Candlestick reversal patterns are essentially just candles that show signs of exhaustion, or a sudden shift in momentum. In other words, we may have been going higher, but suddenly looks as if we are either running out of momentum to the upside, or than the sellers have come in and absolutely taken over. Either one is reason enough to think that we are going to turn things back around. Of course, the opposite is true as well. For example, we may have been falling rather rapidly but eventually the market bounces in the way during the course of the candle that tells us perhaps the buyers are about to take over again. One of the great things about reversal candles is that they can give you a bit of a “heads up” as to trouble ahead. For example, perhaps you were short of a particular currency pair and it forms what is known as a hammer. The hammer is simply a candle that shows that the sellers ran out of momentum, and ended up reversing quite a bit of the momentum. This often can be the sign of the market turning back around to the upside. So if you are already short, this may give you the idea to either exit the market, or at least move your stop loss is to lower levels. You also have the same thing in an uptrend, we form what is known as a shooting star, which is essentially a market going fairly high, and then dropping back down to form a candle with a very long wick. You can move your stop losses higher. On the other hand, when you see the signals you can start trading in the other direction. It’s a great way to pick up trend changes.
The Average Directional Index or ADX, is a momentum indicator that you can use trade financial instruments. It comes with 3 lines, two which shows the directional strength of both positive and negative movement, and then the ADX indicator itself. Most traders ignore the other 2 lines, and for the purposes of this video I will focus on the actual indicator line itself. It is the solid green line, and what it measures it is the actual strength of the trend. It is not dependent on whether or not the trend is up or down, just that it has strength. In other words, it rises when the trend strength is strong, and declines when it may be weakening. The weaker the trend, the more likely you are to see consolidation. When traders use the ADX, they are trying to find a real momentum. So in other words, if we get a break out or some other type of buying signal, traders will often use the indicator to see if there’s any real indication of underlying strength. After all, there are such things as “false breakouts”, which are sudden moves that completely reverse themselves. By using this indicator, you can perhaps avoid some of those. Also, it can tell you sometimes when we are starting to run out of steam, and therefore might be time to step away from the trend and close your position.
One of the most basic forms a technical analysis is trend line analysis. You are essentially looking for support or resistance that follows an angle on the chart. Over time, other traders tend to notice these angles and the support or resistance at that angle into up being a bit of a self-fulfilling prophecy every time we hit that line. However, there are a couple of basic rules when looking at trend line to determine whether or not they are actually valid. As a general rule, the higher the timeframe the more important the trend line. This is because the markets take quite a bit more time to form a trend line on a weekly chart, as opposed to a 5-minute chart. It takes a lot more volume in market trading, and that of course means that there is much more confidence in the barrier. Also, most people require the trend line to withstand at least 3 attempts to break through it. In other words, the trend line needs to be touched 3 times during the previous trading. As far as trend line breakouts are concerned, there are a few ways to trade them. The easiest and simplest way although the riskiest, is to simply buy or sell once we break above or below the trend line in question. However, there is the possibility that you get a little bit of a false break out, so some people will actually use the second method. In this method, people will wait until there is a candle close above or below the trend line in question. Obviously, the higher the timeframe of the candle, the more likely it is to give a true signal. Lastly, some people will be even more risk adverse and wait for not only the breakout, but the return and the retesting of the former trend line as the opposite force. In other words, if we break above the top of a downtrend line, quite often the markets will come back to that trend line and trying to find out if what was once resistance will become support. Once it does, that confirms that the breakout still has plenty of momentum behind it. However, the markets don’t always come back retest, so you do run the risk of missing the move. Ultimately, trend lines are used in almost every trading system out there, and some people will trade just using trend lines themselves. Either way, you have to be very comfortable using them if you plan on doing any type of technical analysis at all.
Candlestick reversal patterns are essentially just candles that show signs of exhaustion, or a sudden shift in momentum. In other words, we may have been going higher, but suddenly looks as if we are either running out of momentum to the upside, or than the sellers have come in and absolutely taken over. Either one is reason enough to think that we are going to turn things back around. Of course, the opposite is true as well. For example, we may have been falling rather rapidly but eventually the market bounces in the way during the course of the candle that tells us perhaps the buyers are about to take over again. One of the great things about reversal candles is that they can give you a bit of a “heads up” as to trouble ahead. For example, perhaps you were short of a particular currency pair and it forms what is known as a hammer. The hammer is simply a candle that shows that the sellers ran out of momentum, and ended up reversing quite a bit of the momentum. This often can be the sign of the market turning back around to the upside. So if you are already short, this may give you the idea to either exit the market, or at least move your stop loss is to lower levels. You also have the same thing in an uptrend, we form what is known as a shooting star, which is essentially a market going fairly high, and then dropping back down to form a candle with a very long wick. You can move your stop losses higher. On the other hand, when you see the signals you can start trading in the other direction. It’s a great way to pick up trend changes. There are also what is known as in golfing candles, and they are simply candles that swallow the previous candle in the opposite direction. What I mean by this is that if the market has been falling, and you simply get a very huge green candle, that typically means of the buyers have taken control again. With that being the case, it looks as if it’s time to either exit any short positions that you have, or start buying. Obviously, the exact opposite is true as well.
In this video, I look at an indicator called the Bollinger Bands. This is an indicator that uses a moving averages as the “mean” of the market. In other words, it’s where the market “should” be in general. That is the centerline of the 3 lines that plot on the chart. The other 2 are based upon 2 standard deviations from the normal pricing. In statistics, 95% of all distribution in a sample set typically falls within 2 standard deviations, and the Bollinger Bands try to form trading signals based upon this mindset. Looking at the chart, you can see that every time the market gets a bit oversold, and typically will try to reach towards the middle line as we go along. The first couple of trades that I point out in this chart are small ones, because they are oversold and we simply go to the moving average. However, you would’ve known this at a time as the Bollinger Bands were fairly narrow. This means that there isn’t a whole lot of volatility in the marketplace, so we are fairly quiet. If you follow the trend overall, typically you do better. There is a trade on this chart that fired off a buy signal, that didn’t reach the mean until lower prices, which of course would have been a loss. However, it should be noted that we were in a downtrend at that point. Without a doubt, the most common way to trade this market is to simply trying to aim for the norm of the indicator, which of course is the moving average, but some people do try to buy oversold conditions and aim for overbought conditions. Of course, they work in the opposite direction as well but that tends to be the more aggressive and dangerous way to trade this particular indicator. You can make an argument that we do go back and forth eventually, but the “safest” way is to simply look for normalcy. There is an argument to be made that Bollinger Bands need a relatively steady and call market, which makes sense considering we are looking for the norm and not the extreme. It should be noted that this is one of the most well-known trading environment, as it allows you to take a little it’s and pieces of the market as we either continued to climb or fall, going with the trend and has been used for decades in the stock markets.
A candlestick that signals continuation can come in several different forms. For example, it can be a very bullish candle that is an impulsive, during a fairly reliable uptrend. In other words, it seems that the buying pressure has picked back up. This obviously works in downtrend as well, as a strong red candle in a downtrend also suggests that the momentum is picking up. Essentially, those are the easiest continuation candlesticks to find. We also have other candlesticks which can happen after pullbacks. For example, an uptrend you could get a hammer which shows that the selling has abated, and that the buyers are starting to come back into the marketplace. Remember, the hammer essentially is a candle with a long wick underneath it, showing that the market has run out of selling pressure. Obviously, a shooting star can mean the same thing, if we have recently bounced and what has been a longer-term downtrend. The shooting star is essentially the same thing as the hammer, only the long wick is above, meaning that the buyers have run out of momentum.
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