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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Want to gain a trading edge with candlestick charts? Find them a little confusing? No worries! Candlestick Charting For Dummies sheds light on this time-tested method for finding the perfect moment to buy or sell. It demystifies technical and chart analysis and gives you the tools you need to identify trading patterns -- and pounce! This friendly, practical, guide explains candlestick charting and technical analysis in plain English. In no time, you'll be working with common candlestick patterns, analyzing trading patterns, predicting market behavior, and making your smartest trades ever. You'll discover the advantages candlestick has over other charting methods and learn the secrets of combining it with other technical indicators. You'll also get familiar with different ways to display and interpret price action, including trend lines, support levels, resistance levels, moving averages, and complex indicators. Discover how to: * Construct candlestick charts * Identify and interpret basic patterns * Trade in bull and bear markets * Work with complex patterns and indicators * Avoid False signals * Understand the components of market activity * Deal with bullish or bearish single-stick, two stick, and multistick patterns * Identify and interpret complex patterns * Use indicators to determine the market * Outperform the market in any conditions Don't know whether to grab the bull by the horns or just grin and bear it? Read Candlestick Charting For Dummies and get it right the first time.
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Veröffentlichungsjahr: 2011
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Candlestick Charting For Dummies
by Russell Rhoads
Candlestick Charting For Dummies®
Published byWiley Publishing, Inc.111 River St.Hoboken, NJ 07030-5774www.wiley.com
Copyright © 2008 by Wiley Publishing, Inc., Indianapolis, Indiana
Published simultaneously in Canada
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Manufactured in the United States of America
10 9 8 7 6 5 4 3
About the Author
Russell Rhoads is a trader and analyst for Peak Trading Group in Chicago. His career in trading and market analysis covers over 17 years. He has a BBA and MS in Finance from the University of Memphis and has done graduate level work in Financial Engineering at the Illinois Institute of Technology. Russell also holds the Chartered Financial Analyst designation.
Dedication
To Bobbie, Dusty, Maggie, Emmy, and especially Merribeth.
Author’s Acknowledgments
The most thanks must go to my wife Merribeth who through a very difficult year, that included producing this book, always was willing to yield to the time I needed to complete this project. Maggie, my daughter, was also always a helpful participant by working quietly alongside of Daddy when he needed to work. To Emmy, who discovered how to push buttons while this book was being written, thanks for not turning the computer off when Daddy hasn’t saved his work.
Thank you to a few current professional associates who’ve been very helpful recently: Mike Wilkins, Bill Annis, and Patrick Guinee. Also, there are some people that I professionally lost touch with that helped guide my career, and I feel I’ve never properly thanked them: R. Patrick Jones, Mickey Hoffman, and Michael Orkin. These people stand out the most in my mind, so I’m taking this opportunity.
As far as the mechanics of putting the book together, Stacy Kennedy, Acquisitions Editor, Chrissy Guthrie, Senior Project Editor, and Carrie Burchfield, Copy Editor, were extremely helpful for this non-writer. Tim Brennan, the technical editor, did an excellent job pointing out areas that needed some improvement. Brittain Phillips gets a special thank you for taking what I’m trying to say and making it readable. Also, I can’t go without acknowledging Michelle Hacker, Editorial Manager, who introduced me to the people at Wiley Publishing, Inc. Without her I never would’ve had the chance to produce a book.
Publisher’s Acknowledgments
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Contents
Title
Introduction
About This Book
Conventions Used in This Book
What You’re Not to Read
Foolish Assumptions
How This Book Is Organized
Icons Used in This Book
Where to Go from Here
Part I : Getting Familiar with Candlestick Charting and Technical Analysis
Chapter 1: Understanding Charting and Where Candlesticks Fit In
Considering Charting Methods and the Role of Candlesticks
Understanding Candlestick Components
Working with Candlestick Patterns
Making Technical Analysis Part of Your Candlestick Charting Strategy
Trading Wisely: What You Must Understand Before Working the Markets
Chapter 2: Getting to Know Candlestick Charts
Recognizing the Many Benefits of Candlestick Charting
Admitting the Potential Candlestick Charting Risks
Comparing Candlestick Charts with Alternative Charting Methods
Chapter 3: Building a Base of Candlestick Chart Knowledge
Constructing a Candlestick: A Core of Four
Considering Additional Information Included on Candlestick Charts
Chapter 4: Using Electronic Resources to Create Full Charts
Turning to the Web for Candlestick Charting Resources
Creating Candlestick Charts Using Microsoft Excel
Exploring Your Charting Package Software Options
Part II : Working with Simple Candlestick Patterns
Chapter 5: Working with Straightforward Single-Stick Patterns
The Bullish White Marubozu
The Bullish Dragonfly Doji
The Bearish Long Black Candle
The Bearish Gravestone Doji
Chapter 6: Single-Stick Patterns That Depend on Market Context
