Charts offer traders a pictorial view of both current and historical price activity. It's a graphical representation of the Open, High, Low, Close of each trading day (or other chosen time period) along with other associated valuable information such as Volume traded, Open Interest, and a myriad of indicators measuring trend, momentum and velocity.
The ability to see and absorb this important information, especially over a long period of time, is critical, and this makes Price Charts a invaluable tool for 3PC, as well as any trader trying to analyze price movement.
There is a philosophical argument to the usefulness of Charts and their ability to predict price, but we view this as total nonsense. We already know that every given bet is individual and a 50/50 proposition. We know that Future price movement cannot be predicted, any more than a Poker Player can predict whether he will make the Straight or Flush he has been drawing on.
However, what charts do offer is valuable information which is presented in a easy to read way, and allows the user to quickly scan through years of data across dozens of securities in short order. They are time-saving, critical tools that you need to become familiar and comfortable with - Period.
Our discussion here is not meant to cover all aspects of charts and assorted indicators as thousands of available books have already been written on this topic. Rather we will discuss what we use, and have found to be most valuable. For a much deeper and expansive discussion, I again direct you to Jack Schwager's "Technical Analysis" on Futures. Another fine book to add to your library on technical analysis is "Technical Traders Guide to Computer Analysis of the Futures Market"
We do warn you though of beginning a search for some hidden secret that will be revealed in those or any other books. We have traveled that road and can assure you that the Golden Secret to Trading success lies in the way you manage your place betting - This is what will separate the winners and losers. On that note let us begin.
The Japanese have been using Candlesticks as a form of technical analysis for centuries. They were trading Rice Futures (before we called them futures or had exchanges) in the mid 1600s, and not surprisingly they came to many of the same technical conclusions that Western traders have. It goes to show you that it is emotions, and human action that drive markets, no matter where or what you trade.
A candlestick has a body as well as a wick - In charting, the body consists of the Open and Close, while the wick or tails, represent the Highs and Lows of the day that extend beyond the open or close. The color of the bar will then dictate whether the close was either higher or lower than the close. So by looking at one bar we have quite a bit of valuable information.
Candlestick charting has unique names for 1 day, 2 day and 3 day patterns such as "Three Black Crows", "Descending Hawk", and "Dark Cloud Cover" There are hundreds of candle patterns and we don't profess to know them all or have the ability to spot them all. What we do have is an eye for certain unique formations that clue us to a potential reversal or continuation of price moves.
When these occur at price levels where we have multiple indicators in Unity, it makes them all the more powerful - So again, this is another piece of the puzzle that will help to direct your trading. As a final note, candle patterns tend to have a "Yin & Yang" philosophy. Meaning that the same exact candle if placed in a impulsive up movement will have a completely different interpretation to one that is places in a impulsive down movement. Let us know take a look at some of the most widely used candle formations 3PC focuses on.
Reversal Candles and Patterns
Hammer & Hanging Man
These 2 candles are 1 day reversal patterns that have long lower wicks, and small real bodies. What this tells you is that price opened, moved sharply lower intra-day, and then reversed and closed back near the open of the day.
If the market has been in a sustained downtrend and then we see this formation we call it a Hammer. This is giving us a clue that the down move has exhausted itself and now traders are locking in profits on their shorts, or longs are stepping in. Either way shorts will be concerned and will be quick to cover in advance of a potential reversal.
If the market has been in a sustained uptrend and we see this candle, it is then called a Hanging - Man. In this scenario we see that the bull trend is being called into question, as price traded much lower than the open during the trading day. Even though dip buyers step in to bring us back near the open, a seed of doubt has been cast. If in the next day or next few days, price begins to move lower bulls will be ready to pitch their position.
Bearish & Bullish Engulfing Pattern
An Engulfing pattern consists of two candle bodies of opposite colors, whereby the second candle body completely Engulfs the first. Typically the preceding candle does not have a large body, and the Engulfing Candle has a large body. The wick or shadow of the candle is not taken into consideration here, only the bodies.
When this happens in a downtrend, i.e. opening below yesterday's open, but then closing above yesterday's close, it signals that bears are beginning to cover and bulls are now pressing their advantage. When in an uptrend, this tells you that the rally is running out of steam and sellers have overwhelmed buyers.
In both scenarios you want to see price action the following day of the Engulfing Candle confirm the reversal pattern and continue in the same direction as the Engulfing candle.
