In previous articles we talked about candlesticks and trend analysis. Now it is time to combine both instruments, and create a powerful strategy which enables you to make high quality predictions about future movements of an asset’s price.
With this kind of strategy you can become a successful trader.
How to combine trend analysis and candlesticks
As we defined in our last article, this is what a trend looks like:
Each bullish trend consists of three major points: The starting point (point 1), tops (point 2s), and bottoms (point 3s). In a bearish trend, the numbers would be reversed: 2 would be the bottom and 3 the top.
There are usually a number of trends developing at any given time in both directions. As you can see in the picture above, there is a long running trend (long red line), which includes a number of smaller trends (short red line, white lines, for example). In fact, each movement from top to bottom or vice versa is a trend in itself (white lines).
The price movement from point 3 to top point 2 is usually quicker and bigger than the reversal. This makes it more attractive for trading. Any signal a trader deducts from candlesticks, for example, automatically becomes more valid and more attractive for trading when it occurs in the direction of the dominating trend and near the trend line.
Trend analysis and candlesticks in action
To better understand how you can use this knowledge to make a successful trade, let’s look at this zoomed in picture from the chart above:
Let’s imagine you were a trader a little after the price hit point 2. You know we are currently in a bullish trend, and that in a bullish trend, the movement from bottom to top is quick and straight. As soon as the price starts to move sideways after point 2, you know that this is a first sign of a possible reversal.
At this point, though, you cannot be sure. It’s still possible that the price will continue to rise after it has finished the sideways movement. You are monitoring the situation to find a good trading opportunity.
Finally, this opportunity comes with the three candlesticks marked in the white square. As a well educated trader you immediately recognize this formation as an Evening Star and know that it indicates falling prices. The trend line you have drawn is still far away and indicates a lot of room for a reversal movement. Still, you know that in a reversal the price doesn’t move as straight as in a movement from point 3 to 2. Therefore, you decide that the prediction is only valid for one day, not further into the future.
Therefore, you purchase a High or Low option and predict, that 24 hours from now the price of the asset will be lower than today. The next day, the stock opens with a big bearish gap. After a quiet day of trading it closes even below the opening price. You win your trade and make a nice profit of about 80%.
In summary, the steps we took to make the successful trade were:
- Understand the main trend (bullish),
- Understand the current market phase (sideways movement after fast raising prices),
- Understand what can happen next (beginning reversal or continuing upwards movement),
- Look for a sign indicating which one will happen (candlestick analysis),
- Find sign (Evening Star),
- Make prediction (falling prices),
- Define timeframe for which the prediction is valid (24 hours),
- Make trade.
With a strategy like this you should be able to win a good percentage of your trades.