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Three Types of Candlesticks Every Trader Should Know

August 15, 2016 by Lior Alkalay 4 Comments

Understanding the various types of candlesticks is one of the first things every novice trader should learn. But the experienced trader should also never forget the candlesticks’ significance. Because sometimes, when you have to figure out what’s about to happen with a certain pair and all other indicators fail, it’s the basics of reading candlesticks that can save the day—just like a sailor who navigates using the North Star when all else fails.

But even when you’re not in the unknown, reading candlestick shapes well lets you figure out the immediate trend quickly and can save time in the long run. So, regardless of your level of trading experience, here are three candlesticks every trader should know.

Hammer Candlesticks

A hammer candlestick, as its name suggests, has a hammer-like form, with the opening and closing price rather close, and the lower shade (or upper shade if it’s a reverse hammer candlestick) substantially long.

Candlesticks

What a hammer signals is a change of momentum. If we examine the bearish hammer, we can see the candlestick’s closing price substantially lower than the highest point. That suggests that selling pressure has been so strong that it pushed for a close that is way below the high; in other words, the sellers have the upper hand. And vice versa for a bullish hammer where the momentum is set to turn bullish from bearish.

Note that each hammer type has a stronger version which suggests the change in momentum will be stronger. If we’re on a bullish trend and the next candlestick is a hammer, where the closing price is not only much lower than the highest price for the candlestick but lower than the opening, then it suggests a much stronger change in momentum.

Nevertheless, the greatest determinant in assessing the strength of the rebound to follow is the shade. The longer the shade of the candlestick compared to the rest of the candlestick, the stronger the change in momentum expected.But on the flipside, beware if the shade is relatively short; the change in momentum might be unreliable.

Doji Candlesticks

A Doji candlestick is a candlestick where the opening price and the closing price are so close they almost align. There are several variations of the Doji candlestick, but these three are the most noteworthy.

Candlesticks

The Standard Doji – The standard Doji candlestick is similar to the general description above, with the opening and closing price aligned (or almost aligned) and the two shades sticking out. What a standard Doji implies is a stalemate between the buyers and the sellers at the opening/closing price. When it comes after a certain trend, down or up, it suggests a pause, and could imply either a resumption of the trend or a change in trend. But that’s not all. Compared to the other two, the standard Doji has a relatively short shade on both sides and that suggests a weaker momentum.

Long Legged Doji – This is perhaps the most interesting Doji candlestick. Just like the standard Doji, the opening and closing price align almost perfectly. But unlike the standard Doji, the shades on both sides are much longer. What it means is that, just like the standard Doji, there is a stalemate between the sellers and the buyers at the opening/closing price. However, unlike the standard Doji, the long shades imply high volatility around the stalemate area. This means that once the stalemate is broken, we can expect a burst of momentum because volatility is high.

Dragonfly Doji – The somewhat exotic name for this candlestick type is a bit misleading. With a long low shadow, the Dragonfly tends to have the same meaning as the aforementioned Long Legged Doji, albeit with a weaker momentum. Because, otherwise, it would be a hammer with a closing price higher than the opening price. (The Gravestone Doji is a reversed Dragonfly Doji, with the same meaning as a bearish hammer and hence only worth this brief mention.)

Engulfing Candlesticks

The engulfing candlestick truly lives up to its name. The candlestick can exist in two forms—a bullish engulfing candlestick and a bearish engulfing candlestick.

Candlesticks

The engulfing candlestick’s clearest distinction is that it engulfs in size the aforementioned candlesticks.

A bullish candlestick will have either a lower opening price than the closing of the previous candlestick or the same price as the previous candlestick closing price but a lower low. But more importantly, the closing price of the bullish engulfing candle is a much higher high. The bearish engulfing candlestick, as illustrated below, is the exact mirror of the bullish engulfing candlestick.

What does an engulfing candlestick signal? A start of a strong trend. Bearish or bullish, when you encounter an engulfing candlestick you should expect a strong move which can be beneficial for momentum traders seeking to ride a strong trend but an engulfing candlestick can also be risky for those who have a position in the opposite direction.

In Conclusion

Obviously, understanding the various candlestick types cannot and should not replace the technical indicators. But recognizing the candlestick types does allow you to quickly figure out what’s coming next, even when in uncharted territory. When the picture cannot be completed by technical indicators, knowing the candlesticks to watch could be your guiding star.

Filed Under: How does the forex market work? Tagged With: candlestick chart, doji, engulfing, hammer

How to Trade the GBP after Brexit

July 12, 2016 by Lior Alkalay 2 Comments

The selloff in GBP pairs after Brexit presents a challenge for a trader. At first glance, the strategy for the key GBP pairs, mainly that of the GBP/USD and GBP/JPY, should be simple. The GBP is in vertical short, falling almost in a horizontal line; therefore, the trader should apply a vertical short strategy. But when it comes to the GBP, and for that matter, any pair trading at multi-decade lows, the game plan should be slightly different. So without further ado, here are some tips to trade the GBP after Brexit and any pair that is under its historical lows.

GBP: Two Risks

In the aftermath of the GBP Brexit meltdown, GBP pairs, such as the GBP/USD, have two major risks that we have to navigate around – direction and momentum.

Direction – Since we are talking about multi-year lows, we cannot know when the bottom will emerge, because the pair is in uncharted territory.

