Basic Technical Analysis From The Butcher, page-22

I'm going to write up something short on candle sticks. Now I will try (I tend to get carried away on things once I get started) to keep it concise and not go into too much detail because candlestick charting is something that you can study in isolation. It is from my understanding one of the earliest forms of technical analysis and as such there is a huge body of knowledge on it so I wouldn't do it much justice. Again, my favourite resources are www.thepatternsite.com and www.stockcharts.com/school Both of the websites are kept up to date, and in the case of the pattern site, Tom Bulkowski who runs it is very heavy on his statistical analysis that he uses to back up his ideas so you can see in terms of percentages how likely a signal means what you think it does. You would be better served to dig through those guys for some really deep analysis.

There are patterns that sets of candle sticks make up which serve as indications, just the same way that larger form chart patterns do. I however, had not had the time to really dig into the individual patterns that these patterns make (however it is one of my aims this year) so what I do is rely on candle shapes at particular moments in time. Keep in mind I do this part time, however I am trying to step into full time trading, I just don't have deep enough pockets to do so yet, so there are unfortunate gaps in my knowledge, and I am forced to back things up on intuition rather than fact sometimes.

Now we should all know by now what candles are at least and how they fit into a chart. The bodies are the opening and closing price, the tails are the high and low price and the colour means a close on a high and a close on a low (Green and Red Generally, but other colours are used). So, keeping in mind that the charts show everything known to market participants at a given point in time, I use this sort of thumb rule when analysing candles: A fat candle means high conviction in either direction, and a small candle means uncertainty. The volume at the point of the candle (sometimes before and after also) works like a multiplier of the conviction and uncertainty. It gets a bit wishy washy after this because at certain points they mean more than others, so I like to think of them as pings on a radar screen; when a funny candle happens at a particular point, it should prick your ears up and put you on alert, but you would be foolish to act on it alone. So an example.

I spotted a nice little example here. I will not name this candle, because it does have one. But I'll let you challenge yourself to work it out. But there are several things that we can spot that serve as an indication to the immediate price. First, that candle has a small body and long tails. So this means that the trading on that day was very volatile but ultimately no one knew the direction of the price; that's textbook uncertainty. Second, it bumped into a point where a resistance line could be set. Third, it is well out side of the Bollinger band.
Finally, and this is a little harder to spot, but the trading had been below the 200MA. We know that the 200MA on a big cap company is an important line and a move above it shouldn't be taken lightly. Given that the price action had recently moved below it, it had attacked it once before and failed, this sharp rise and breach should have been viewed with skepticism. So all these signals together could have been interpreted as a sell signal. Of course, it is always easier to pick these things after the fact.


Good ol' fashioned wheat. Now this little segment of day trading on wheat of some action that I cherry picked shows what fat candles can mean. They show certainty if they are present in non volitile trading. Notice how on those fat candles that when the green fat candles appear the trading continues in the direction it was going in? Same for the reds.

Ah ha! a counter example! No my friend, you're wrong. There are distinct difference in these fat candles and the ones above. Mainly, these candles step outside the Bollinger Bands, making them immediately volatile trading candles. Second, no real trend direction was set, so again, their precence means volatility so they no longer represent certainty, rather irrational exuberance.

Its late now, and that was a lot more than I hoped to write, but hopefully there is enough here to get you thinking. Go check out the websites Ive mentioned for some better examples. And as usual, if you thought that somewhere in this post I encoded secretly some financial advice or a tip to buy some shares actually you are mistaken. It is likely however, you have undiagnosed schizophrenia and your inner voices are telling you to buy shares. My advice, ignore them, don't buy any shares, and go and see a doctor to get your head checked.