Japanese Candlesticks
Candlesticks are a recording of the epic battle between the bulls (bulls charge up) and the bears (bears claw down). At the center of each candlestick is the body, this represents the difference between the previous candlestick close and the current candlestick close. At either end of the body are thin lines called wicks or shadows, these show the maximum range that the price fluctuated for that given candlestick's time period. A white or green candlestick symbolizes a win by the bulls and show that the price of a currency has risen. A red or black/blue candlestick symbolizes a win by the bears and the price for that time period has dropped.
Support and Resistance
Candlesticks make it easy to identify support and resistance. Support Levels are created when many traders believe a currency is oversold. These levels can be derived from any number of technical indicators including Fibonacci levels and oscillators. These two technical indicators will be explained in later lessons, but for now you can derive support and resistance levels from previous price history. Resistance areas are the same idea as support areas except at these points traders believe the currency is overbought and will go back down The price must bounce off of a resistance or support level at least twice before it can be considered a strong level.
Example of Resistance: on the daily chart below notice how the price bounces off of the 1.4100 - 1.4200 price range three times. This is a strong resistance level.
Candlestick Formations
You'll notice candlesticks with much shorter bodies usually located at both support and resistance, these candlestick symbolize a draw between the bulls and bears, where neither party can gain the upper hand. This is also known as a doji. |
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Similar to the doji and another symbol of indecision between the bulls and bears is called a spinning top, where the wicks are very long in the body is very short. |
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Next up are the hammer or hanging man. These both look the same and signal a reversal, however, the hammer occurs after a downtrend, and the hanging man occurs after an uptrend. These are both symbolized by a short body with no upper wick and a long lower wick. |
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Next we have the inverted Hammer and shooting star. These are signified day a short body with no lower wick and a long upper wick. They also symbolize reversals. The inverted Hammer occurs after a downtrend and the shooting star occurs after an uptrend. |
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Engulfing patterns occur when a candle opposite of the previous candle ranges so that it fully engulfs the previous candle. A bullish engulfing occurs when the body of a white candle completely encompasses the body of a black candle. A bearish engulfing occurs when the body of a black candle completely engulfs the body of a white candle. This is considered a significant reversal pattern. |
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There are many, many other types of candlestick patterns that specialized candlestick traders look for . Some of these patterns are extremely useful to know, however, as beginner the above patterns will be more than enough to look for. You don't want to start seeing patterns everywhere they don't occur all the time, but if you know too much then you will end up looking for them and forcing yourself to see them even if they don't exist.
Homework Trade:
In the graph below, it is rather obvious that the price has bounced off of the 1.3960 level twice. We can safely assume that there is a level of support here. If you wanted to trade this support, first you must make sure that you are going with the larger trend, then you would wait for the price to bounce off of the 1.3960 support level by at least 10% of the total distance to resistance. In the chart below 1.4120 is a reasonable resistance area. So 1.4120 - 1.3960 gives us the difference about 160 pips. 10% is 16 pips. To be safe I would make sure the price bounced off of resistance by at least 20 pips. I would enter the trade at 1.3980 with a stoploss at 10% below resistance or 1.3940. My profit target would be twice my risk of 40 pips, so 80 pips. This makes my first profit point at 1.4060. At this point if I did not sell completely out of all my lots, I would raise my stop loss to break even (1.3980) and continue following the trend. this would give me a guaranteed gain of 80 pips bands I would no longer have any risk in this trade.
Watch your currency pair across several chart time frames and try to identify these five candlestick patterns. You can go back and Forex history if you need to and then notice what the currency pair does after each of these formations. Were they accurate reversal indicators?
Additionally, if you notice strong levels of support or resistance on your current charts, make a trade using what you have learned.