Inverted Hammer & Shooting Star
These candle patterns are the opposite of their cousins the Hanging Man and Hammer. The difference here being that long wick is on top of the small body, whereas the prior 2 candles were a small body on top of a long wick.
Spinning Tops and Dojis - Signs of Indecision
A Spinning Top is a candle with a small real body, which has both a upper and lower wick that is greater in length than the body - This activity of a open, a move lower, then a reversal higher, only to close near the open is a sign of indecision between market participants.
A Doji is a candle where the open & close are the same, or almost the same. The wicks can vary in size. Here again, traders aren't sure what to do and any intra day movement is reversed and we close right where we started.
We watch carefully for these candles particularly after we have been in a Impulsive move. If price is trending in a direction and then you start to see indecision, it signals that a cessation on trend may be at hand.
Final Thoughts on Candlesticks
As with all Technical analysis I again have to highlight that we are not rigid in our interpretation of candles. At 3PC we are more interested in the "spirit" of the law as opposed to the letter.
Candlesticks have so many variations, nuances, and different names that the strict follower can look at our above example of hanging man and begin yelling that it is a Butterfly Doji or that our Inverse Hammer is actually a Harami Cross - What do these 3pt Morons know about candlesticks anyway?!
What we know is that we care not what it's called, or if it technically met a official definition in the Bible of Candlestick pattern. What we do care about is the story being told especially at inflection points; and even more especially when numerous other indicators are signaling in the same direction.
We hope you can now see the value in this centuries old tape reading method, and encourage you to become as familiar with it as you see useful for your trading operation.
Just like a clock where the second hand moves faster & exerts force on the minute hand, and then the minute hand to the hour hand, so do different time intervals impact each other when analyzing price information on a chart.
The shorter the time frame, the faster the signal - however the tradeoff is that there are many "false" signals. The longer the time frame, the slower the signals being generated, but they tend to be more reliable.
Each trader's unique personality and style will determine which time frame they are most comfortable dealing with. Here at 3PC we use the Daily & Weekly time frames for research and analysis that drive our trading signals and overall program. We will then use a hourly chart to fine tune entry & exit intra day.Alchymist tools use Daily & Weekly data, and we use charting applications from our brokers to view hourly charts, or even shorter time frames such as 30min or even 10min bars.
The key point to be aware of here is that each time frame can be telling it's own story which is not necessarily in sync with the higher one. So it is very common to see a bearish signal or formation on a hourly chart, while the daily picture looks quite bullish. (or vice versa). They are 2 separate pieces of information that have to be considered as part of your over-all trading strategy.
Classical Charting Patterns
Prices on a chart may move in a chaotic and random manner - other times they paint a familiar picture that Chartists will recognize and want to act off of. Similar to our discussion on Candlestick patterns, there are countless formations that can be formed or categorized, and like any subjective analysis, opinions will vary widely on interpretation of what the picture is saying. If you are interested in incorporating this into your trading toolkit, be sure to focus on the general picture and the story it is telling, as opposed to dogmatically ordaining a specific outcome based off of a particular chart pattern.
What you can be 100% sure of is that the Gangsters, along with their algo robots, will be painting these patterns onto the price charts, eagerly waiting for traders to dive in with full leverage once the "neckline on a Head & Shoulders Top is broken", or some other widely known and followed pattern emerges. It is there that they will pounce, with maximum force, ready, willing, and able to separate you from your chip stack.
Here at 3PC, we are not interested in trading off Chart Patterns or Indicators that are discussed and used widely by the trading community. So our commentary and use of these Classical chart patterns will be more anecdotal, and another level of confirmation to our Proprietary indicators as we search for trade opportunities, as opposed to driving any decision making.
In our early years we traded solely off of Wedges, Flags, Pennants, Cup with Handle Breakouts, Head & Shoulders and the like. But the banksters were beating on us as if we were a speed bag; other times a heavy bag - Either way, we learned not to like the taste of leather, and changed up our tactics some. We learned a revolutionary strategy in fighting... something called "Duck" i.e. as in move your head so as not to get hit! (you might want to focus on this yourselves)
All of these chart patterns are based off some sort of consolidation and then break out of that zone - i.e. a new high or low being made, triggering you to act. I am not disparaging charting in any way as I'm sure all of these patterns have a 50% win rate if you were to take the time to analyze their performance statistically. And we do take note of them & sometimes act on them, provided we have consensus across our other indicators. I am simply warning you again, not to look for a Holy Grail in patterns on a Chart.