Understanding Market Environments
Delving Into Dojis
Looking At Other Patterns: Spinning Tops
Discovering More about Belt Holds
Deciphering between the Hanging Man and the Hammer
Chapter 7: Working with Bullish Double-Stick Patterns
Bullish Reversal Patterns
Bullish Trend-Confirming Patterns
Chapter 8: Utilizing Bearish Double- Stick Patterns
Understanding Bearish Reversal Patterns
Making a Profit with Bearish Trend Patterns
Part III : Making the Most of Complex Patterns
Chapter 9: Getting the Hang of Bullish Three-Stick Patterns
Understanding Bullish Three-Stick Trend Reversal Patterns
Working with Bullish Three-Stick Trending Patterns
Chapter 10: Trading with Bearish Three-Stick Patterns
Understanding Bearish Three-Stick Trend Reversal Patterns
Forecasting Downtrend Continuations
Part IV : Combining Patterns and Indicators
Chapter 11: Using Technical Indicators to Complement Your Candlestick Charts
Using Trendlines
Utilizing Moving Averages
Examining the Relative Strength Index
Cashing In on Stochastics
Buddying up with Bollinger Bands
Chapter 12: Buy Indicators and Bullish Reversal Candlestick Patterns
Buying with the RSI and Bullish Reversal Candlestick Patterns
Buying with the Stochastic Indicator and a Bullish Reversal Candlestick Pattern
Chapter 13: Sell Indicators and Bearish Reversal Candlestick Patterns
Shorting with the RSI and Bearish Candlestick Patterns
Using the Stochastic Indicator and Bearish Candlestick Patterns for Shorting
Chapter 14: Using Technical Indicators Alongside Bullish-Trending Candlestick Patterns
Using Trendlines and Bullish-Trending Candlestick Patterns for Buying and Confirmation
Combining Moving Averages and Bullish-Trending Candlestick Patterns
Chapter 15: Combining Technical Indicators and Bearish-Trending Candlestick Patterns
Putting Trendlines Together with Bearish-Trending Candlestick Patterns for Selling and Confirmation
Combining Moving Averages and Bearish-Trending Patterns for Short Situations
Part V : The Part of Tens
Chapter 16: Ten Myths about Charting, Trading, and Candlesticks
There’s No Difference between Candlesticks and Bar Charts
Market Efficiency Makes It Impossible to Beat the Market over the Long Run
Only a Full-time Professional Can Make Money in the Markets
Technical Analysis Is Nothing More Than Reading Tea Leaves
Charting Is for Short-Term Traders Only
You Must Be Rich to Start Trading
Trading Is an Easy Way to Get Rich Quick
Candlestick Charts Require More Data and Are More Difficult to Create
The Trading Game Is Stacked against the Small Trader
Selling Short Is for Professional Traders Only
Chapter 17: Ten Tips to Remember about Technical Analysis
Charts Can Give False Signals
People Will Give You a Hard Time
There’s No Definite Right or Wrong Opinion of a Chart
A Single Chart Doesn’t Tell a Whole Story
Charting Is Part Science, Part Art
You Can Overdo It
Develop a Backup System
Error-Free Data Doesn’t Exist
No System Is Silly As Long As It Works
Past Results Don’t Always Predict Future Performance
: Further Reading
Introduction
Years ago, when I was playing around with my first quote machine on the floor of one of the Chicago exchanges, I came across the candlestick charting function. My personal charting software, which I ran on a DOS-based PC with no hard drive (yikes!), had no such function. When the candlestick chart popped up on the screen, I was fascinated by what came up, and my curiosity was piqued. The charting system looked useful and promising, but I didn’t know much about it. It wasn’t like I could just run an Internet search on candlestick charts to find out more, so I proceeded to the exchange library to find out about candlesticks.
The exchange library was stocked with just about every investment and trading related book in and out of print, but I was surprised to find very little information on my newly discovered method of charting prices. I could find only one book about candlestick charting, along with a couple of articles. And the articles were about the book! Not exactly what I’d call a wealth of information.
Fast forward to today. Candlestick charting is now far more of a mainstream trading tool than it was when I first saw it flash up on the screen of that primitive exchange floor computer. In fact, I recently noticed that the charts used in the Wall Street Journal are now candlestick charts. But although candlestick charts are more common in the financial world, not very many traders take full advantage of the vast potential of candlesticks.
I’m hoping to do my part to change that with this book. Candlestick charts can be hugely helpful in nearly every aspect of trading, and savvy traders should take the time to understand candlesticks and how they can enhance and enrich any trading strategy.
About This Book
This book isn’t intended to be an end-all-be-all guide to profitable trading. It’s meant to provide readers with some insight into how candlesticks are created and how they can be used to analyze the psychology behind what happens over the course of trading days. (When I say “psychology,” I’m not trying to conjure up images of Freud and Rorschach tests; I’m talking about the motivating factors that help to determine how the market behaves.)
I hope that the candlestick methods described in this book help readers to make trading and investment decisions that lead to solid profits, but unfortunately, there’s no guaranteeing that. What I can guarantee is that after reading this book (or even parts of this book), you can gain a useful understanding of what candlesticks are, what they represent, and how they can be used in trading.
