How to use candlestick charts and indicators-MillionFin Expert

How to use candlestick charts in the stock market

In the stock market, learning to read candlestick charts is crucial. These charts reveal the interplay between supply and demand, influencing market prices. By mastering this skill, day traders can better comprehend price shifts and gain insights into market trends. Let’s delve into the art of reading candlestick charts for day trading! 📈

Understanding Candlestick Charts in Day Trading

A candlestick chart is a valuable tool for traders to analyze price action in financial markets. By studying individual candles, traders can determine opening and closing prices for specific periods, as well as highs and lows. This analysis provides insights into trends and potential reversals. Candlestick patterns on forex charts reveal trend continuation or potential reversals, while individual candlestick formations signal optimal buy or sell opportunities.

The chosen timeframe determines the duration each candle represents; for instance, daily candles illustrate open, close, high, and low prices for a day. Interpreting candle components helps traders make informed forecasts about potential price movements, such as identifying significant gaps between a candle’s close and open that may suggest further price declines.

How do you identify candlestick patterns?

In candlestick trading, the candle’s body reflects opening and closing prices during a specific period. This information is crucial. Traders can quickly grasp the price range for a stock within that timeframe by glancing at the body. The body’s color provides insights into whether the stock price is rising or falling.

Here are some key points:

• Red candles in a month-long chart (with each candle representing a day) indicate a declining price trend.
• The vertical lines above and below the body, known as wicks or shadows, represent the stock’s high and low traded prices.
• Short upper wicks on red candles suggest the stock opened near its daily high.
• Conversely, short upper wicks on green candles suggest the stock closed near its daily high.

In summary, a candlestick graph reveals a stock’s high, low, opening, and closing prices. Pay attention to body length, color, and shadow length—they convey valuable information about market sentiment. Understanding these details is essential for interpreting candlestick charts effectively.

Candlestick Chart Patterns

A candlestick chart is a valuable tool for comprehending investor sentiment and the dynamics between demand and supply, bears and bulls, greed and fear, among other factors. While a single candle provides useful information, identifying patterns involves comparing it with its preceding and succeeding candles. To fully capitalize on these insights, traders must grasp various patterns within candlestick charts.

Let’s categorize these patterns into two sections:

1. Bullish patterns
2. Bearish patterns 

Bullish Candlestick Patterns

1. Hammer Pattern:
   • Characterized by a small body and an elongated lower wick.
   • Typically found at the end of a downward trend.
   • Signifies a powerful surge of buying activity, even in the face of selling pressures.
   • A green body indicates a stronger bull market than a red body.
2. Inverse Hammer Pattern:
   • Exhibits a short body and a long upper wick.
   • Commonly appears at the bottom of a downward trend.
   • Suggests buyers are poised to regain control.
3. Bullish Engulfing Pattern:
   • Consists of two candlesticks: a small red candle completely encompassed by a larger green candle.
   • Indicates a bullish market driving prices upwards, even if it opens lower than the previous day.
4. Piercing Line Pattern:
   • Involves a lengthy red candle followed by an equally long green candle.
   • The second candle’s closing price must be above the midpoint of the first candle’s body.
   • Clear sign of robust buying pressure.
5. Morning Star Pattern:
   • Three-candle pattern: short-bodied candle sandwiched between long red and green candles.
   • No overlap between short and long candles.
   • Strongly indicates diminishing selling pressure and emergence of a bull market.
6. Three White Soldiers Pattern:
   • Comprises three green candles with minor wicks, opening and closing at higher levels than the previous day.
   • Observed after a downtrend, suggesting an imminent bull trend.

Bearish Candlestick Patterns:

1. Hanging Man Pattern:
   • Exhibits a short body and a long lower wick.
   • Typically found at the peak of an upward trend.
   • Signifies that selling pressures outweighed buying momentum, revealing bears gaining control.
2. Shooting Star Pattern:
   • Features a brief body and an extended upper wick.
   • Commonly seen at the pinnacle of an upward trend.
   • Often opens higher than the previous day, followed by sharp decline—resembling a shooting star.
   • Clear indication of selling pressure prevailing in the market.
3. Bearish Engulfing Pattern:
   • Involves two candlesticks: small green candle fully engulfed by a larger red candle.
   • Manifests at the peak of an upward trend.
   • Signals deceleration in upward movement and impending downtrend.
   • Downtrend more pronounced if red candle’s size is substantial.
4. Evening Star Pattern:
   • Three-candle pattern: short-bodied candle sandwiched between long red and green candles.
   • No overlap between short and long candles.
   • Strong indication of reversal in upward trend.
   • Heightened significance if third candle surpasses gains made by first candle.
5. Three Black Crows Pattern:
   • Features three consecutive red candles with small wicks, opening and closing at lower levels than previous day.
   • Observed after an upward trend—robust indication of imminent bear market.

What is the 3 candle rule?

These two candlestick reversal patterns appear on candlestick charts. Each pattern consists of three individual candles arranged in a specific sequence. They signal that the current trend has lost momentum, potentially leading to a reversal in the opposite direction.

