Published On: Wed, Feb 6th, 2013

Identifying Trading Opportunities with Candlestick Charts

One of your top priorities when you commence trading the financial markets is that you must become very proficient at identifying quality trading opportunities exhibiting good profit potential with minimum risk exposure. Once achieved, you should then seek techniques that can assist you in optimizing the protection of your equity.

You could achieve this objective by studying candlestick patterns on either the four hour or one hour trading charts of all those assets that interest you. Basically, you will be seeking confirmation verifying that your proposed decisions to open new trading positions are wise and that your prospects of achieving winning trades are well-founded and justified.

However, you must realize that you will have to undertake such tasks utilizing an objective mindset by strictly preventing your emotions from influencing the process of your decision-making in any way whatsoever. For example, you should refrain from opening a new trading position just because you have a good gut feeling about the outcome especially if you are presented with technical or fundamental indications advising the opposite. You will just endure serious financial losses over the long haul if you were to constantly adopt such a naive approach to your trading.

In contrast, you should always seek additional confirmation concerning the viability of potential new trading opportunities by studying the applicable trading charts. You can undertake this task by analyzing the candlestick formations of your selected currency pairs. You should only then consider opening a new trade if you discover additional verification supporting the findings of your initial analysis. If you utilize such an approach, you will find that your trading success will improve significantly.

For example, envisage that you have constructed a trading strategy with the primary intent of detecting ‘tops and bottoms’ based on the Average Directional Movement Index. You select to trade the GBP/USD; choose the 1 hour time frame and utilize the EMA20 (exponential moving average) as a support/resistance. In addition, you will locate stop-losses for your new trades using the EMA40.

 candlestick opportunities 1

After you activate the one hourly GBP/USD trading chart and the ADX14, EMA20 and EMA40, the above chart appears presently a strong bearish trend with ADX14 above 30. Your strategy advises opening new short trades by using the following criteria.

The ADX14 must be higher than 30 indicating a strong trend. You must then wait for price to rebound against EMA20, which acts as a resistance level during bear trends.  Next verify that the EMA20 level has held and that price is assuming its downward path by confirming a candlestick close below EMA20, as shown in the above diagram. You can then open a new short and locate your stop-loss above EMA40.

As the above chart demonstrates, these conditions were met and you are advised to instigate a new short, as labeled on the above diagram. However, you would be wise not to rush this decision but instead seek further confirmation verifying the validity of such a decision. You can accomplish this goal by examining the candlestick patterns near the proposed entry point for any recognizable patterns. By doing so, you will note that the candlesticks generate the well-known ‘dark cloud cover’ formation, as shown in the next diagram

candlestick opportunities 2

This configuration is very representative of a strong bearish reversal comprising a large bearish candlestick that overshadows the prior bullish one. To create such a formation, the second candlestick must open towards its highest level and then close below the mid-point of the first candlestick. As you can confirm, such a configuration appears at the point of entry, displayed on the first chart, providing additional evidence that a bearish retraction is about to occur.

You can also examine candlestick patterns for any evidence of new trading opportunities in their own right especially if your own trading strategy is not providing you with any fresh signals. If you do detect any interesting patterns then you must investigate further into why they have been created. You should then revisit your trading strategy in order to identify whether it is producing any evidence confirming the validity of your candlestick findings.

In summary, you will discover that candlestick formations are utilized by many traders to identify and verify major price patterns, such as breakouts, reversals, retracements and fakeouts. For example, you can utilize candlesticks to assist you in assessing and differentiating between reversals from retracements.

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.