Conventions Used in This Book
To help you navigate this book, I use the following conventions throughout:
Italics are used for emphasis and to highlight new words that are presented with easy-to-understand definitions.
Boldfaced text is used to indicate key words in lists.
Monofont is used for Web addresses.
I make an effort to use as many examples as possible in the text, and each and every example I present is one that I found while searching through actual charts. I did that to show you not only how common it is to come across these candlestick patterns in everyday trading, but also how eminently possible it is to use them in live trades. They’re out there, and they’re waiting for you to harness their power!
Also, with each new candlestick pattern that I introduce, I present at least one case where it succeeds in producing a useful signal and one where it produces a dud. Candlesticks are terrific, but they’re not perfect, and recognizing the failure of a signal is just as important as picking up on a valid signal.
What You’re Not to Read
When you come across the Technical Stuff icon, you may skip ahead because this icon indicates information that’s additive to trading knowledge, but not essential to gaining knowledge about candlestick charting.
You can also skip the sidebars that are placed throughout the text if you’re pressed for time or you want only the essential information. Sidebars contain nonessential material, and you can tell them apart from the rest of the text because they’re placed in gray shaded boxes.
Foolish Assumptions
Because knowledge of candlesticks varies widely from trader to trader — even traders with the same amount of trading experience can differ quite a bit in their candlestick know-how — I’ve made the assumption that you have at best a very basic understanding of what comprises a candlestick chart. My apologies if you already know a little about candlesticks, but hey, it never hurts to review and hone those essential candlestick skills. I build understanding from the ground up, beginning with how to create individual candlesticks and finishing with how complex candlestick patterns can be combined with other forms of technical analysis. Also, I’m operating under the assumption that you’ve had some sort of experience trading a stock or at least a mutual fund. I assume that you’ve spent some time looking over stock charts in the past too.
How This Book Is Organized
I’ve organized Candlestick Charting For Dummies into five parts. Each part offers a different set of information and skills that you can take away to incorporate in your personal trading strategy. You get a feel for candlestick basics or understand some simple candlestick patterns and how to trade based on them. You tackle some more complicated patterns and figure out how it’s possible to use candlesticks in tandem with other popular technical indicators. The possibilities for candlestick charts are many and varied, and I do my best to touch on a wide range of their uses and benefits.
Part I: Getting Familiar with Candlestick Charting and Technical Analysis
In the first part of this book, I introduce candlestick charting and some other basic charting concepts. You may be wondering what advantages candlesticks have over other types of charts. Believe me, the rewards are plenty, and you can read all about them in Chapter 2. Want to know what price data elements are combined to generate a candlestick? That’s all contained in Chapter 3, along with some information on how to embrace the other types of data that you may run into when reviewing candlestick charts. And in the last chapter of Part I, I also let you know how to tap into a variety of free and for-purchase electronic resources for charting, which are critical in today’s high-tech trading environment. I even include a low-tech alternative: how to draw charts yourself.
Part II: Working with Simple Candlestick Patterns
Part II features descriptions and explanations of some of the most basic and common candlestick patterns. The simplest candlestick patterns involve just one day or one period of price data, and you can find information on those patterns in Chapters 5 and 6.
Two-stick candlestick patterns are one step up from those basic patterns, but just a single step up in complexity can provide quite a bit of additional information and versatility. Some extremely helpful two-stick candlestick patterns pop up frequently on candlestick charts, and if you want to really capitalize on candlesticks in your trading strategy, you need to know how to identify and trade them. Don’t worry; I’ve got you covered in Chapters 7 and 8, which wrap up Part II.
Part III: Making the Most of Complex Patterns
Three-stick patterns are the most complex patterns that I deal with in this book, and their nuts and bolts are explained in this part. (Three-stick patterns in Part III — convenient, right?) Like their one- and two-stick counterparts, three-stick patterns tell you what a market or security is about to do next, and the added stick means that these patterns are a bit more rare but that much more exciting. You can get your three-stick candlestick pattern bearings in Chapters 9 and 10.
Part IV: Combining Patterns and Indicators
I begin Part IV with Chapter 11, which offers a more in-depth discussion of several other technical indicators. It’s useful for any trader to understand a variety of indicators because you can use them alone, to confirm your candlestick signals, and in combination with candlestick patterns.
Although candlestick patterns alone have proven to be reliable trading tools, using them in combination with other indicators can greatly enhance their ability to predict the future direction of a market or a stock. In the rest of Part IV, I take some simple and complex patterns and combine them with pure technical indicators to show you how coupling the two techniques can lead to profitable trading. The chapters in this part are chock-full of fascinating real-world examples from a variety of markets and industries.
Part V: The Part of Tens
You can’t have a For Dummies book without a Part of Tens, and this book is certainly no exception. The final part includes a few helpful lists, including myths about trading, a few things to keep in the back of your mind about charting, and some resources that you can consult to further your candlestick understanding.
