Everyone when they first start trading think candlestick patterns are the best. Such easy patterns to look for with a 90% success rate. Sounds great right? Of course, you know by now that’s all BS.
I love candlesticks.
I hate candlesticks.
Let’s use the image right for an example, thanks to wiki for image. This is called a hammer candle. This means that the price started near the top of the candle, came down during the time-frame (say 1 hour for example) and then returned above the original starting price. So there is a very large tail on the bottom of the candle and a small body on the top without a tail on the top too (or with a very minimal tail.)
What are we taught to do when this happens?
The answer if you didn’t know is to buy/long. The reason is because this candle shows there is pressure coming in (or strength coming in) from the bulls or the buyers. The bears tried to push the price down but it still finished above the opening price. Very strong signal for a buy right?
And here is where the major issue lies.
95% of traders take candlestick patterns at face value. This means if you are looking to buy a pair and you see a hammer pattern then you’ll jump into the buy. If you are looking to sell a pair and you see the inverted hammer then you’ll sell the pair… This is what about 90% of forex “gurus” teach.
The problem is people do not look at the overall strength and power of the market.
If you think of a currency pair with a certain power going up or down. In a ranging market there isn’t much power either way. In a steeply falling market the bears have the power and vis versa. This is stage 1 into the “how to avoid losing all your money with trading forex candle patterns” (catchy title). Don’t go against the overall trend if it is POWERFUL. Let’s take a look at a few examples.
Below is an example on the hourly of USD/CAD. As you can see we have a really nice hammer candle formation. Even better the immediate trend looks like an uptrend too. Everyone BUY USD/CAD!
4 hours later….. You are 44 pips down, or hopefully stopped out for less.
This could have been avoided really easily by looking on the higher time-frames at the overall trend. This is clearly a downtrend and as a result we shouldn’t be looking to hit the buy. Instead we should look to hit the sell on the shorter time-frames. If we are analysing the 4 hour we should look to enter the 1 hour.
How To Use Candle Stick Patterns
This is my personal strategy when I’m looking to trade a candlestick only (which is rarely)
First I will look for the overall trend. If you are looking at the 4 hour chart look at roughly 2 weeks previously and see if there is a definite trend. If the overall trend in the last 2-3 weeks until today is a downtrend then we need to look for an inverted candle during a pull back, so we can then sell.
Second I will look at the support and resistance levels and how strong they actually are. Let’s say there is a strong support or resistance level approaching in an overall trend, can we catch the pull back off this? The answer (for this strategy is NO) We want to want for the market to break that resistance level and then re-test it. If this re-tests with a candlestick we are looking for. Say for example a downtrend that breaks a strong support level but the market pulls back to test this level and hits it with an inverted candle. THEN we can hit the sells and only then do we have a 80% trading strategy.
Third of course is the actual candlestick pattern in itself. We need to see that at a support level and during a pullback for the overall trend for us to open a trade.
- Do not take trades SOLELY off of candlesticks.
- Add other trading elements to increase confidence of each individual trade (support/resistance), overall trend etc.
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Thanks for reading.