The Tale of One Candle
Let's get back to real basics, but look at them with the eye of a veteran. Let's also not look at just the basic data, but the meanings behind the data that turn it into useful information. In the tale of one candle we explore the psychology behind a single candle. Everyone is trying to come up with the "one true" pattern or indicator, or whatever, to beat the market.
That is sheer folly. There is no one true - see all - do all - be all - pattern to make you rich. The market is much like a giant Las Vegas. The house has the edge and unless you have 10 billion dollars, a seat on the exchange, and your trading computers within inches co-located with the main exchanges - then the deck is going to be stacked against you for being a market mover. Instead you must become a market observer. In your observations you can locate an edge for yourself and exploit it in much the same way card counters in Las Vegas have an edge.
In Las Vegas, if they find you have an edge they boot you out, whereas in the market if you have an edge you are rewarded.Part of finding your edge is to dispassionately evaluate any and all data you think is important in order to give you INFORMATION. So in looking at a single candle (to start with) you are starting on a path of finding out more about yourself than about what the market is doing. In discovering yourself you will uncover an edge. Your job is to explore and exploit your own edge.The market is in many ways like a giant pari-mutuel system. The money you "win" comes from the people that "lose".
The only people guaranteed of making any money is the "track", the "house", and the "broker". They take a piece of every action for managing the action - kind of a neat gig if you can get it. So your job is to create an edge for yourself so you can come out on the right side of the betting system called the stock market.
What most books tell you: I am sure we're all familiar with opening up any old book on candlesticks and looking at page 1 and 2 and seeing a simple drawing of a candlestick: "open close high low", "open close high low", and, oh by the way "open close high low", and we immediately stop thinking after that. Here is what they don't tell you...
Let's get back to thinking and putting ourselves in the shoes of the original rice speculators in Japan 700 years ago and wonder what this all means. The didn't have computers, they had communal places like Saki houses, baths, shrines, Geisha houses, markets and gathering places - where real people would gather and talk (yes, to each other).
If you hang out with certain people long enough you get to know their tells, their body language that allows you to add nuance and inflection to the words they are telling you. You begin to understand the social pressures that drive people. If you are wise you know the pressures that have command power over you. You learn that some of the stuff you believe is pure BS. Ridding yourself of those BS beliefs will start to give you an edge. Knowing what your tells are, also starts to give you an edge. In short you find that no matter what you are bartering for to make a buck, it always and ultimately involves people.
People behave in sometimes fairly predictable ways when they act as a crowd, or when they are fearful, or hopeful, and yes, even when they can be manipulated to be fearful or hopeful. What most people forget is that the markets involve people with all their foibles. While you may not get all of this information out of a single candle, you should start to be able to piece together the psychodynamics of the market, truly a market of people, based on understanding a single candle. Starting to understand the psychodynamics of the market gives you an edge that people who only throw darts at stock charts will never have. It will give you an edge over people who only look at numbers (fundamental analysts) but forget that there are people who are behind the numbers. When we ascribe meaning to a fact, then we are opening the door for speculation, intrigue, and misinterpretation of the intent of those facts. That is what everyone pouring over the entrails (ok, so they are stock charts) of the freshly sacrificed chicken (stock) is doing. They are trying to read the future in a bunch of guts. There is no way to predict the future accurately, or everyone would be rich overnight on the backs of the people who didn't get the wake up call. If everyone had perfect information the stock market would cease to exist.
Imagine everyone knowing that a stock was going to go up and jumping in with buy orders. If everyone put in buy orders then who is going to sell to them if everyone knows the stock is going up? No one! You would have the worst kind of stalemate possible. Even the market makers, whose job it is to ensure liquidity in the market, would crumble in the face of this situation.It is only the uncertainty and unpredictability of the market that makes a market. Even with uncertainty you can still carve out an edge. Part of your edge is understanding where the "big boys" are going and getting out of their way while waiting for tidbits to rain down on you from their battles. As I said, unless you can throw a few billion around in the market you are only picking up scraps, and scraps in a multi hundreds of billion dollar trading day are plenty good enough to live on. Now, think about what I said. What do you think about and how do you feel when you think you are a scavenger? Are you already setting yourself up for failure because you don't like the connotation of being a scavenger? Have you already blown your psychodynamics by thinking that you can't play because you aren't number ONE?
People blow themselves up all the time before they even put in the first five minutes on any new endeavor. Don't be that guy. And in case you missed it - DON'T BE THAT GUY. If the name scavenger bothers you, change it to "soldier of fortune" or "opportunist" or any other name you like the sound of, but don't lie to yourself about what you are in relationship to the main players of the market, or you will hubris your way out of your complete bankroll. You will find as you go along that YOUR interpretation of a piece of data says more about you than about the data. With any interpretation it is easy to get lost in the emotion of groupthink, and hard to see beyond your own personal biases Know that going in. So here we explore a single candle, without adding a lot to the exploration from neighboring candles, or from other signs and signals along the way. Squeezing the understanding out of a single candle is critically important to being able to eventually look at two candles or three candles, or many more candles and indicators all telling individual and group stories, and being able to make the best possible interpretation for your "edge".
In the beginning: We are all familiar with the shape of candles. Here is one now: It's drawn as a rectangle and perhaps has shadows or wicks above and below. The proper term is "shadows". If you go nuts whenever anyone calls them something else then that person has an edge over you. Give up your need to be right and play the game behind the game. I call them wicks, shadows, tails, whiskers, or whatever else I can call them and still hope to be able to make you understand what I am talking about. Don't get lost in the name and forget what you are about.
So let's look at candle 1:
It shows an opening price (A)
closing price (B)
the high of the day (H)
and the low of the day (L).
Great, but what else can we say about it? Does it appear long or short to you? In that simple answer lays the beginning of your semantic relationship with the psychodynamics of the markets and indeed your relationship with the world. Realize that it only takes one buy or sell at the end of a day (or period) of only a single share of stock to make that the closing price of the day (period). In a day that traded millions of shares of stock at many prices all it takes is one share to be bought or sold at a particular price at market close to make that the closing price of the day. Think about that before you put all your trust into your interpretation of that candle.
This by itself is the strongest reason for looking at multiple time frames in your analysis. It only takes one person to affect the shape of a candle. In looking at multiple time frames you get to see if that "one person" is being consistent with all of the people that bought or sold earlier in the day.
Never take any candle at face value until you have looked at multiple time frames. Start your investigations by asking yourself "Is this a long candle"? If I think this is long, what does the average trader think this is? Is there a more objective way to decide how long this is? DO I care about absolute length or is everything in relationship to everything else? IS this long for this stock or not? Why didn't I start off by asking if I think this is short? Is it too long or too short? What does "too long or too short" really mean? As you start to wrestle with this you are exercising very important pieces of your mind in relationship to your view of the world.