Icons Used in This Book
I used the following icons throughout the book to point out various types of information:
When you see this icon, you know you want to store the accompanying nugget of candlestick or trading wisdom somewhere safe in your brain.
This icon offers hands-on advice that you can put into practice as you trade. In many cases, the information found next to this icon tells you directly how to conduct a trade on a pattern or technical analysis method.
If you ignore this information, you can wake up one day in a den full of writhing, angry pit vipers. Okay, so it’s not that bad, but this icon really helps you avoid making costly trading mistakes.
This icon flags places where I get really technical about charting. Although it’s great information, you can safely skip it and not miss out on the discussion at hand.
Where to Go from Here
To figure out which area of this book to dive into first, think hard about what facet of candlestick charting you want to understand. Want to get grounded in the basics, or polish up on a few candlestick fundamentals that you may have forgotten since you read that online article about candlestick charting months ago? Check out the next page, on which Part I begins.
If you want to get cracking and find out about a few real candlestick patterns and how they can tell you what a market or security is going to do next, I suggest that you flip to one of the chapters in Parts II or III. I cover many candlestick pattern examples in those chapters — more than enough to give you plenty to look for as you pore over charts on the Web or on a charting software package.
You may have been recently exposed to some other technical indicators and it’s possible that reading about candlesticks alongside some of that familiar material may help you get your feet wet. If so, make a beeline for Part IV, and enjoy!
The water’s fine no matter where you choose to dive in, and you’re just a few page-turns away from adding a powerful weapon to your trading arsenal.
Part I
Getting Familiar with Candlestick Charting and Technical Analysis
In this part . . .
I don’t know of any traders or investors who’ve taken the time to fully understand candlestick charting and then not used the techniques in their trades. After you’ve taken the time to grasp candlestick basics, it’s tough to deny their advantages over other types of charts, and the profits can certainly speak for themselves. But the basics must come first, and that’s what Part I is all about.
I begin this part by setting candlesticks in context with several other types of charts, so you can get a feel for candlestick benefits. After that, I explain the price action and signals that candlestick charts generate, and I show you how a candlestick is constructed and what its variations can mean. To close Part I, you look at the range of electronic resources available for candlestick charting, which you can exploit with just a few clicks of your mouse.
Chapter 1
Understanding Charting and Where Candlesticks Fit In
In This Chapter
Taking a look at options for charting and why candlesticks are superior
Making sense of candlestick construction
Exploring the wide variety of candlestick patterns
Using technical analysis alongside your candlestick charts
Understanding a few trading and investing basics
The advent of the Internet has leveled the playing field for securities traders. Access to markets once meant placing orders through a broker, and now it’s little more than a couple of mouse clicks away. Commission rates are dramatically lower, and access to market information is now in many cases free. Getting into securities trading is now easier than it ever has been, and the result is a whole generation of investors and traders that handle their finances without professional help. Technology allows these people to enjoy many new types of market information, and one of the best tools available is candlestick charting.
Candlestick charting methods have been around for hundreds of years, but candlesticks have caught on over the past decade or so as a charting standard in the United States. I’ve been working with candlestick charts for quite a few years, and I’ve seen many traders — novice to professional — develop a fierce loyalty to candlesticks after taking the time to understand their uses and potential. I think you’ll feel the same way, and this book is the first step on the path to conquering candlesticks.
The material contained in this chapter exposes you to many of the facets of candlestick charting that continue to fuel its rise as one of the most popular charting techniques. I begin with the overall role of candlesticks within the context of charting. I cover the advantages of candlestick charting, and the basics of candlestick construction. I also take the opportunity at the end of this chapter to discuss how to get started as well as give some insight into the characteristics and habits that successful traders employ in their pursuit of profits. Enjoy, and happy charting!
Considering Charting Methods and the Role of Candlesticks
With advancements in technology and the growing availability of trading and investing resources available to traders, many options exist for the charting of securities. There are several different types of charts and dozens of variations and features to be configured on each type. It’s important that you’re clear on the options and, perhaps more importantly, why candlestick charting is at the top of the heap. This section explains.
Getting a feel for your options for charting
When it comes to alternatives to candlestick charting, the three main charting contenders are as follows:
Line charts: These charts are simple and helpful for short-term decisions, but they’re quite limited in the amount of data presented.
Bar charts: These are much more useful than line charts and are the most common, but they’re not as versatile as candlestick charts.
Point and figure charts: These are tried-and-true charting methods, and they’re great for recognizing support and resistance levels, but they’re far less dynamic than candlestick charts.
Each one of these charting methods can be used effectively to ratchet up the effectiveness of your trading strategy, but they pale in comparison to candlestick charts for a number of reasons, a few of which I describe in the next section.
Realizing the advantages of candlestick charting
You’d be hard pressed to find someone who’s more enthusiastic about candlestick charting than yours truly. I can go on and on about the advantages that candlesticks afford. If you want to read more of my gushing about the many great advantages of candlestick charting, turn to Chapter 2, but here are my top reasons:
One of the best features of candlestick charting in general is the visual appeal and readability. You can glance at a candlestick chart and quickly gain an understanding of what’s going on with the price of a security. You can also tell whether sellers or buyers have dominated a given day, and get a sense of how the price is trending.
