The Study Of Stock Market Through Technical Analysis

Lesson -> The Candlesticks - Basics

4.1 - History repeats -The Presumption

As we have already mentioned, the technical analysis relies on the fact that history is likely to repeat itself. This is probably the most important assumption in Technical Analysis.

This assumption is important because candlestick patterns heavily depend on it.

Consider today the  7th July 2014, few events are taking place in the stock. Following the factor:

  1. The stock has been falling over the past 4 trading sessions
  2. Today (7th July 2014 is the 5ThSession, and the stock is falling due to relatively lower volumes
  3.  Today's stock trading range is much smaller than the four previous days.

Let's assume these factors are in play and that the stock falls on the 8th of July 2014. The stock then rallies to a positive close. The stock rose on the 6th day as a result of these 3 factors.

The time passes, and we can safely say that the same set of factors are observed for five consecutive trading sessions. What are your expectations for the 6 th day of trading?

History repeats itself, nothing but an assumption. This assumption needs to be reaffirmed. If a set of factors has worked in the past, it tends to be repeated in the future. We expect the same outcome, provided that the factors are the exact same.

This assumption means that we can expect stock prices to rise on the  6th trading session.

4.2 -The Expected Patterns In Candlestick:

Candlesticks can be used to identify trading patterns. The patterns help technical analysts to plan trades. Patterns are created by grouping multiple candles in a specific sequence. Sometimes, however, a single candlestick pattern can identify powerful trading signals.

Candlesticks can therefore be broken down into multiple patterns or one candlestick.

We will learn the following under the single candlestick pattern:

  1. Marubozu
    1. Bullish Marubozu
    2. Bearish Marubozu
  2. Doji
  3. Spinning tops
  4. Paper umbrella
    1. Hammer
    2. Hanging man
  5. Shooting stars

Multiple candlestick patterns can be a combination of multiple candles. We will be learning the following information under the multiple candlestick patterns:

  1. Engulfing is a pattern
    1. Bullish Engulfing
    2. Bearish Engulfing
  2. Harami
    1. Bullish Harami
    2. Bearish Harami
  3. Pattern for Piercing
  4. Dark cloud cover
  5. Morning Star
  6. Evening Star

You must be curious about the meanings of these names. Some patterns, as I mentioned in the previous chapter retain their original Japanese names.

Candlestick patterns allow traders to develop a holistic view. Each pattern has an inherent risk mechanism. The entry and stop-loss prices can be viewed using candlesticks.

4.3 - Candlestick: Some Speculation

There are a few things we should remember before we dive in and begin to learn about the patterns. These assumptions apply to candlesticks only. These assumptions are specific to candlesticks. We will continue to refer to them later on.

These assumptions might not be obvious at this stage. These assumptions may not be obvious to you at this stage. I will go into more detail as we move forward. These assumptions should be noted.

  • Sell weakness and buy strength- bullish (blue), and a weak (red) candle represents strength. Therefore, whenever you buy, make sure it is a blue day. If you sell, make sure it's a day with a red candle.
  • Flexibility with patterns (quantify, verify)- Although a textbook definition of a design pattern may contain certain criteria, market conditions could lead to minor changes to the pattern. You need to be flexible. But one must be flexible within certain limits. Therefore, it is important to quantify flexibility.
  • Find a previous trend- A bullish pattern should be viewed as a prior trend. If you are looking for a bearish trend, the prior trend must be bullish.

We will be learning more about single candlestick patterns in the next chapter.

Key points:

  1. History is prone to repeat itself. We altered this presumption by adding the factor angle.
  2. You can break down candlestick patterns into multiple patterns.
  3. Three important assumptions are made about candlestick patterns.
    1. Sell weakness and buy strength
    2. Flexibility is key - verify and quantify.
    3. Consider following a previous trend.