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.
These chunks of your mind usually stay well hidden and only crop up when you blow a trade, or look for reasons and meanings when things either are going your way or aren't going your way. If you are typical you will blow your own horn when things go your way and blame something else when things don't go your way. Now is the time to give up that BS and own everything good bad and even the ugly. If you can't, you might as well stop reading now and go to the racetrack.If you are still here, relax.
You can make yourself nuts by asking all these questions with no real answers. This is what your mind does to amuse itself; it creates endless chatter. You will also likely fall into pity parties when things don't work. Just set a mind trap to wake you up when you start blaming the phase of the moon and your dog's toenail length for why the current trade didn't work out.
Many are familiar with such things as Maslow's hierarchy of needs, or the 5 stages of loss and grief, etc. Here is Richard's circle of BS. Notice when it happens to you.
1 Oh no, the trade went wrong- it must be that the broker is screwing me over. NAHHH
2. Oh no, the trade went wrong ? it must be that the whole market is against m NAHHH
3. Oh no, the trade went wrong ? it must be something wrong with me NAHHH
Rinse and repeat from the top.The same thing can be done when everything works except most people usually stop with, "The trade worked. I am a wondrous and shining star of a trader" and refuse to explore further. (The Hubris model of failure) The one advantage you have, as a trader, is to set up a trading plan, compare your results to what you did with your trading plan, and adjust accordingly. Anything else and you should be selling apples on a street corner or busking for nickels because trading isn't for you.
The first most important thing you can do is NOTICE when you are BS'ing yourself. Don't even bother to try to do anything about it. Just notice it. Why? Did you ever notice that the more you try to change something the more you fix it in place? The more you are focused on having a significant relationship the less often they show up, the more often you worry about body size and image the more often nothing happens that you like.
It is just the way it is. You are flooding your brain with images of failure and your brain is more than happy to deal with it in its own inimical way by going into agreement with you, so for now just practice noticing your own BS.
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The answer to that first little question, "is this a long candle?, depends on you and how you see the world, how you see opportunity, how you see your relationship with money, and so on. Didn't think you would find all that in asking one question, huh? All of these issues usually remain hidden to us, clouding our view of why we think certain things about what we see every day in the market. I call the hidden information we don't see, our "superstitions". They have command power over us and we haven't really thought much about them (because they are hidden - haha) The worst form of a superstition is outright prejudice when you simply know something in every fiber of your being without having any evidence for it and you act as if its true.
As humans we create and inherit a lot of our prejudices. Whether we know what they are or not, they have command value over our actions. Part of our job is to shine a strong light on them, perhaps to illuminate our prejudices so they aren't so scary or perhaps to sterilize them so they no longer command us.Here we will be looking at our prejudices in interpreting stock market data. Only you can choose whether to use your prejudices or sterilize them.For one person this may be a LONG candle. For them the notion of LONG is tied up with a notion of a more volatile stock. Why? Well, let?s assume the longer the candle then the more the stock has moved from the low of the day to the high of the day over a wider range of prices. Of course you have to ask yourself many other questions, but let's just stick with this. This stock may move over a range of prices every day for a wild number of reasons, but ask what they might be (Note, wide range is even subject to multiple interpretations, but hang in there)
The original buyers like the price at A and start buying up available stock until there is not enough left at the original price so the price goes up to where some people are willing to sell the stock.This happens all day until the point H is reached and then most of the people think it is worth selling some of the stock and it may get all the way down to L and then back up on a roller coaster until it closes at B If the total distance between H and L is 10% of the value of the stock then you might consider this a long candle. Is this a hard and fast number? HELL NO, but whatever numbers you choose, choose them to give you a predictable and repeatable edge in further analysis. Write it down as part of your trading plan.IF the distance between H and L is less than 2% of the value of the stock it might be considered a short candle. (Same hell no comment applies)Do those numbers make sense to you? Would you pick different percentages? So if we have a long day candle encompassing a large amount of the value of the stock we might consider that day to be "volatile", but probably need more clues.This is the "art part" of stock evaluation. Each one of us has a different paintbrush and different colors with which to make our own art. This is where music becomes Jazz.
Learn to use YOUR tools and make your own art, not just paint by the numbers from someone else's work. You can now start to see why many people can see the same elephant, paint it slightly differently, yet it will still be recognized as an elephant by most of the rest of the world. Your plan is your plan and it is yours to adjust and play with so long as you actually do the work and stop trying to crib off of my plan (other than to use it as a starting point) i.e. in the world of art you do not have to reinvent paint colors unless you want to). However, we all know people, even ourselves, who want to be spoon fed trades and trade set-ups without participating on their own. They will forever be at the mercy of the billion or so people offering advice for a fee. Okay, you get the idea. Let's take several particular types of candles.
There are really only two candles you need to concern yourself with, and these two come in several flavors) The first candle has no wicks and the second candle has wicks. There are several flavors of each, which we will eventually get into. For now let's deal with the basics.
