Trading Elementary School Lesson 2

Trading Elementary School Lesson 2 – Full Lesson List:

1. Support and Resistance.
2. Japanese Candlesticks and Trading.
3. Fibonacci Trading.
4. Moving Averages.

Trading Elementary School Lesson 2 – Japanese Candlesticks and Trading

Japanese candlesticks are a type of charting. As they say, a picture tells 1,000 words. So, to save us writing a thousand words (and you having to read them), we’ll just show you the below image:

You can use these for any time-frame (1hr, 24hrs, etc., it doesn’t matter).

The Japanese candlestick will then describe the price action in that given time-frame. Just for reference, they are called “Japanese” candlesticks, because they were invented in Japan (obviously).

The information required to construct a Japanese Candlestick is:

1. Open Price.
2. High for the time period.
3. Low for the time period.
4. Close for the time period.

To create the candlestick follow these rules:

1. If close is above the open the it’s a hollow/transparent candlestick.
2. If close is below open, then a filled candlestick (black/coloured).
3. The transparent/filled section is the ‘body’.
4. The thin lines sticking out of either end are ‘shadows’. They represent the high/low range

(Top of upper shadow is the ‘high’. Bottom of lower shadow is the ‘low’).

Japanese Candlestick Anatomy

The size of the ‘body’ of the candlestick indicates the strength of the buying activity, in the given time period. The longer the body the stronger the buying/selling pressure (depending on the colour of the stick).

A short body stick indicates there was little buying/selling activity in the given time period.

In summary:

1. Long and transparent = strong buying activity (the longer the white candlestick, the further the close, above the open). So this means aggressive buying pushed the price and it increased a lot from open to close, for the time period.
2. Long and filled = strong selling activity (the longer the white candlestick, the further the close, below the open). So this means aggressive selling pushed the price down a lot for the given time period.

What’s in the Shadows

Long shadows (lines) indicate that trading prices occurred well past open/close.

Short shadows indicate the opposite. And most of the price action was kept in a tight range, near to the open/close.

To summarise the shadows:

1. Long upper shadow and short lower shadow = buyers bid price higher, but then sellers took charge and drove prices back down. So trading ended back near its open price, for the time period.
2. Long lower shadow and short upper shadow = sellers forced price lower, but then buyers took charge and pushed prices back up to near its open price by end of trading.

Basic Japanese Candlestick Patterns

The standard patterns to know are:

1. Spinning Tops.
2. Marubozu.
3. Doji.

1. Spinning Tops

These are Japanese Candle Sticks with long upper and lower shadows and small bodies. They can be either colour. This pattern indicates indecision between buyers and sellers.

There is little movement from open to close.

The long shadows show that buyers and sellers were tussling back and forth, without anybody but gaining the upper hand. There was a stand-off.

To interpret this pattern, if you see a spinning top formation during an uptrend, buyers are running  out. Look out for a reversal. A spinning top formation during a downtrend would indicate a lack of sellers remaining. Look out for a change in direction the opposite way.

2. Marubozu

Here there are no shadows from the bodies. This means the high/low is the same as the open/close.

There are two types of Marubozu:

1. White Marubozu : Long white body and no shadows. Open price = low price / close price = high price. This candle is very bullish.
2. Black Marubozu : Long black body and no shadows. Open price = high price / close price = low price. This candle is very bearish.

3. Doji

A doji candle has a very small body. It is so small that is appears as what looks like a horizontal thin line. This give the candlestick the overall appearance of a cross.

This would indicate that, while pricing moves both above and below the open price, during the given time period, it closes very near the open price.

Buyers and sellers tussled in trading, during the period, and the end result was a draw.

When you see a Doji form after a series of candlesticks with long bodies, this is a signal. It indicates that sellers are becoming tired and they’re weakening.

This may well be your opportunity, as a buyer, to come into the market at a cheap price. However, before getting too excited, you’ll need to confirm the price reversal to profit. So here you are looking for a white candlestick that closes above a long black candlestick’s open.

Single Candlestick Patterns

The single candlestick patterns we will be looking at here are:

1. Hammer / Hanging Man
2. Inverted Hammer / Shooting Star

1. Hammer / Hanging Man

Hammer and hanging man look the same, but have opposite meanings. They are characterised by short bodies, long lower shadows and a very short (or no) upper shadow.