Also, even after reading up on the most rudimentary of candlestick basics, you can easily spot the opening and closing price for a security on a candlestick chart. These price levels can be very important areas of support and resistance from day to day, and knowing where they are can be extremely helpful, especially for short-term traders.
Candlesticks aren’t just a pretty face. Candlestick charts also feature specific patterns that you can identify and use to decide when it’s time to buy, sell, or wait on a trade or investment. These patterns can be a real boon to your work with securities, and you can combine them with other technical indicators for even more reliable results.
Understanding Candlestick Components
You can’t trade and invest effectively by using candlestick charts unless you understand candlestick patterns, and you may have a very hard time understanding those patterns if you aren’t familiar with basic candlestick construction. Candlestick charting starts with the knowledge of what it takes to make a candlestick and how changes in that basic information impact a candlestick’s appearance and what it means. For starters, you need to know what goes into creating a candlestick’s wick (the thin vertical line) and its candle (the thick part in the middle).
The following four pieces of information are combined to create a candlestick:
Price on the open: The price at which a security opens on a given period is the first piece of information used in creating a candlestick. Depending on whether the security’s performance is bullish or bearish, the opening price corresponds to either the bottom edge of a candlestick’s candle or the top edge.
Candlesticks that represent bullish price action appear white on a chart, and candlesticks that represent bearish price action appear black.
High price: The highest price that a security reaches during a given period corresponds to the top of a candlestick’s wick. If a security opens at a certain price and then trades consistently lower than that price throughout the period, there won’t be any wick at all above the candle.
Low price: The lowest price that a security reaches during a period corresponds to the bottom of a candlestick’s wick. If the price action for that period is extremely bullish and prices trade higher than the open, there won’t be any wick below the candle.
Price on the close: After a security finishes trading during a given period, its closing price is the last piece of information used to create a candlestick. Depending on the security’s performance during that period, the closing price can correspond to either the top edge of a candlestick’s candle (if the period was bullish) or the bottom edge (if the period was bearish).
As a true candlestick devotee, I believe that you can gain far more insight into a period’s trading by looking at a candlestick than you can by looking at another type of charting tool. Want proof? Take a look at Figure 1-1.
Figure 1-1: Bullish and bearish candlesticks side by side.
You can tell right away that the up day has a white candle and the down day has a black candle. That simple difference alone clearly reveals the nature of the price action that took place during that period. In the case of the candlestick with the black candle, there was more selling pressure than desire to buy. And the candlestick with the white candle indicates that there was more buying pressure than desire to sell.
Why is this so important? Candlestick charts quickly clue you in on the type of buying and selling that’s been going on during a given period and where it may occur again. In many cases, the buyers continue to buy and the sellers continue to sell during subsequent periods or if the price reaches a level that has spurred them to action in the past.
For more information on candlestick construction, refer to Chapter 3.
Working with Candlestick Patterns
The components of a candlestick may be the bones of candlestick charting, but candlestick patterns are the heart and soul. Patterns appear on candlestick charts as simple, single-stick occurrences or complex, multi-stick formations, and many different types of patterns can tell you what may be in store for a security that you’ve had your eye on for trading or investing. And knowing what may lie ahead can be the difference between a profitable trade and a flop.
Candlestick patterns indicate when prevailing trends reverse or when they continue. Both types of patterns are very useful because they tell you when to get into a trade, when to get out of a trade, when a trade you’re in may make no sense, and even when to hang onto a trade you’re already in. Check out Chapters 5 through 10 for more info on identifying and trading on a wide variety of candlestick patterns.
Simple patterns
Some candlestick patterns are very simple: A single candlestick on a chart can serve as a candlestick pattern. A single candlestick that signifies time to buy or sell is very appealing to traders who are just starting to work with candlestick charts because after you understand the basics of candlestick construction, you can immediately start identifying simple patterns and using them to make more informed trading decisions. Flip to Chapters 5 and 6 for several great examples of how just one candlestick can tell you what a security’s price is going to do in the immediate future.
I also consider double-stick candlestick patterns as simple patterns, and you can explore several varieties in Chapters 7 and 8.
Complex patterns
When a candlestick pattern includes three periods’ worth of price action (three candlesticks), I consider it a complex pattern. Many complex candlestick patterns require specific price activity over the course of three days for the pattern to be considered valid, and I discuss a range of them in Chapters 9 and 10.
Complex candlestick patterns can be frustrating at times because you may watch with anticipation as a pattern develops nicely for the first two days only to fizzle out on the third.
Complex candlestick patterns are more rare than their simple counterparts, but they can be worth the wait. Because the conditions and criteria for a complex pattern are so specific, it’s more likely that the signals they offer will be good ones.
