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How To Use Candlestick Charts

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Written by Timothy Sykes
Updated 1/3/2023 6 min read

This is a trading challenge student guest post for all you chart lovers out there:

Candlestick charts are attributed to the Japanese and an apocryphal story involving a man tracking the price of rice for a year, noticing the seasonality and expertly buying and selling rice to exploit the patterns he discovered.

That story holds meaning regardless of whether it’s true. Any asset that is traded on a market is affected by seasonality.

You hear it with adages like selling in May, or even Black Friday for retail stocks.

Companies report year-over-year growth results in order to compare the same time period per year, in an effort to account for seasonality.

The stock market is more complicated than a crop like rice, and there are intervening factors that can interfere with the seasonality trends.

A second great benefit of the candlestick charts, as opposed to line charts, is that they are great indicators of momentum.

Momentum, being the combination of volume and movement, does incorporate all the aspects including seasonality and the intervening factors whatever they may be.

Being a solid depiction of momentum with numerous is what makes candlestick, and the OHLC charts, the primary chart style for traders.

A lot of new traders tend to use line charts, because they are the cleanest and the ones people are most familiar with.

Most chart patterns are based on candlesticks, which is the reason that OHLC charts are not used most often.

Data, data, data

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The quote from the Sherlock Holmes movie is very apt at describing candlestick charts in comparison to the simple line chart.

There are 4 data points per interval as compared to line graphs. A candlestick is composed of the high, open, close, and low of the particular interval chosen per candlestick, just like the OHLC chart.

The wicks are the high and the low, with the ends of the bar forming the open and the close.

Whether the top one is the open or the close is determined by the color of the bar.

Red is universally down, but positive bars can be green, blue, clear, or black depending on the specific chart used.

bullish and bearish candlesticks in technical analysis

Four data points yield a lot of information, and better capture the momentum of a stock. Assuming you have a regular uptrend on 5-minute bars seeing a long wick on top but a red bar can mean the end of current trend for a pullback.

Day traders who use large accounts and leverage can trade these signals for a profit consistently.

There are lots of ways that a candlestick chart can signal to the trader that a pattern is changing or forming.

The quicker the interval per bar the more subtle the trends that can be detected.

These trends are small movements in absolute terms, but day traders have a large amount of leverage at their disposal, and usually do not trade with tiny accounts.

There can be many trends identified per day and just looking at one stock and one chart can keep a trader busy, and following just a handful of stocks can yield trades day after day.

Timings and Intervals

Larger intervals for the candlesticks steamroll over the subtle trends but each bar incorporates more information due to the greater amount of time. As the interval on the bars increase that piece of information can be considered more substantial.

A signal on a 15-minute bar is more trustworthy than a 1-minute bar.

There are diminishing returns as time gets greater, and as you move into the extreme levels charting becomes less useful.

Do not use weekly candles and assume that all the signals are accurate, because lots of things can interfere with the chart signal with stocks.

Charts might not be great indicators over vast periods of time, though even then they can be useful, but from just the chart and perhaps some other indicators a skilled trader can guess at the near-term trend with a high level of accuracy.

Profit depends on the execution of the trade, but even being able to see the patterns is impressive. Charting is a vast subject that needs to be tackled methodically, and it takes time to learn all the ins and outs. However, it is an extremely important part of a short-term trading strategy.

The Doji – Arguably the most Important Candle

doji is a candle where the open and the close are at the same level or nearly the same level. There are many variations that focus on the length of the wicks that form the top and bottom of the candle, but they should all be considered doji candles. Doji’s are one of the key ways to find reversals, corrections, and other things signaling the end of a trend, but on their own are neutral signals.

reading candlesticks ILUS chart example of a doji
ILUS chart: 6-month, doji example (Source: StocksToTrade.com)

A consistent downtrend of red bars can end in a doji or at least pause. In the example above, the doji signaled a reversal to the upside after three red days. The reversal didn’t last long, but it’s a good example of the psychology at play.  A series of doji’s can indicate a plateau with minute variations giving clues about the direction of the next short-term trend.

There are many other patterns, but the doji shows up in them more than most others.