The hammer pattern indicates that a bottom is approaching. The long line (shadow) is indicative that buyers have finally managed to overcome all the selling and close is near open.

While this hammer pattern is indicative of a good entry point to go long, it is not absolute. More confirmation is needed.

Such confirmation would typically be a white candle stick that closes above the open, on the right side of the hammer move, as above.

The hanging man pattern is the opposite. This would indicate that a top is approaching, as sellers start outnumbering the buyers.

The long line (shadow) at the bottom indicates that prices have been pushed lower by sellers during the given period. While Buyers have pushed the price up again, they have done so only to a point near the open.

So now we should be wary that there are not enough buyers left to sustain the momentum to the upwards price action. Perhaps consider going short at this point.

2. Inverted Hammer / Shooting Star

On the opposite side of the spectrum we have the Inverted Hammer / Shooting Star.

They look identical, and they differ from the previous formations in that the line (shadow) is long on the upper side.

We get an inverted hammer formation in a declining market and we may be in for a reversal on prices. The long shadow at the top indicates that, while buyers tried to bid prices higher, sellers resisted and worked to push the price back down. However, the buyers won the skirmish and the session price closed near its open.

Given the above, we may very well have an indication that all the sellers are done and we are only left with buyers.

On the opposite side of the spectrum, we have the shooting star pattern. The short body with the long upper line (shadow) is the same as the hammer formation. The only difference is we see it when the price has been rising.

The formation is indicative of a price that opened at its low and did a pull back to the bottom, after rallying. Sellers overcame the buyers. The pattern is a bearish indicator that the market has run out of buyers.

Dual Candlestick Patterns

Here we look at patterns involving 2 candlesticks. Hence the name ‘dual’ candlestick. The combination of certain candle-stick patterns together can be a stronger indicator than just a single formation.

The most common patterns to watch for are:

1. Bullish Engulfing Candles:

A dual candlestick pattern signalling a strong bull price action may be on the way. This occurs when you see a bearish candle, immediately followed by a larger bullish candle.

2. Bearish Engulfing Candles:

This is the opposite of the bullish engulfing candle pattern. The bullish candle is followed immediately by a bearish candle. This would be a strong indicator of a coming downward trend.

3. Tweezer Tops / Bottoms:

These are dual candlestick patterns indicating a reversal. This patterns typically occur after an long uptrend / downtrend period. Look out, as a reversal is likely.

They are named this because the pattern on the chart looks like a pair of tweezers.

What you want to look out for is when the first candlestick matches the overall trend is the same as the overall trend. But then the 2nd candle stick is the exact opposite, forming that tweezer shape.

Make sure that the line (shadow) is of equal length, in the same direction.

Triple Candlestick Patterns

The main triple candle stick patterns to watch are:

1. Evening / Morning Stars.
2. Three White Soldiers / Black Crows.
3. Three Inside Up and Three Inside Down.

1. Evening / Morning Stars:

These are reversal patterns and you’ll typically find them at the end of a trend.
You’ll spot them when you see a bullish candle, followed by a candle stick with a small body (bullish and bearish), then the third candle confirms the reversal when it closes past the midpoint of the first candle.

2. Three White Soldiers / Black Crows

For the three white soldiers pattern you’re looking for three long bullish candles after a downtrend. This would indicate a reversal. After an extended downtrend period it is a very strong signal that the market has reversed. It’s one of the strongest.

Such a pattern is only confirmed valid if the second candlestick is larger than the previous candle body. Further, the second candle stick should have a small (or no) upper line (shadow).

Then the final candlestick should be the same size as the second, at least, with a small (or no) line (shadow).

When you see that, it’s a three white soldiers pattern.

The three black crows pattern is the exact opposite of three white soldiers.

3. Three Inside Up and Three Inside Down

Three inside up is a trend-reversal pattern at the bottom of a downtrend. With it a new uptrend may be starting.

For a three inside up formation you are looking for the first candle at the bottom of a downtrend, with a long bearish candlestick. Then the second candle will come up to at least the midpoint of the first candle. And the third candlestick should to close above the first candle’s high.

On the other hand, the three inside down formation comes at the end of an uptrend. It is the inverse of the other pattern.

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