Candlestick Continuation & Reversal Signals

The Japanese candlestick charting is one form of forex chart to display the currency market movement. As shown on the diagram below.

The importance of Japanese candlestick understanding is to study the emotions of traders as reflected on the chart. These emotions are shown on the chart patterns formation such as doji, harami, morning star, evening star, etc to represent the different emotional patterns in the market. An in-depth study of these chart patterns can be found in Steve Nison book called the "Japanese Candlestick Charting Techniques". In this book he explains about the emotional definition/psychology about each patterns of the chart formation and how to use them.

In order to simplify the explanation I shall touch only on two significant usage of the candlestick which is the continuation and reversal patterns.

Diagrams below shows the common continuation patterns. The psychological explanation for this pattern is when some traders are taking profit from the overbought/oversold situation it will create relatively weak movement called corrections. Corrections occurs to normalize the movement after the market deviate to far out of the way from the overall average movement.

Apart from taking profits some traders also might watch out for for any complete reversal that might be taking precedent. However after studying the candlestick getting thinner in body size indicating that the correction is getting weaker and reversal is very unlikely to happen. Therefore continuation of the market is becoming very certain.

Bullish Continuation Patterns

Bearish Continuation Patterns

Reversal signals is shown the morning star or evening star formation or sometimes called hammer or hanging man. The psychological explanation behind this formation is the after high volumes of movement (strong body) the second candle suddenly form a thin body (morning/evening star) which indicates weakness of continuation. At this point traders should be wary of quick reversal might take place. Strong and quick reversal usually taken place in the area of overbought/oversold where the traders desperately trying to get out of their position to avoid profits cut-back.

Bearish Reversal

Bullish Reversal

To study more candlestick pattern go to Chart Schools or FX.WORDS

The candlestick charting works better on the 4 hourly and daily time frames because of the majority of traders who trade within these time frames are using it as a must indicator signals.

Moving Average Custom Indicators

Creating your own combination of indicators does not meant do as you like. Usually traders will do this after studying the behavior of the chart for sometimes to determine the general patterns of movement. For example they study the time frame and the movement patterns using moving averages.

The most common of customs made indicators will consist of moving average lines. The moving averages are actually the foundations of most indicators such as MACD, B. Band, etc which take the average of the market volume. So the idea of using moving averages is by taking the best of all averages to predict the overall market movements. This is what we are going to do.

We will use 2 simple moving average lines. The first moving average line setting is 120 (Red) and another 50 (Blue) to create a combination of lines that is similar to MACD or Slow Stochastic on the chart. It is going to look like this.

The above signal bullish and below signal bearish

Based on the person who created it this signal is good to use in 15 minutes time frame. The application goes like this when the blue line moving above the red line this is bullish signals or the opposite when the blue line moving below the red line this is bearish signal as shown on the chart.

What is time frame?

The measurement of time in analysis. Can be in periods of minutes and hours or daily, weekly, monthly and yearly either way Time Frame must be specified. It can also be more generally referred to as Short, Medium or Long Term. In forex trading software platform you will find that the charts are divided in several set of time frames i.e. 5, 15, 30 minutes, 1 & 4 hourly, daily, weekly, and monthly. By dividing the chart it provide the flexibility of analysis for traders either they want short, medium, or long-term.

Don't be confused even though there are divided this way actually the chart is inter-connected with each other. The lower time frames i.e. 5 minutes is actually the zoomed-in version of the major time frames. And Monthly time frame is simply the general display of all the time frames. Using candlestick chart we can simply explain by taking 1 candle equal to 1 month of movement that is consist of 4 candlesticks of weekly time frame as 1 month is equivalent to 4 weeks.

Why important to understand time frame?

Perhaps one of the the ultimate achievement of every technical trader is being able to master the all time frames available. This is very important in order to success especially if you are short-term daily traders. You will be able to see the details and the bigger picture of the market directions. For example if you are 15 minutes trader you will have to look for 4 hourly or daily time frames to look for the overall positions and directions of the market. This will gives you the overall picture where will the big movements will be heading to after all small fluctuations are done.

Higher Time Frame Increase Chances of Success

Most traders do not want to get themselves involve in complicated situation especially the multiple time frames. Still they being able to have great success in trading by using only a single time frame. Yes this is possible!! By looking at the big picture of the market using the higher time frame such as daily, weekly, and monthly. This is the method used by the long-term traders who relied on trend to make decision which usually bring them healthy successful trading career.