Momentum – Again, we have no way of knowing when the momentum will change from vertical bearish movement to a trend to a possible range bound.

So how do we handle those unknowns? We use strategies that minimize the risk from the elements.

Buy on Hammer Reversal

As we can see in the chart below, and as is common when a vertical short occurs, after the vertical short comes a brief bounce. What indicates that that bounce is coming is a hammer reversal candle. A hammer reversal candle is a candle where the middle is long and the opening price and closing price are very close. Once we get a hammer reversal candle we can expect a small bounce.

To increase our confidence in an upcoming bounce we can and should combine a MACD indicator. If the MACD indicator suggests weakening momentum, we get a confirmation. Once we get our confirmation it is a signal to buy; our limit should be set below the opening price of the first full bearish candle of the latest vertical short.

GBP

Why should we use this strategy? When we have no indication as to when the pair will bottom out, it’s hard to take a short without risking a sudden bounce back. Normally, it’s less advisable to trade but, under the current conditions, this pattern gives us a chance to reduce the risk of the unknown and minimize the time we are exposed to a choppy market.

Sell on a Major Pull Back

At some stage, every short, no matter how strong, gets a major pull back. That will be our first real opportunity for a short entry. Once we get a major reversal, and by major I mean at least 38.2% of a Fibonacci retracement, then we will get our opportunity to short. That’s because no bearish trend ends without at least two attempts at the same low. That means that, at such a stage, we are no longer in an unknown and our target is the pair’s lowest point.

It’s important to note that when a pair experiences a major retracement it usually signals the end of a vertical short movement and thus is a signal for us to stop using our hammer reversal strategy.

Our limit is now known, aka the low of the pair. And our signal to short can be varied, as in trading a short under any other circumstance. Oscillators such as the MACD, Average True Range and the Stochastic Oscillator can help us time the resumption of the bearish momentum and ride the bearish wave.

But what’s important to understand here is that after a major retracement, it’s much safer to start trading on a longer term and ride a bearish wave.

In Conclusion

Although those insights have been implemented on the latest meltdown in GBP pairs, the tactics we learned here are not only useful for the GBP but can prepare you for the next FX pair meltdown, whether it’s the Euro pairs or the Brazilian Real pairs. What those tactics teach you is how to trade a rather risky situation with plenty of uncertainty. Sure, it is still risky to trade a currency in a meltdown, but at least, with the tactics above, you can avoid the major pitfalls.

Filed Under: What's happening in the current markets? Tagged With: Brexit, candlestick charting, Fibonacci, GBPUSD, hammer, oscillator, retracement

Understanding Overbought and Oversold

February 26, 2015 by Richard Krivo Leave a Comment

If you are cooking something and you check on it and you see that it is “overdone” or “overcooked”, what is your immediate reaction?  Exactly.  You take the dish out of the oven.  Remove it from what caused its current overdone state and the sooner the better.

Too late for our chicken dinner below…

burned

 

What if your car’s engine is “overheated”?  Same deal…you do what it takes to get the engine cooled down.  Immediately stop doing what caused the engine to become overheated in the first place.

overheat

 

Given these natural reactions, it is easy to see why the initial and almost immediate move by many newer traders to an “overbought” or “oversold” trading scenario is to do the opposite in that case as well.

They reason that since many buy (long) orders moved price up and pushed the indicator into overbought territory, we must do the opposite and take a short (sell) position.  Conversely, if many sell orders caused the price to drop and move into oversold territory we much begin to take long positions.  It’s almost as though they expect price to snap back like a rubber band when it reaches these overextended zones.

Well…what is instinctively the proper reaction for chicken dinners and car engines is not necessarily the proper reaction when trading.

It is important to remember that when an indicator goes into the Overbought/Oversold areas, it can remain there for quite some time.  Just because the RSI or Stochastics indicator reads overbought for example, does not mean that price action on the pair is like a tightly compressed spring that is going to immediately snap back toward the Oversold area.

Let’s take a look at a historical Daily chart of the NZDJPY pair below for an example of this…

overbought chart

Notice on this chart that when Slow Stochastics went above 80 (in the red rectangle) into the overbought area, price continued to go up for another 780+ pips and Stochastics stayed overbought the entire time.  Clearly a trader who went short when it first when into overbought territory would have missed out on a great move.  They also would have gotten stopped out of their short position very quickly.

To see an example of where price retreats  when Slow Stochastics goes into overbought territory we need to look no further than the area labeled “A” on the chart.  In this case the candlesticks around “A”, dojis, spinning tops, shooting star and a hammer, indicate the potential for a pullback.

The point to be made is that either scenario can play out so don’t have a knee jerk reaction to the overbought and oversold areas of an indicator.

Remember…

Only take entry signals from an indicator that are in the direction of the longer term trend.

For example, if the trend has been strong and prolonged to the upside, it stands to reason that the indicator will be in overbought territory since it reflects the bullish push of price action.  To take a short position at that point would to trade against the trend and that would be introducing more risk into the trade.

Good trading,

Richard Krivo

RKrivoFX@gmail.com

@RKrivoFX

Filed Under: Uncategorized Tagged With: doji, hammer, NZDJPY, overbought, oversold, shooting star, short, Stochastics, trend

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