This is the second part (Continuation of my previous guide: Candlestick charts Technical analysis).
As mentioned in the previous article, I'm going to cover some candlestick patterns you can encounter on any asset.
Before moving on, here are a few points to note:
Technical analysis (TA) is best used to identify small inefficiencies in the market, and are best suited for short-mid term trades/investment opportunities (say scalping and swing trading). I would not personally recommend TA alone for long timeframe investments and stuff, and in case you want to do that, please consider checking the fundamentals, and sentiments behind the asset as well.
Holding period can range from a few minutes to around a few weeks, (at max, around a few months in some cases, and not beyond that)
Often, you may hear people telling that TA doesn't work in Bitcoins/altcoins, or they missed out big pumps, or they lost huge money.
These are because:
- They lost money because of poor risk management
- They missed out pumps, because TA is used to identify short term inefficiencies, and is more about getting consistent returns from a market
- People become too greedy or emotionally attached with an asset.
- Because they FOMO or panic sell/buy an asset
All these things even happened with me as well, in my early days
Disclaimer: I'm not a certified financial advisor, and even though I've been trading for quite a few years, I urge people reading this, and my other posts to #DYOR (Do your own research) before taking any financial decisions! There is no guarantee whatsoever that you will become a profitable trader.
I'll try to cover this guide in the most newbie friendly way as possible, and in case you don't understand something, feel free to let me know in the comments, or on Twitter :)
The content of this article is primarily for educational purpose only.
Here is the link to the previous series in case you have missed out: [1], [2], [3]
As mentioned in my previous article, TA is versatile, and is not just limited to cryptocurrencies. It can be applied on any asset, because in the end, humans with similar psychology are trading all the assets. (If someone says TA can't be applied to Bitcoin, ask that person whether aliens trade this asset)
For applying TA, you need not understand the fundamentals behind an asset.
It can be Gold, silver, Bluechip equities, microcaps, bitcoin, altcoin, shitcoins, anything.
If there are buyers and sellers in the market, TA can be applied.
A few assumptions in TA:
- Market discounts everything: For example: If some coin (or asset) is having any listing news on a major exchange, the price may start going up before the news is published, maybe because an insider started buying before everyone else. But a technical analyst will spot the price change, and take a trade. For the Technical analyst, the "How" is more important than the "why". He/she may not be interested to know why the insider bought the shares/coin before listing, rather, "how" the price will react after listing.
- History Repeats itself: I'd rather say it tends to rhyme. Have a look at the famous wall street cheat sheet! (do a search on your favorite search engine, and you may be amused)
- Prices move in trend: All major moves in the market is an outcome of trend.
Two different types of patterns in candlesticks:
- Single Candlestick patterns
- Multiple candlestick patterns.
These are the two types I'm going to cover in the series. Most of them can be found online, elsewhere, for free as well, but I'm going to cover a few more insights later on, while taking reference from these articles
Before we go on, we should follow a few rules:
There are a lot of people who get 'married' to a certain asset, and they keep on buying that asset, even when the asset is trending downwards, and they continue to do that until they get REKT. Then they get frustrated after some more time and rage quit, cut losses, and after which the price actually starts going up. (lol)
Now this kind of a thing happened with me as well, so I've started following a few rules which helped me personally:
- Always buy strength and sell weakness. (But at the same time, that doesn't mean that you will buy the top of an asset. you won't want to buy an asset which pumped 200% in one day; that will be illogical). Similarly, if you have a managed risk, and you believe in a certain asset, don't do TA on that. simply buy small amounts and forget. That's the best strategy.
- Be flexible with patterns. The defined pattern on textbooks, and on various educational videos, and even on this article may be different than the actual patterns. There will be variations, which you need to identify.
- Look at te previous trend: If you are looking at a bullish pattern, prior trend should be bearish. If you are looking at a bearish pattern, prior trend should be bullish.
Single candlestick patterns:
Single candlestick patterns are Japanese candlestick formations composed of just one candlestick.
Candlesticks covered:
- Marubozu
- Hammer/Hanging man
- Inverted Hammer/Shooting Star
- Spinning Top
- Doji
Marubozu
Also known as: yo sen(bullish)/in sen(bearish):
This candlestick contains a long body, with no visible wicks/shadows.