Making Technical Analysis Part of Your Candlestick Charting Strategy
A stunning amount of mathematical ingenuity is applied to security trading analysis. The options for technical analysis can be as simple as the average of a few days of closing prices and as complex as applying calculus to price action to indicate the momentum of prices. The possibilities are endless, and you shouldn’t be shy about including some of them in your trading strategy alongside candlestick charts.
Take the time to get familiar with an array of technical indicators to make you a more versatile trader and enrich your work with candlestick charts. For example, it’s great when you spot a candlestick pattern indicating that it’s time to buy, and at the same time, your favorite technical indicator is also flashing a buy signal. Combining trading tools helps build your confidence and can help you quickly determine when a trade isn’t going to work out, allowing you to exit with minimal losses.
I explore several different types of technical indicators in Chapter 11 and clue you in on a few ways that you can combine these indicators with candlestick patterns in Part IV (Chapters 11 through 15). Find a few technical indicators that match up to the type of trading you want to pursue and add them to your candlestick charts. Read up on the choices, and if Chapter 11 isn’t enough, you can always turn to Technical Analysis For Dummies (Wiley) by Barbara Rockefeller. The added understanding of technical indicators can really aid you in your candlestick charting efforts.
Trading Wisely: What You Must Understand Before Working the Markets
Security trading and investing can be a financially rewarding and fulfilling experience, but it’s far from a risk- and stress-free undertaking. I want to make clear to you a few key points and concerns before diving into my candlestick charting discussion, so that you’re fully aware of what you’re up against and what you can do to maximize rewards and minimize risks.
Trading can be an expensive endeavor
There’s money to be made on the security markets, but don’t be fooled into thinking that earning profits is easy or effortless. Many smart people have taken on trading as a hobby or profession and been quickly humbled by poor trades and losses. Do your homework and practice wise money management, or you could end up joining their ranks!
By doing homework, I mean look at charts and develop a trading plan. The more you prepare, much like for a test, the better your trading results should be. I’ve seen a direct correlation between the level of trading success I’ve achieved and how much time I’ve put into preparing for trading situations. As far as wise money management, the key here is making sure to take a loss when it becomes apparent a trade isn’t going to work. Take the loss and move on. Take this loss early and quickly before it becomes a much bigger loss.
The most important rule for managing your trading and investing funds is to not risk money that you can’t afford to lose. There are many obvious and unforeseen risks in the financial markets. If your lifestyle changed dramatically because a trade or investment wiped out your account, then you’re probably putting too much of your personal net worth on the line.
Paper trading costs you nothing but time
Paper trading refers to the practice of tracking trades on paper that haven’t been traded in an account. Professional traders tell you that paper trading isn’t the same as putting real money at risk on the markets. As a professional trader, I totally agree. The emotional rollercoaster involved with making and losing money can’t be matched in a dry run. But if you’re a novice who’s just starting to understand the ways of the market, I think paper trading is a great idea. The risks are nil, and the educational benefits are outstanding. Even after 15 years of trading experience, I still tend to paper trade new ideas or systems for a while before putting real money to work.
If you’re new to trading, test out your trading ideas and refine your trading strategy by signing up for a trial account online with an electronic broker. (You can read all about electronic trading resources in Chapter 4.) All you stand to lose is a little time and some pride. But that’s better than jumping right into a live trading scenario and getting taken to the cleaners!
Developing rules and sticking to them
Throughout this book, I stress the importance of setting rules for yourself and sticking to those rules. I just can’t stress enough what a good practice that is for any trader. Making and losing money on the market is a very emotional experience, and one of the main reasons some traders lose big when they should lose just a little (or even win) is that they let their emotions take control of their trading. You can help take emotions out of the equation if you develop trading rules and adhere to them no matter what happens.
Create a set of trading rules for yourself, and stick to those rules. Include rules such as the following:
When to get into trades
Where to place stops in various trading situations
What amount of money to risk on trades and investments
When to get out of trades, either with a loss or profit
Write down your rules and keep them handy for a quick review when you’re in the midst of a trade, and you’re having second thoughts about what action to take.
I’ve been trading for a long time, and I can say without reservation that creating and adhering to a set of trading rules is the best way to reward yourself both personally and financially for the effort you put into the markets. I always follow the rules that I’ve set for myself, and although it may sound crazy, at this point I’m more proud of my rules than I am of my profits. All traders have to come up with their own sets of rules that talk to their trading style and comfort with risk, and you should keep that in mind and jot down potential rules as you explore the contents of this book.
Chapter 2
Getting to Know Candlestick Charts
In This Chapter
Considering the advantages of candlestick charting
Examining a few potential candlestick problems
Checking out the competition: Line, bar, and point and figure charts versus candlesticks
Ever wonder why a trader or investor would choose candlestick charts over other types of charts when analyzing price action of investments or markets? Well, this chapter provides some answers.
Trading and investing aren’t easy undertakings, and they’re certainly not easy professions. Most traders — professional and amateur alike — and investors struggle just to keep up with the market’s performance as measured by the Standard & Poor’s 500 Index (S&P 500). The S&P 500 is an index comprised of 500 of the largest stocks traded in the United States (U.S.) and is considered representative of the stock market as a whole.