THE NO WICK CANDLE (marubozu)
The candles on the left (white and green) both represent the same type of price movement from open to close.
This is a bullish candle in that it opens at one price and closes at a higher price than the open The two on the right represent the same thing. Black and red indicate a bearish candle in that the price opens at one price and closes lower than the open. Just looking at the way the price is represented, start to notice your reaction to seeing an empty?candle as bullish. Do you prefer to see green indicating money?? That is a prejudice that could influence your way of thinking when a stock moves. Many professional traders revert to white (open) or black candles just to remove even the tiniest of prejudices from their analysis. If you think of open or hollow... Does it make you think the stock is going up or that it is empty? Examine all those notions now so you can see which way your many years of learning has bent your mind so that you can deal with stray irrational thoughts based on color or the notion of hollow or full etc.
Most people never look at this and blithely go through analysis unaware that even these subtle prejudices are warping their view. If they are aware of this then they can discount ?irrational? exuberance or fear. Many people like red and green. They are "happy" Christmas colors and they interpret everything in terms of a Christmas-y, happy, gift-y time of the year.
The stock market is no place for that kind of misinterpretation. It may give you gifts, but only because you work to obtain them, not because it's a happy time of the year. Knowing some of your prejudices (or even better, let's call them superstitions with regard to colors and size and shape), simply choose a set of colors you are going to use to represent up and down candles. Because it is a choice you can go back and choose again. Only if you find yourself saying "I like green because . . . ?" will you notice that you are operating out of superstition.
IF you operate out of superstition you cannot choose because you will always have reasons and excuses as to why you did what you did. Choosing means choosing - FOR NO REASON. Anything else and a superstition is running you.Does this mean superstition is bad? No. Choose between eating a nice turkey sandwich or a lump of dirt I wager that most of you would eat the turkey sandwich and I am sure you will have dozens of reasons why and your prejudices in this case would lead you to a probably more satisfactory result than eating dirt. SO, don't try and throw all your prejudices away. You can't. Don't try and claim you have no prejudices. You would only be lying to yourself and everyone around you. Just discover the ones that are running you that have previously been hidden from you hidden your superstitions.
The superstitions you choose have no command power over you because you can simply choose again. The ones that you are unaware of are in the drivers seat of your life. Now let's look at the candles again. Notice anything unusual? They don't have wicks (shadow is the politically correct term, but I will use them interchangeably). So, what does this tell you? And remind yourself we are only interpreting a single candle. Look at the two on the left. What they tell me is: (I will be using the word "day" and "time period" interchangeably, but you must remember it can be any time period.)
For whatever time period the candle represents the stock price climbed from the open to the close and we exited that time period at the high price for that period.Does this mean the price went up in one giant leap NO, it could do anything in the middle of the day.Does this mean the stock never went down during the day? NO, it does mean that the stock price never went lower than the opening price. During the time period it could be doing all kinds of interesting things like testing resistance, bouncing off of support, etc., as long as these bounces were within the price range indicated by the candle.Now you can see why multiple time frame analysis might be crucial. If you want to see what the story during the day was, choose smaller time periods. If you want to see what the long-term story is, choose larger time periods. If you are a swing trader you might want to spend a lot of time on the daily chart while referring to other time frames for a more complete picture. If you are a day trader, well you might want to spend a lot of time down in the one minute charts, but come up for air on the daily charts just to make sure you haven?t gotten lost in the forest.Maybe your edge involves some other way of assessing time periods. It's all yours to choose.To me this candle shows that the traders for some reason weren't too interested in a major tug of war during this time period. If we looked within this candle at shorter time periods, there may have been times during the day when traders were involved in rather hot tugs of war, but eventually they all agreed that the price should go higher.Ultimately this can be seen as an orderly bullish move during the time period.The same can be said "bearish" for the red candle.
So now sit back and see how you feel. Do you "like" orderly bullish moves? Are you comfortable with them, more so than bearish moves? Get all of your notions out on the table otherwise you will be at the mercy of the ones you don?t see coming. There is a reason its called being blindsided.Okay, now let's look at the other kinds of candles, the ones with wicks. There is a whole procession of ones with wicks as I have drawn below I will discuss these as open or up day candles (bullish) and the same discussion can be made for down day (bearish) candles.
As you look at this do you see an order or a progression If you do then realize it is all due to your own personal psychodynamics and comes from the need for the brain to make some kind of sense out of raw data even if it means imposing meaning where none might exist. The best way the brain tries to make sense out of things is by imposing patterns. Hence any kind of technical analysis is like mainlining heroin. The brain is reveling in all the patterns. Your job is to keep the brain's addiction for patterns from leading you down a disastrous path.
You are not your brain. Trading stocks should not be your brain on heroin! Further, we are only looking at interpreting single candles at this point yet notice how easy it is to turn your original intent into one of latching onto patterns and trying to imbue meaning in them. Does it help you to know that these are all some flavor of a bullish candle? They are all open or green, which means the prices close higher (or equal to) the opening price.
