Why It's Good to Know Basic Candlesticking

I did not realize it until a few people pointed it out that I had close to an 80% win rate.  Personally I want to believe it is a fluke because in reality I am not that good.  I'm still learning. As I think about it, I have traded scared for a long time.  Just recently I have begun to trust my stops and allow trades to just work.  But I have always been a very technical person and managed my risk by not trading until I have a group of starts in alignment versus just a couple and using hard, tight stops.  I know to continue to grow and make a living at this I will need to take a little more risks and be a bit more aggressive.

When I first started trading, I was a fan of "clean" charts.  I did not use any technical indicators to assist me in making trades.  I watched the candlesticks, Level II, and the volume.  I was moderately successful. The patterns I learned were based on candlesticks forming it, but not true "candlestick patterns".  The fact is you could see those patterns using any type chart.  I only learned the basics about the candlesticks such as what a shaded and un-shaded candle meant as well as what the wicks meant.  This kept everything simple and clean which is what I needed when I first began learning how to trade.  As I progressed and began to develop my own identity as a trader, I began to learn other indicators to help me with identifying setups and when to enter and exit trades. (VWAP and RSI).  If you look at my charts now compared to when I first started sharing them, you will see they still look pretty clean. The reason is I need the cleanest view of the candlesticks as possible because I feel they tell me the rest of the story.

Just for reference, candlestick patterns are a form of technical analysis and charting used in the market. Candlesticks can be used in all time frames, from those looking for long term investments to those who swing or day trade.  The trick is to not get so engulfed in trying to learn all of the candlestick patterns that you lose everything else.  As you will see, I only use a few to aid me in my trading.  For me, I have learned that if I use candlesticks as part of vetting a setup for a potential trade I can decrease my market risk exposure. However, I will not rely on just candlestick patterns to make a final decision.  It is all part of the setup. If there is any interest I will do another blog looking at the ones I use more closely with more examples.  For instance, lets look at a chart of a ticker I traded yesterday:

$370 profit HMSY Long Stock by AverageJoeTradr

This ticker hit my reversal filter around 11:30.  I like to take these short if I catch them early enough but the RSI was below 25 and I typically stay away because there usually isn't enough room to get a decent profit before it stalls or begins to reverse. In this case it would have been a nice short, but I want to remained disciplined because most of the time it doesn't work out that well. I have made bad trades in the past by not being patient and trying to anticipate but not, I make sure I wait for the signal.  In this case I was looking for a reversal so on the 5 minute chart I want to see a doji making LOD, preferably a bullish hammer, then a nice green candle fully engulfing it:

I don't like the green candle after this hammer in this example because it would be too long for me to be comfortable trading. I couldn't get a tight enough stop to give me the proper risk/reward but this give you the idea what I am looking for.  So if you look at the hammer that formed on LOD around 2:10 on HMSY you'll see that the RSI is in the 15's, a nice green candle printed next, and I entered on the following green candle making my stop on the low of the previous candle at 15.13.  It was a little more than the $50 max but I will go up a little if the setups looks this good.  Now, had the previous green candle run up another .10 or .15, I would have not been able to take the trade or I would have had to use a lot smaller position size to get my risk in check.

My initial target on this reversal was 15.55-.60 to take profits, and snipe another move to the VWAP. It slowed in the high 15.30's and I almost took profits, but if I am going to be a trader, I need to stick to my plan. I moved my stop up to break even.  It was so strong when it made it to the 15.55 mark I just moved my stop up to .55 and held on for the move to the VWAP.  Worst case scenario I would get stopped out on my initial target, but still a good profit.  I held until I had to leave to go get my kids otherwise I would have raised my stop to the VWAP and held to the bell.

As you can see, in this trade I used the RSI to determine whether the ticker was a good candidate to short when it hit my filter and that it was below 20 indicating it was a strong reversal candidate.  I used the candlestick pattern, "bullish hammer reversal", to help verify that a reversal was setting up, and I used the VWAP to help me plan my targets.  Also, if a ticket is within .25 of the VWAP I won't take a reversal trade.  I will wait to see how it react around the VWAP and will execute a trade based on that, but that is not my typical strategy.  I also look at the price action (Level II and volume) and all these stars need to be in alignment before I take the trade.  Has to be a solid setup.  Do I slip up and take bad trades? YES! But I use journaling to help me prove to myself that it's best to wait for solid setups.  So what if I'm bored.  I just need to get back to my real job then!

($51) loss HZNP Long Stock by AverageJoeTradr

Ok, here is another trade I took Friday.  Looking for the same reversal setup.  I didn't get a doji on LOD, which is ideal, but I did get a bullish engulfing signal where you have a red candle fully engulfed by a green candle that printed after it.

I got that and a quick scan of the RSI and it was in the high 14's.  I am a good ways away from the VWAP so I get in.  In this case I forgot to line a couple of the stars up.  Number 1, there was no way I could get a decent stop because the green candle that printed had a .35 range. I entered the trade without figuring my stop.  As soon as I did after I took a position, I was stopped out.  I never checked the price action. The volume for me was too light for a late afternoon push.  Not an ideal trade.  I let the RSI and distance from the VWAP influence my decision without fully analizing the candlesticks or price action

($45) loss NVDA Short Stock by AverageJoeTradr

Another example of a mistake I made on Friday by not taking the candlesticks on the chart into account.  This hit my reversal screener about 12:00 and it looked like it was still in a downtrend.  It was close to the VWAP and the RSI was above 30.  Typically I can get a good .40 to .50 move on a short prior to it setting up to reverse.  I completely ignored the bullish hammer doji that printed and entered a short position because the next candle opened lower and it gave me a good tight stop on the high of the previous candle.  Before I knew it I was stopped out.  Then I looked at the candlestick pattern and there was that doji as big as day telling me no, I'm not going to fade anymore just yet.  Another losing trade that I would not have taken if I had followed my rules for vetting a potential trade.  I get excited when I have a couple of good winning trades and then I feel invincible. That's usually when I try and give it back to the market Gods!

I guess the most frustrating thing for me has been I started out with candlesticking being the basis for my trading which everything else was built around.  Everything I have learned and integrated into my trading has improved me and made me a better trader, but when I start crossing the line and leave out fundamental parts, I begin making mistakes.  I will have my trade vetting routine on a post-it on my monitor from now on.  I know I can't be right all of the time but at least I will be right by following my rules.  I can't control the ticker and what it does after that.  

Green Trading Everyone!