This is why it is important to know, as it shows up the most on candlestick charts and has a particular importance. It is also the most easily identifiable on quick glance.

Conclusion

Charting is difficult to learn, because there is so much to learn. Stick with it, and do not rush it. It takes time to apply everything well. It along with other technical indicators form the basis for most short-term trading strategies. Even between days it is very useful. Only when you start going into weeks and months does charting need to be balanced with other things.


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Author card Timothy Sykes picture

Timothy Sykes

Tim Sykes is a penny stock trader and teacher who became a self-made millionaire by the age of 22 by trading $12,415 of bar mitzvah money. After becoming disenchanted with the hedge fund world, he established the Tim Sykes Trading Challenge to teach aspiring traders how to follow his trading strategies. He’s been featured in a variety of media outlets including CNN, Larry King, Steve Harvey, Forbes, Men’s Journal, and more. He’s also an active philanthropist and environmental activist, a co-founder of Karmagawa, and has donated millions of dollars to charity. Read More

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* Results are not typical and will vary from person to person. Making money trading stocks takes time, dedication, and hard work. There are inherent risks involved with investing in the stock market, including the loss of your investment. Past performance in the market is not indicative of future results. Any investment is at your own risk. See Terms of Service here

The available research on day trading suggests that most active traders lose money. Fees and overtrading are major contributors to these losses.

A 2000 study called “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” evaluated 66,465 U.S. households that held stocks from 1991 to 1996. The households that traded most averaged an 11.4% annual return during a period where the overall market gained 17.9%. These lower returns were attributed to overconfidence.

A 2014 paper (revised 2019) titled “Learning Fast or Slow?” analyzed the complete transaction history of the Taiwan Stock Exchange between 1992 and 2006. It looked at the ongoing performance of day traders in this sample, and found that 97% of day traders can expect to lose money from trading, and more than 90% of all day trading volume can be traced to investors who predictably lose money. Additionally, it tied the behavior of gamblers and drivers who get more speeding tickets to overtrading, and cited studies showing that legalized gambling has an inverse effect on trading volume.

A 2019 research study (revised 2020) called “Day Trading for a Living?” observed 19,646 Brazilian futures contract traders who started day trading from 2013 to 2015, and recorded two years of their trading activity. The study authors found that 97% of traders with more than 300 days actively trading lost money, and only 1.1% earned more than the Brazilian minimum wage ($16 USD per day). They hypothesized that the greater returns shown in previous studies did not differentiate between frequent day traders and those who traded rarely, and that more frequent trading activity decreases the chance of profitability.

These studies show the wide variance of the available data on day trading profitability. One thing that seems clear from the research is that most day traders lose money .

Millionaire Media 66 W Flagler St. Ste. 900 Miami, FL 33130 United States (205) 851-0506 This is for information purposes only as Millionaire Media LLC nor Timothy Sykes is registered as a securities broker-dealer or an investment adviser. No information herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security or fund. Millionaire Media LLC and Timothy Sykes cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. The reader bears responsibility for his/her own investment research and decisions, should seek the advice of a qualified securities professional before making any investment, and investigate and fully understand any and all risks before investing. Millionaire Media LLC and Timothy Sykes in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned in communications or websites. In addition, Millionaire Media LLC and Timothy Sykes accepts no liability whatsoever for any direct or consequential loss arising from any use of this information. This information is not intended to be used as the sole basis of any investment decision, nor should it be construed as advice designed to meet the investment needs of any particular investor. Past performance is not necessarily indicative of future returns.

Citations for Disclaimer

Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. Available at SSRN: “Day Trading for a Living?”

Barber, Brad M. and Lee, Yi-Tsung and Liu, Yu-Jane and Odean, Terrance and Zhang, Ke, Learning Fast or Slow? (May 28, 2019). Forthcoming: Review of Asset Pricing Studies, Available at SSRN: “https://ssrn.com/abstract=2535636”

Chague, Fernando and De-Losso, Rodrigo and Giovannetti, Bruno, Day Trading for a Living? (June 11, 2020). Available at SSRN: “https://ssrn.com/abstract=3423101”