with you the truth about candlestick patterns that you might not be aware of. There are a few things that I want to cover.
1. The gap element about candlestick patterns
If you study the bullish engulfing pattern, traditionally, the next candle’s open has to gap lower than the previous day’s low and then close above the previous day’s high. That’s how it engulfs or covers the previous day’s candle.
This is fine if you trade the stock markets because the markets can gap up and down often. But when you’re trading the Forex market like on the 1-hour timeframe in the Forex market, you’ll realize that there aren’t many gaps on the charts.
Does that mean that a bullish engulfing pattern cannot be applied to the Forex market? No, it just means that you have to then tweak the candlestick pattern to suit the Forex market.
One simple way is that, for those candlestick patterns that require gaps, you’ll just have to ignore the gap portions of them in the Forex market.
For example, in the bullish engulfing pattern, if you trade the Forex market, you’ll rarely get a gap below the previous candle’s low. In this case, as long as the bullish engulfing pattern covers or engulfs the previous candle’s body – then that to me is a bullish engulfing pattern.
You have to consider the gap element, especially when trading the Forex market.
2. Candlestick patterns don’t tell you how the price moved
Yes, a bullish candle tells you that the price has closed above the opening price that’s why it’s bullish and green. But it doesn’t tell you exactly how the price moved from the open to the close.
Could it be that the price went up from open to close in a straight line? Or did it go up, down and then up again? Or maybe it went up, retrace by 50% and then went up again? Or maybe it went up and started consolidating near the highs?
You’ll have no idea how the price moved from the open to the close. That’s one thing that candlestick patterns won’t tell you. You have to be aware of this limitation.
If you want to know whether the price is likely to break above the previous day’s high just by looking at a green candle, you won’t get much information out of it because you can’t analyse the micro details of how the price moved from the open to the close.
This is kind of like another limitation of candlestick patterns that you want to be aware of. Of course, it’s easy to overcome this limitation by going down to a lower timeframe to see the details.
But the reason I’m sharing this with you is to tell you the truth about how candlestick patterns work.
3. Candlestick patterns are not the only way to read charts
New traders might be surprised, “Wait what, Rayner? There are other ways to read the charts?” Yes, you can also use things like line charts, bar charts, etc.
I have also seen some prominent professional stock traders use only bar charts and they don’t even want to get involved with candlestick charts and patterns because the bar charts pretty much provide similar information to what candlestick patterns provide.
And maybe to them, it’s kind of less overwhelming as there are no colours to the bars but you can see the range of the candles and the volatility contraction patterns.
Again, I just want to share that candlestick patterns and candlestick charts are not the only way to read or visualize a char, there are many other ways to do so.
4. Candlestick patterns are useful as entry triggers
They can be used as a trigger to get into a trade, but they are not meant to be used in isolation. So, if you spot a hammer or a shooting star, it doesn’t mean that you’ll enter the trade immediately.
I know some traders would think that if they spot a hammer then it’s a bullish hammer and it’s time to buy. No, candlestick patterns are not a trading strategy, they are simply tools to help you get into a trade, provided all the other market conditions are met.
Don’t use candlestick patterns in isolation. For example, if you’re trading in an uptrend and the price comes into an area of support or an area of value or for some fundamental reasons, you think that this market is about to go up higher.
Then the candlestick patterns are useful to tell you when to exactly enter a trade. It’s useful as an entry trigger. That’s number four. And finally…
5. Don’t memorise candlestick patterns
If you’ve studied trading textbooks, courses and stuff like that, you’ll realise that there are a lot of patterns out there. From shooting star, hammer, bullish engulfing, piercing, dark cloud cover, harami, doji, etc. These are just a fraction of what there are out there.
And the key thing that I want to share with you is, don’t try to memorize all these different patterns out there, you will burn yourself out – in fact, there’s no need to memorize all these patterns.
I’m going to share with you two things. Pay attention to these and I can guarantee you that you don’t have to memorize any other candlestick patterns ever again. Sounds good?
#1: Ask yourself where did the price close relative to the range
A candlestick has the open, high, low and close prices. So ask yourself, where did the price close relative to the range? Because if the candle closed near the highs of the range, it’s a bullish sign that the buyers are temporarily in control.
But if the price closes near the lows of the range, it’s telling you that the sellers are temporarily in control, that’s why the price has closed near the lows of the range.
If the candle closes in the middle of the range, then it’s pretty much undecided – buyers and sellers are pretty much in equilibrium.
#2: Ask yourself what’s the size of the candlestick pattern relative to the earlier candles
For example, if you see a huge bullish engulfing pattern that’s much larger than the last five candles, this tells you that there is strength and strong conviction behind the move.
If the size of the bullish engulfing is similar or even smaller than the earlier candles, then it’s telling you that this candle is pretty much insignificant and the volatility in this market is contracting. So this candle is quite insignificant in the grand scheme of things.
But if you noticed that the size of this candle is much larger compared to the last five candles, then this tells you structurally that this market has something going on. Because this candle wouldn’t be huge if there’s no huge buying pressure pushing up the price to close higher.
Let’s do a quick recap on what I’ve discussed today…
- Beware of the gap element of candlestick patterns when you’re trading the Forex market
- Candlestick pattern doesn’t tell you exactly how the prices moved in between the open and close
- Candlestick patterns or candlestick charts are not the only way to visualize or read the chart – you can use bar charts, line charts, etc.
- Candlestick patterns are useful as an entry trigger to get you into a trade, but you shouldn’t use this pattern in isolation
- You don’t have to memorize every single candlestick patterns out there – pay attention to (1) where the price closed relative to the range and (2) the size of the candlestick pattern relative to the earlier candles
With that said, I wish you good luck and good trading. I will talk to you soon.