How to Make Money Trading with Candlestick Charts

Make Money on Stock Market with Candlestick Charts


Japanese rice traders have successfully used candle signals to amass huge fortunes for nearly four centuries. Constantly refined and tested over time, candlestick signals are now being used the world over for trading all financial markets, including stocks, derivatives, and currencies, etc.



This Post explains step-by-step how you can make money by trading the powerful and proven candlestick techniques. Here is how: Explanation of major candle signals; how to recognize them and use them effectively

Explanation of major candle signals; how to recognize them and use them effectively The underlying market psychology revealed by each candle formation How to combine candlestick signals with Western technical analysis to take advantage of high probability trades which generate explosive profits

Stop-loss settings for various candlestick signals for cutting losses. Master this and you will be way ahead of fellow traders. 

How the use of candlesticks with technical analysis provides a simple mechanical trading system that eliminates emotional interference, panic, and greed 


How to use candlestick charts for making money from longer-term trading and investing 

PLUS: proven, market-tested trading ideas, tips, and common mistakes to avoid based on the

Introduction 

The Japanese art of candlestick trading has been around for nearly four centuries. Japanese rice traders successfully used these signal formations to amass huge fortunes. Since then, the signals have been refined, tested, and utilized in a variety of markets.


Wherever an instrument can be traded in an open market by traders, candlestick signals can be used to profit in such markets. Candlestick signals depict the change in investor psychology. They visually show a trader the sentiments of the other traders in that particular stock or market. It does not matter if the signals are applied to commodities, stocks, or futures. Candlestick signals work with all of them. 


It does not matter whether the market is the Nasdaq, the Nikkei, the German DAX, or the Nifty. All of these markets can be analyzed and traded using candlestick charting. Why do people around the world pour their hard-earned money into the financial markets? Why do they not keep their money invested in fixed price no risk certificates? The answer is obvious. 


They take the risk of investing in stock, currency, and futures markets in order to get higher returns on their money. The allure of hitting it big in the stock market keeps their dream of financial independence alive. 

They look for a good nest egg to be built from the gains in the market for a comfortable retirement. Yet the percentage of investors that actively manage its portfolios is paltry compared to those who keep pouring money in the market hoping they would strike gold someday.

 (Henceforth we will use the terms “market” and “stock market” to include the stock, commodity, and currency markets.) Ask yourself which category you fit in from among the following: You listen to analysts on TV to get recommendations for buying stocks. 

You subscribe to a stock picking service for your stock investments. You try out the latest stock picking software, lose money and start all over again. You get your stock investment ideas from your friends, your colleagues, or the local tea vendor. 

You have tried all of the above, lost money, and given up on the stock market altogether. If you have done any of the above, you are not alone. Most investors are the same everywhere. They keep searching for the one golden technique that will work each and every time they put their money in the markets. 


They do not spend enough time to independently study the market itself. They tend to believe that analysts on TV, who do all the research and generously offer their recommendations are motivated by the idea of making you rich! That is being very naïve, indeed. 

Most traditional investors believe in a “buy and hold” strategy. 

 

They believe in “averaging down” a stock. Their thinking is limited to “It will go up one day”. They will argue against timing the market. 

These are the people who spend more time thinking about what clothes to wear to the office on any day than they do about their investments and their financial future. Part of this stems from the fact that real-time access to market data was very limited till just a few years ago. 

People used to be able to look at their investments only at the end of the day. 


Trading costs, i.e. buying and selling commissions, were also very high. But those factors are no longer valid. Information technology has changed the trading scenario. More and more people are now opening online trading accounts. They now have access to real-time instantaneous data. 


Technology has also helped to drive down trading costs considerably. As the BSE and NSE equity indices rally because of the underlying strong growth fundamentals of India, individual investors would naturally want to increasingly participate in the markets. 


It is extremely important that these investors and traders educate themselves in learning the language of the markets. The markets speak in subtle ways. 

They are always giving clues to their directional movements. Candlestick trading is all about reading this subtle language of the markets. There are more than fifty candlestick signals defined by Japanese traders. However, of these, we will focus on the most common ones. 


You will find that these major candlestick signals occur often and repeatedly. Your time as a trader or investor will be well spent if you understand these major signal formations. There have been a handful of books written on candlestick charting so far. 


Most of these books have been written from the perspective of trading in the US markets. This book is specifically written with the Indian trader in mind. All the included charts are of companies trading on either the National Stock Exchange or the Bombay Stock Exchange. By the end of this book, you will be able to look at any chart and analyze it yourself. You will be able to turn off the analysts on TV and unsubscribe your stock picking service. You will discover within you the ability to diagnose the health of the market. 


That ability will bring with it the confidence to enter high probability big profit situations which will, in turn, help your portfolio grow rapidly. However, let me warn you. This is not a “get-rich-quick-scheme” book. 


It will not turn you into an overnight crorepati. The intention of this book is to teach you how to use these powerful candlestick techniques correctly and effectively. Wealth generation will automatically follow! The next chapter will go into detail about the construction of candlesticks and more importantly the psychology underlying those candlesticks.