Calculations:
a) Bullish Marubozu/Yo Sen: Open = low and close = high; and there should be a good difference in the Open and close price.
b) Bearish Marubozu/In Sen: Open = high and close = low; and there should be a good difference in the open and low prices.
Bullish marubozu will signal a buying opportunity, and bearish marubozu will signal a sell opportunity.
Here's how it looks in the actual chart:
Example, of Bullish Marubozu(marked by MB) on Bitcoin 4H chart:
Notice the spike in price after the Marubozu was formed.
Similarly, the same case holds true for a bearish mazubozu price as well.
Stoploss: The low of the candle (for bullish) and high of the candle (in case of bearish marubozu.)
Take profits: 0.5-1%, or more, depending on other factors.
Alrernatively, you can keep holding with a trailing stoploss. (More on this later. These fall under advanced order types, so if you don't understand yet, don't worry. I'll cover them later on)
Hammer/Hanging man:
Ideally, this kind of a candlestick looks like a hammer, where the wick will be usually two times, or even longer than the body.
Both the candlesticks have small body and long wick/shadow at the bottom.
This candlestick price action shows sellers came into the market during the period but by the close the selling had been absorbed by buyers. Hence, the bullish bias, if hammer occurs after a downtrend.
A hammer formed when previous trend is down signals a bullish future. (long/buy)
A hammer formed when previous trend is up,(also known as hanging man) signals a bearish future. (short/sell)
Let's have a look at a few examples, in terms of recent price action on Bitcoin charts:
Stoploss: the low of the candle.
Take profit: It is difficult to find out, so it's better to use a trailing stoploss here, and watch the reaction of the next candle..
(I personally take a trade, and watch out for small signs of bullish exhaustion before exiting)
Note:
There can be setups where a bullish hammer is formed, but the open is higher than the close (or i other words, it is a red, or a black/transparent hammer). If the previous trend is down, both of them are bullish in nature. Similar for the hanging man setup as well.
Let's have a look at the hanging man setup:
While setting stoplosses, we should take into consideration, that there can be fakeouts as well (take the above example only where the next candle breached above the high of the hangingman pattern before Bitcoin started trending down). So we should be cautious of the fakeouts while setting stoplosses. Ideally, we should set some buffer aside)
Quick Note: Hammer is Bullish, Hanging man is bearish.
Inverted Hammer/Shooting Star:
Just like the sibling of Hammer/hanging man, this looks exactly the same and opposite on chart.
Both candlesticks have small bodies, and long wick/shadow at the top.
Inverted Hammer occurring in a downtrend usually signals a reversal (high probability of going up) , and a shooting star candle occurring after an uptrend signals a reversal (high probability of going down)
Let's have a look at the Bullish inverted hammer in action:
Note: This kind of a candlestick occurring in a downtrend signals a reversal, as you can see in the above chart. The inverted hammers have been marked.
Also note that the first inverted hammer trade setup got invalidated, made a long lower wick, and then went up. so that is another reversal in play. This is a situation before a major move, which usually traps a lot of traders while their stops get hit and then the trade goes in the opposite direction.
In the second inverted hammer, which occurred after a small bearish trend, it had a small upwar movement, and respected the stoploss.
So keep this scenario in mind as well! This can save you some frustration.
If you are solely playing using candlesticks, just move on, an catch the next setup if your stop gets hit. Discipline and risk management is more important.
Now let's have a look at the shooting star candle in action:
Recommended Stoploss: subsequent highs or lows of the candle. (Low in case of bullish candle, High in case of a bearish candle)
Recommended take profit: Usually it can be safe to take a 1:1 Risk:Reward setup, and you can take the targets to be equal to the length of the body, though you can update your stoploss in profits on the next candle and let the win run on it's own.
Spinning Top:
If a candle has a small real body, with the upper and lower shadows being almost equal in length, it is called a spinning top.
This means, buyers and sellers, both are unable to take prices to their preferred direction.
But, this can give useful information if the prior trend is considered, just like the hammer example.
This is because, we can be certain that a particular trend is losing ground; even though we can't be 100% sure which side will pick up.
Sometimes, this can even signify further indecision and signal more sideways movement and this is the place where both bulls and bears get chopped.
If you notice the volume, you will even see the volume declining on the subsequent candles, as the sideways price action continues, which further signifies that both bulls and bears are losing ground.