In order to be one of the successful few who beats the market and other market participants, you should strive to develop a competitive advantage or some unique insight, commonly referred to as your “edge,” that you believe most market participants aren’t using or considering. I can’t say that using candlestick charting provides an edge by itself — and it does come with a couple of potential problems. But when combined with recurring patterns and other technical indicators, you can find your edge!
In this chapter, I cover candlestick charts — the good and the bad — and I review a handful of alternative charting methods. But in the end, you understand why candlestick charting is the way to go!
Brief history of candlestick charting
The history of candlestick charting stretches back to Japanese rice traders in the 17th or 18th century. This fact is why candlestick charts are frequently referred to as Japanese candlestick charts. A very smart man named Munehisa Homma developed the methodology of monitoring the price of daily rice trading, and his methods eventually evolved into what traders and other market watchers call candlestick charting.
Homma found that having a visual representation of daily rice trading allowed him to make more informed buy-and-sell decisions during the hectic trading day. It’s said that Homma once had a streak of over 100 winning trades!
Fast forward to the early 1990s, when Steve Nison published a book and magazine article on candlestick charting. Until then, candlestick charting wasn’t widely used. Nison’s first book, Japanese Candlestick Charting Techniques (Prentice Hall Press), served as an introduction to candlestick charting methods for many traders and investors in the United States. Over the next 15 years, the acceptance and use of candlestick charting became widespread, and the use of computer software for analyzing recurring patterns proved profitable for many traders.
Recognizing the Many Benefits of Candlestick Charting
Trading, investing, and charting styles are plentiful. You can spend hours debating what type of approach to the markets is the best. For me, and for a growing number of other traders, the benefits of a candlestick chart versus other types of charts aren’t really debatable. Let me tell you why.
Changes and developments in the way stocks and other securities are traded (and when they’re traded) have made trading an increasingly complex undertaking. (For more info, see the nearby sidebar, “What makes up a day?”) Because trading is becoming more and more complex, the need for a consistent, dynamic charting method is more important than ever. Traders need easy-to-read charts that allow them to make quick decisions and efficiently analyze patterns. Candlesticks offer those benefits and many more, all covered in this section.
Seeing is believing: Candlesticks are easy to read
It sounds pretty simplistic, but one noteworthy advantage candlesticks have over other charts is their readability. For many people who strain to read the fine print and also for the younger traders who don’t want to deal with the headaches that can come from staring at bar charts all morning, candlesticks are an attractive option. Consider Figure 2-1, which displays a bar and a candlestick in a side-by-side comparison.
Figure 2-1 gives you a basic idea of why candlesticks are easier to read, but it doesn’t really provide a full picture of why they’re also much better at helping traders to visually interpret price action (how the stock or market traded during the day relative to the opening price), which is an essential skill for successful trading. Take a look at Figure 2-1, which takes a couple of weeks’ worth of trading data and displays it using traditional bar charts and candlestick charts, respectively.
Figure 2-1: A bar versus a candlestick.
Notice the dramatic difference between the bar chart and the candlestick chart. By comparing them, you can clearly interpret what’s occurred from day to day, including the openings, closings, and how they change from day to day. The candlestick chart is a superior way to interpret the price action from day to day when compared to a bar chart. Don’t worry — I cover how to read candlestick charts extensively in several other chapters, but even in this simplistic example you can see that knowing where a stock closed relative to its open on a given day is a powerful piece of information that you can glean quickly from a candlestick chart.
What makes up a day?
The definition of a trading “day” used to be very simple. Trading was done on a central exchange with specific opening and closing times. For example, trading on stocks listed on the New York Stock Exchange (NYSE) began at 9:30 a.m. and ceased at 4:00 p.m. Now trading in these stocks commences on some electronic communication networks (ECNs) hours before the NYSE opens and hours after it closes. (An ECN is a network of brokerage firms and traders, which allows for trading directly between the brokerage firms and traders.) A “day,” therefore, is much different than it was in the past. Throw in futures exchanges and currency markets that trade almost 24 hours a day, and this issue becomes even more confusing. With all that trading outside of exchange hours, what constitutes an actual day, for data purposes?
Currently, in the case of stocks, the official open and close are based on the primary exchange they trade on, but in this world of expanding electronic trading, the actual open and close are becoming more blurred. With respect to futures markets that trade almost 24 hours a day, it’s almost impossible to pin down a day. For daily testing, I use data between 7 a.m. eastern standard time (EST) and the close at 3 p.m. to constitute a day.
You can spot bears and bulls quickly
Knowing a security’s closing price relative to its opening price during a certain period is vital information. Candlestick charts allow you to quickly identify the days when a closing price is above an opening price and vice versa.
I like to think of the daily price action as a battle between bears and bulls. Bears win when the price of a security closes lower than its open, and bulls win on the days when the close settles higher than the open.