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Simple Application of Slow Stochastic

The slow stochastic is constructed with two lines moving average just like MACD. Likewise the application is also exactly the same as MACD that is when both line is moving upwards meaning the market is going up or vice versa. The interception point of slow stochastic signal a reversal of direction just like MACD.

Despite of the exact application of the two, slow stochastic has a major advantage over MACD. It's speed of movement faster than MACD and it moves closely following the real live chart movement. Therefore it is heavily used by daily traders to take advantage of the short-term volatility movement of the chart. See the chart below as MACD moving downwards once but stochastic has already take two cycle to downwards direction. This major advantage making slow stochastic as the most popular indicator of all.

Slow stochastic is almost universal usage, and every traders who have known about its application will use it. The most effective application of this indicator is by combining with other indicators and also the in depth understanding of multiple time frame

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Simple Application of Bollinger Bands

The Bollinger Band is one the most popular used by traders to determine trend and the limit of movement (support & resistance level). It is constructed using three moving average lines designated by the upper band, middle band, and lower band. These three bands are the ideal setups or targets profit for trading or commonly known as support and resistance level. Apart from that it is also can be used to signal break-outs.

How to use Bollinger Band?

As you may notice in everyday trading, the chart/market generally moving within the limit boundary of the bollinger bands. For example it moves from bottom to top and top to bottom passing by the middle band where usually there is a break taking place. The bollinger band is simply a dynamic support & resistance level.

The band is very dynamic where sometimes it can get wider or squeeze narrower. Using this behavior technical traders use it to determine the break-out of the market. Usually when the band squeeze and getting narrower the probability of break-out is near. As the break out occur the band become wider and eventually develop narrower gap before making another break-out.

Another application of the Bollinger Band is use to determine a continuation of a trend. Using an up-trend example the candlestick chart move closely along the upper band marching upwards. There will be time that traders wants to get profit from every movement a correction will occur. As the correction occur the chart/movement will fall at the middle band instead of the bottom. This indicate that a trend is still underway. If the chart fall on the bottom it signals a trend reverse is about to begin. Read more on this go to here "Using Bollinger Band "Bands" To Gauge Trends"

In complex application bollinger bands need more than just of the applications mentioned above. And a vital success of using this tool will also depend on how far you are familiar with multiple time frames application.

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Simple Application of MACD

Moving Average Convergence/Divergence or MACD in short is one the most classic technical indicators that is still being popularly used in analyzing forex trading. It is called the lagging indicator because it always move behind the real chart movement.

How to use MACD?

In simple application MACD is very easy to use as it is only constructed with two moving average lines. The two lines is usually colored in blue and red where blue is upward direction signal and red is the opposite. When the red line moving up parallel with the blue line this signal upward direction or the opposite downward when the blue line moving down parallel with the red line. Every movement has an end and reversal which signal by the interception of the two line.

Advantage of MACD

Since the MACD is one of the most used indicators we can make assumption that most traders will have similar intention when make decision for example they will make buy or sell on the interception point. In complex application MACD is more than just that we need to include the element of emotion in our decision.

Disadvantage of MACD

Since it is a lagging indicators it takes quite sometimes to wait which can be very frustrating. Furthermore in most occasion the market always moving ahead of MACD and by that time you will miss the big hit and waste your time waiting. Many traders use multiple indicators to reduce the flaw gap of a single indicators.

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Fundamental Vs Technical

There are two types of traders in the forex market namely the technical and fundamental traders. Some traders are a little more extreme to believe that one is better than the other or vice versa. The fact is none better than the as both have its own flaws in the system.

The Fundamental Traders

They relied on the economic data such as trade balance, interest rates, non-farm payrolls, etc to predict the future directions of the forex market movement (read more on fundamental of forex fundamental). Usually their success will come only if they trade the long-term of the market direction. This is because it takes sometimes for any economic data to take effects. There are short-term effects though, but it is highly unpredictable.

Source: ForexFactory.com

The Technical Traders

Technical traders relied heavily on indicators and also the physical patterns of the market movement such as Bollinger Bands, Slow Stochastic, MACD, Trend, etc. Short-term traders are usually very keen on using it because they want precision within short time period. Although they cannot predict precisely the market movement, moving average is used to estimate the average size of the market. Thus using the average they can determine the boundary limit of movement called support and resistance level.

Source: FxStreet.com

Summary

In summary both technical and fundamental are equally reliable as well as flawed. Our objectives to study them both is to increase reliability and reduce the flawed of a system that we are using in trading. And for those extremist who claimed that one system better than the other because they are fanatic of their own system without analyzing others.

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