Spinning top in action: Both bullish and bearish scenarios.
Quick note: Spinning top after a downtrend signals that trend may go up, and spinning top after an uptrend suggests that trend may go down.
Stoploss: This can be critical to decide, as many spinning tops won't result in a reversal.
But you can use other metrics for confirmation.
If the candle is unusually large, the risks will be more, so it is better to take very little risk.
Take profit: This does not provide a price target, so it is better to look out for other trend changes and use a trailing stoploss and book profits on next immediate trend change.
Doji
Dojis are very similar to the spinning tops.
The only difference is that this particular candlestick does not have a real body at all!
So, the opening price, and the closing price will be almost same. There will be wicks on both sides.
The upper and lower shadows/wicks can practically be of any length.
Whatever we learnt for spinning tops apply to Dojis as well.
Doji represents that neither the bulls, nor the bears are in control.
If you break down the chart, (In my case since I am using 4H chart, you can go to the 1 hour chart, or even a 15 minute chart, to see what's cooking, to get the fine print.
Many times I have personally seen spinning tops and dojis act as continuation of a trend, rather than reversal, so this is one reason, I look out for other confirmations before taking a trend.
(Stay tuned for my article on Chart pattern, where I will cover about trend continuation, consolidation and stuff)
As a hint: If you know about symmetric triangles forming on chart, imagine that.
Let's say a symmetric triangle formed on a 15 minute chart. Now if you zoom out and check the daily chart, you will see a Doji (mentioned below) or a similar spinning tops :)
I'll share this thing later with a live example later on, which will clear the concept behind many things later on.
Let's see dojis in action:
As you can see, on this chart, there are two dojis in action, marked on the chart above.
In the first scenario, it briefly signalled a short term reversal in price, before going down again.
So if you spot a doji/spinning top, remember that the whole market is in indecision.
Now there can be some variations in Doji.
A gravestone doji is one where the open and close price is at the low price, or very near to the low price. Gravestone Doji after an uptrend, just like shooting star, signals a reversal.
A dragonfly Doji, is one where the open and close price is at the high price, or very near to the high price. Dragonfly doji, forming after a downtrend, just like a bullish hammer, signals a reversal.
A long legged doji signals indecision.
I am sharing the image I took from Investopedia below:
Source: https://www.investopedia.com/terms/d/doji.asp
*Also note: A gravestone doji, at the end of a downtrend, may potentially signal a bullsih reversal, just like the bullish inverted hammer example.
Similarly, a dragonfly doji, at the end of an uptrend, may potentially signal a bearish reversal, just like the bearish hanging man example!
I'll recommend you to check the investopedia article, and other sources as well, for reference.
In my opinion, it is not difficult to learn about candlesticks. There are plenty of free resources online, so do check them out!
Investopedia, Wikipedia, Babypips, Nasdaq, Zerodha varsity (this is an Indian stock market broker) and some blogs are great free resources.
Note: If you want to see the candlesticks on tradingview, like in my examples, go to the "Indicators" section and select the candlestick pattern option.
Feel free to play around with them.
Further reading:
https://www.babypips.com/learn/forex/basic-candlestick-patterns
https://zerodha.com/varsity/chapter/single-candlestick-patterns-part-1/
https://www.nasdaq.com/articles/overview-single-candlestick-patterns-2019-06-07
Candlestick patterns:
https://hitandruncandlesticks.com/marubozu-candlestick-pattern/
https://www.investopedia.com/terms/h/hammer.asp
https://www.investopedia.com/terms/d/doji.asp
https://www.investopedia.com/terms/s/shootingstar.asp
So as you see, if everyone has access to almost all resources, why can't everyone become profitable traders?
Ans: Because the secret is risk management, which no one teaches you. π
I can't teach risk management through blogs, but I'll cover about them over time in my future blogs.
Remember: If you are asked to take a position in a market blindly, you still have a 50% chance of going down, and a 50% chance of going up.
It depends on other factors, whether the trade will be in your favor or not.
Second thing which many people miss out or ignore is the high market fees.
If you keep on paying high market fees, profitable trades can run into losses.
Stay tuned for my next article, which will be on multiple canlestick patterns, an then I'll move over to the basics of support and resistances!
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