Figure 2-2 is a great example of bearish and bullish days on a candlestick chart. Although the two candlesticks are the same size and shape, you can tell the difference between a bear and a bull:
The bear: The black filled-in candlestick indicates a bearish performance by the security because the close is much lower than the opening price.
The bull: The hollow (white) candlestick indicates a bullish performance, meaning that the opening is lower than the close.
Chapter 1 covers hollow candlesticks that show a higher close than open and a filled-in candlestick that shows a lower close than open.
Understanding the ways that prices are trending is very useful information when making buy-or-sell decisions. The old saying “The trend is your friend” is a constant reminder that you always want to be on the more dominant side of price action. By recognizing whether the bulls or bears are the more dominant group, you can be conscious of the trend and better prepared to stay on the right side of the market.
Figure 2-2: Bearish and bullish days on a candlestick.
Bulls and bears
The terms bull and bear have been in the trading lexicon for many years. Both terms apply to people and market trends. A bull is a market participant that expects or wants the market to move higher, but it is also an expression to explain when the market goes up: bullish market. A bear, on the other hand, expects the market to decline (person) and indicates a declining market. But where did these terms come from?
Although there’s some debate over the origins of the two terms, they may be attributed to a man named Thomas Mortimer, who wrote about the precursor to the London stock exchange in the late 1700s. He wrote that a bull bought stocks without putting any money down with the hope of selling at a higher price before having to settle up. And according to Mortimer, a bear sold stock he didn’t own without putting up any money also hoping to exit the position at a profit before he was forced to settle up.
Seeing into the future (sort of)
The goal of charting and technical analysis isn’t to see what’s happened in the past, but to attempt to predict the future. Basically, if you can predict the future for a majority of the time, you should be able to profit nicely through wise investing and trading. Because candlestick charts are chock-full of info, they aid a trader as she works to predict and profit from future price moves.
For example, a trader may study old candlestick charts and notice that when a security’s closing price is much higher than its opening price, it seems to open higher the next day — a situation commonly referred to as a gap opening. That trader can buy the security on the close of the day and place an order to sell the next day, thus making a profit. Figure 2-3 provides a clear visual example of a gap opening.
Just by studying past price action on old candlestick charts, the trader in this section’s example is able to predict a small piece of the future and use it to turn a profit. History does repeat itself in markets and trading, and you can use this repetition to your advantage by considering past candlestick charts, which can be a cinch to read. But always keep in mind that as with all aspects of technical analysis and investing, past results do not ensure future returns.
At the very least, be sure to pay attention to price gaps, because they indicate an increase in volatility in the price of a security. When there’s an increase in volatility, there’s an increase in trading opportunity. Many other types of patterns, including those that incorporate candlesticks, reappear and may be profited from.
Figure 2-3: Two candles showing a classic gap opening.
Showing price patterns
Recognizing patterns on candlestick charts is easy, and you can combine two or more candlestick charts to flesh out a reliable pattern that can lead you to profitable trading. For example, a common price pattern that serves as a good sell signal is depicted in Figure 2-4.
The pattern is a two-day pattern, and the third day is a common reaction to the first two days. Here’s the typical progression:
1.The first day is a strong open-to-close day.
The closing price is considerably higher than the opening price. The first day is a victory for the bulls.
2.The second day reveals very little price action because the close is very near the open.
The second day is a wash because higher prices entice more bears to be sellers.
3.After this shift from bullish to neutral price action, the following day is a down day.
The third day is a winning day for the bears!
Figure 2-4: A common candlestick sell pattern.
Once again, a trader who studies candlestick charts and patterns can easily spot this change. Such a momentum shift is useful to someone who owns a security and is considering selling or a trader who has the ability to sell short. (See the sidebar “Selling short, in short” in this chapter for more information.)
Understanding price gaps
Price gaps are very common in the financial markets, and occur on charts when no overlap exists between consecutive period highs and lows. For instance, if XYZ stock’s high is 81 and its low is 80 on a given day, and then the next day it opens higher than 81 — let’s say 83 — and trades in a range between 82 and 84, a gap with no trading exists between 81 and 82. That stock gapped higher and never closed the gap. If the stock had opened much lower — 77 or 78, for example — and never reached the previous day’s low, it would’ve gapped lower.
So what causes price gaps? These gaps are usually the result of news about a certain security being released outside of market hours. It’s not uncommon: Most companies release their quarterly earnings or other big news either after the market closes or before it opens. The market adjustment to that news causes price gaps. Also, a gap may occur on specific stocks just because they’re moving up or down due to a gap in the overall market. This may occur due to a release of some economic news before the market opens or possibly due to a macro event such as a terrorist attack.
You should remember that gaps always get filled when the high to low price action of a future day covers the price range where no trades occurred. But you can’t always tell when gaps will be filled. When the dot.com bubble was building, some Internet stocks had several price gaps on their way up to stratospheric valuations. These gaps were eventually filled, but anyone trying to short these stocks for the gap being filled would’ve ended up in the poorhouse before any gap filling took place. (Take a look at the “Selling short, in short” sidebar for more information on shorting.)