Understanding Three Inside Up/Down Candlestick Patterns

On candlestick charts, the three inside up and three inside down patterns are types of candle reversal patterns. These patterns require three individual candles to form in a specific sequence, indicating that the current trend has lost momentum and a move in the other direction might be starting. 📉📈

• Three Inside Up Pattern:
  • Bullish reversal pattern.
  • Composed of:
    1. Large red candle.
    2. Smaller up candle contained within the first one (bullish harami).
    3. Another green (up) candle closing above the previous one.
• Three Inside Down Pattern:
  • Bearish reversal pattern.
  • Composed of:
    1. Large green candle.
    2. Smaller down candle contained within the first one.
    3. Red candle closing below the previous one.

Trading the Three Inside Up/Down Candlestick Patterns

The three inside up/down pattern isn’t necessarily a trading signal, but rather an indicator that the short-term price trend might be shifting.

If you choose to trade based on this pattern, here’s a possible approach. For a bullish three inside up, you could initiate a long position near the close of the third day’s candle, or at the opening of the next day. Your stop loss could be set below the low of the first, second, or third candle, depending on your risk tolerance.

In the case of a bearish three inside down, you might want to enter a short position near the close of the third day’s candle, or at the opening of the following day. Your stop loss could be set above the high of any of the first three candles.

These patterns don’t come with profit targets. So, it’s advisable to have another strategy for deciding when to book profits if they arise. This could involve using a trailing stop loss, exiting based on a predetermined risk/reward ratio, or employing technical indicators or other candlestick patterns to signal when to exit.

The pattern is quite prevalent, but its reliability is not always guaranteed. It’s a short-term pattern, so it might occasionally lead to significant trend changes, but more often it results in minor to moderate shifts in the new direction. There’s also a chance that the price won’t continue in the anticipated direction following the pattern, and might instead revert back to the original trend.

Aligning your trades with the long-term trend could potentially enhance the effectiveness of this pattern. For instance, during an overall uptrend, you might want to look for the three inside up during a pullback. This could indicate that the pullback has ended and the uptrend is resuming.

Similarly, during a downtrend, you could look for the three inside down after a minor upward move. This could suggest that the upward move has ended and the downtrend is resuming.

Which candlestick pattern is best?

There are many candlestick patterns that indicate an opportunity within a market – some provide insight into the balance between buying and selling pressures, while others identify continuation patterns or market indecision. However, it is important to remember that although they are great for quickly predicting trends, they should be used alongside other forms of technical analysis to confirm the overall trend ¹.

The shooting star candlestick is often considered as one of the most dependable and superior candlestick patterns for day trading. This kind of intra-day chart typically displays a bearish reversal candlestick, indicating a peak, unlike a hammer candle which signifies a bottom trend.

Line charts are frequently used in day trading. These charts only show the closing price. Each day’s closing price is linked to the next day’s closing price, providing a concise summary of prices.

Candlestick patterns usually form over a period of 1-3 days, making them short-term patterns that are applicable for 1-2 weeks. Hammers and shooting stars take just one day to form. Engulfing patterns, piercing patterns, and dark cloud cover patterns take two days.

The shooting star candlestick is often considered as one of the most dependable and superior candlestick patterns for day trading. This kind of intra-day chart typically displays a bearish reversal candlestick, indicating a peak, unlike a hammer candle which signifies a bottom trend.

Here are some of the most common candlestick patterns that traders use:

1. Hammer: A bullish pattern formed of a short body with a long lower wick, found at the bottom of a downward trend.
2. Inverse hammer: A bullish pattern formed of a short body with a long upper wick, found at the bottom of a downward trend.
3. Bullish engulfing: A bullish pattern formed when a small red candlestick is followed by a large green candlestick that completely engulfs the previous day’s candlestick.
4. Morning star: A bullish pattern formed when a long red candlestick is followed by a small-bodied candlestick that gaps lower, followed by a large white candlestick that gaps higher.

Which indicator has high accuracy?

There are several indicators that are known for their high accuracy in trading:

1. Tradest Indicator Script: This is a custom script that measures the average price of a currency pair over a specific period of time, like the last 200 days or year of price action to understand the overall direction. Along with other reversal spotting custom algorithms, it provides great opportunities for entering the positions¹.
2. RSI (Relative Strength Index): This is one of the best indicators for option trading that determines the position of the market based on gain and loss for a period². It can be used equally well in trending or ranging markets to locate better entry and exit prices¹.
3. Slow Stochastic: This is another highly accurate indicator used in trading¹.
4. MACD (Moving Average Convergence Divergence): This is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price¹.
5. On-balance volume (OBV): This is a technical trading momentum indicator that uses volume flow to predict changes in stock price³.
6. Accumulation/distribution line: This is a volume-based indicator designed to measure the cumulative flow of money into and out of a security³.
7. Average directional index: This is used to quantify trend strength³.
8. Aroon oscillator: This is a trend-following indicator that uses aspects of the Aroon Indicator (Aroon Up and Aroon Down) to gauge the strength of a current trend and the likelihood that it will continue³.
9. Bollinger Bands: This is a lagging Indicator that provides the overbought and oversold conditions of the market with price and volatility.

Each of these indicators has its own strengths and weaknesses, and they are often used in combination to confirm each other’s signals and improve the accuracy of predictions.

You May Also Like:

1. Which Indian & US Stocks to Buy this year
2. How to Invest in Stocks- Beginner’s Guide