Candlestick Trading: The Basics

This chapter is not going to be an essay on the science of psychology — though it would be very interesting to know what reputed psychologists like Carl Jung and Freud would think about the art of trading! This chapter will hopefully link in your mind the importance of the psychological underpinnings of trading stocks.

Fear and Greed

Fear creates panic and panic creates supply in the marketplace. Greed produces exuberance, giving rise to the demand. As humans, we cannot escape these two emotions while trying to make money in the marketplace.

When you watch a stock you own go down, you get overwhelmed by fear and anxiety. Such emotions create havoc in the mind:

  1. How low will the stock go and how much will I lose?
  2. What if my spouse/parents/friends find out about this pathetic losing trade I made?
  3. Should I get out now? What if the stock turns around as soon as I sell it? How much of a fool would I be then? And on and on and on.

Notice for Great!

We are all slaves to these two emotions. They are also the trader’s worst enemy. If you are expecting that I am going to show you how to master these two, often overpowering, human emotions, you are going to be sorely disappointed. For that, please browse through the self-help section of your favorite bookstore. 

The fact is that experienced and successful traders know that they cannot master these two emotions. They know that all profits will evaporate into thin air if they fall into the trap of trying to master them. What they do, however, is design a system and abide by the system’s rules to execute their trades. 
They realize that the market is much bigger than them and their egos. In order to win in the market, they have mastered the art of understanding the subtle hints of the market. This is where candlestick signals assert their dominance. 

Candlestick signals, by the very nature of how they are constructed, point out the messages of the market. These signals have been time tested for over four hundred years. 

They would not have been around for this long if they wouldn’t have had strong underlying market logic. These signals depict the outcome of all the cumulative knowledge of the traders and investors playing that stock. Stock prices have little to do with the actual fundamentals of a company. 

Instead, they have a lot more to do with the company’s “perceived” fundamentals. It does not matter what a company has achieved till date. If the perceived growth of the company is doubtful, then the stock has little or no chance of appreciation. What would you rather be buying? A good, well-known company but with little perceived growth or a company which

traders and investors believe will grow for the next few years. I would buy the latter. This is what makes the stock market so dynamic. The fear of losing money and the greed for making more money creates the demand-supply imbalances that move stock prices. If you take away one lesson from this book, let it be this — as a trader, you should always be buying into other’s fears and selling into other’s greed.


And this is not as complex as it sounds. Once you are done with this book, it will be very easy to recognize the emotions of the traders in that stock. Candlesticks make the analysis visually apparent. This book is for those who want to make money in the stock market. And the easiest way to do that is to live by the above principle. You can either be a shark in the ocean or be eaten by one!

Candlesticks Light the Way

Let us now look at how candlesticks are drawn. You need four price points to draw a single candlestick. Considering an example of a daily candlestick, you need:

  1. The high price of the day; 
  2. The low price of the day; 
  3. The opening price of the day; 
  4. The closing price of the day.

The two parts of the candlestick are:

  1. The body: This is the part between the open and the close. In case the day’s opening price is lower than the closing price, the color of the body is white (some charting services will make this green). Conversely, when the day’s opening price is higher than the closing price, the color of the body is black (sometimes shown as red).
  2. The shadows: The upper shadow is the line above the body and the lower shadow is the line below the body. In the case of a black-bodied candle, the upper shadow is from the day’s open price to its high price and the lower shadow is from the closing price to the low price of that day. Conversely, in the case of a white-bodied candle, the upper shadow is between the closing price and the high price of the day, and the lower shadow is between the opening price and the low price of the day.

Candlestick chart
 
Candlestick closing price

 White Morubozu 

This is a white candle with no shadows at either end (see Figure 2.3).

White Morubozu

It depicts a day when the low of the day is the same as the open and the high of the day is the same as the close price of the day. This usually represents a very bullish formation as it shows the bulls had the upper hand throughout the day.

Black Morubozu 

This is a black candle with no shadows at either end (see Figure 2.4).
Black Morubozu

This occurs when the high of the day is the same as the open price of the day and the close of the day is the same as the low price of the day. What does this candle represent? It shows domination by the bears throughout the day. Generally, this would be considered a very bearish candle.

Opening Morubozu 

Figure 2.5 shows two cases of an Opening Morubozu.

Opening Morubozu
As you can see, they do not have a shadow attached to their opening price end of the body. The white candle denotes that bulls took control right from the start while the black candle suggests that the bears dominated right from the open.

Closing Morubozu 

As can be seen from Figure 2.6, the Closing Morubozu does not have a tail attached to the closing price end of the body.
Closing


The white candle implies that the bulls took over control during the day and ended the day strong. On the other hand, the black candle suggests that the bears took over during the day and forced the price to close at the lowest level of the day.


Doji 

The Doji is one of the most important candlestick formations. will discuss this signal in detail. For now, we will define the Doji as a candle where the opening and closing prices are the same. Figure 2.7 shows a Doji candle.
doji

Please note that given how candlesticks are constructed, it is very much possible to have a dark candle even when the price closes higher compared to the previous day.

Similarly, you can have a white candle form even if prices close down for the day. Each candle is independent of the previous day’s candle. This is a very important point and you need to make sure you understand this concept clearly.

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