The Doji, candle D, is the only one that if interpreted all by itself just sits on the line between bullishness and bearishness. Remember thi ?fence sitting? behavior when we get to look at multiple candle patterns in another paper.Let us practice looking at individual candles as if they represent a whole microcosm of support and resistance areas for a particular period. Why?
It's simple; because if you look at where the price closed it is as if that area is a resistance to any further price increase for that time frame. It is a resistance line The inverse is true for an opening price, which represents a point of support. If it didn't offer "support" then the price would have opened lower. We can also look at the wicks as other areas of interim support and resistance for the period in much the same way. Keep this in mind as we go through the various candles.
So lets look at these: CANDLE A - The lower shadow (wick) indicates that some time during the day (or whatever period the candle represents to you) the price headed lower than the opening price, but the whole candle reminds you that the price eventually climbed back up over the opening price to close even higher. So while the bears were trying to drive the price lower the bulls eventually won the day and moved the price higher. How much of a struggle was it? IF you had a short lower wick (think back to our discussion of what long and short means), then not much of a struggle. In this case, the shorter the wick then the less overall bearish sentiment was driving the trading for the day.
Why? Suppose right after opening you decided to take some profit by selling out some of your position and that you would take any price available for it. In effect you are SUPPLY-ing stock to the market. Let's not worry about the size of your position right now, just the price action. IF you open the stock up for sale and people are willing to pay you just a little less than what the stock opened for, that would be the start of a lower wick only insofar that people eventually started buying and driving the price higher. IF people never bothered to try to buy the stock back, then you would have to drop your price even lower to interest them in buying it, hence making a longer and longer wick until such time as you hit a point where someone said, "AGHHH, I cant stand it any more. Buy the danged stock!?". IF they waited a long time the wick would get longer. If instead they thought that buying it back almost immediately was a good thing then the wick would be shorter.If they never bought it back but then the price went lower and lower because other people still wanted to sell, then you might even end up with a bearish candle on the day wherein the stock price closed lower on the day than where it opened. In that case, the bottom dropped out and the stock found no support at all until it hit the bottom for the day.
That is a separate discussion. For now, assuming that people were comfortable buying the stock back at some point during the day, then the bottom of the wick would represent support. So without knowing anything else, a shorter lower wick represents a more bullish outlook for the stock. You can now see why you might be interested in other indicators and signals to help you know if this is a short-term phenomenon, or one created by only a few individuals trying to manipulate the price to their advantage. You have no way of knowing at this point. The Christmas market is an excellent time to discuss this. For example, do you think that most of the large buyers and sellers are into hard trading just before and after Christmas, or do you think they are out and about enjoying their families and friends and only a few hard core nuts are buying and selling Do you think a lot of institutions are in the market with frenzy, or is the staff off taking vacations? All of these clues add a different perspective to your own personal psychodynamic and may help you evaluate the stock itself, but none of them change the meaning of the single candle.Immediately notice how much you are wanting to read more and more INFORMATION out of a very few DATA points. This desire can lead you down some very costly paths. Especially if you "hallucinate" a reality that is not supported by the minimal amount of data you have at hand This hallucination effect is exactly what every pundit, talk show host, late evening stock commentator, news channel, tweet, and pontificator is trying to drive you to. Shut them all off and listen only to your own conversation.
So the lesson is this: do not try to over interpret the candle. See the candle for what it is, and know that your own peculiar psychodynamics and need for security will cause you to bring in any of a bazillion other data points to help you make sense of this single candle.Start by asking yourself what a "short shadow" is. Typically, people call a shadow that is less than 1/3 the length of the body "short". Is this a good definition for you and the way that you want to trade? If not, choose another definition and stick by it.
CANDLE B: This is a longer shadow than A. Typically it is about the same size as the body of the candle. Everything mentioned in A applies here. The one difference is that when the bears beat the stock down, the bulls fought much harder to bring the price back up a farther distance before closing higher To me this indicates a battle the bulls still won, but not without taking some lumps from the bears.
CANDLE C: This candle has two shadows indicating still more of a battle where the bulls didn't fully win back their gains during the day. Thus the stock closed lower than the high of the day, but still on a positive note. It is perhaps a cautionary note to anyone who is trying to be wildly bullish. This is evidence to be cautious.
CANDLE D: This is the infamous DOJI candle. It shows that during this time period the bulls and the bears were pretty evenly matched in their desires and needs. The longer the shadows, the more intense the battle between the bulls and the bears. Imagine fighting all day just to end where you started, not gaining and not losing, but perhaps several million shares passed hands. When we come to look at other indicators this will provide some valuable insights. There are three basic forms of the DOJI:
2014 r p karasik
This doji has a long lower shadow. Even though the stock opened and closed at the same price, the bears beat the stock price all the way down during the period to the bottom of the wick, and the bulls pushed it all the way back up. In general this shows a strong rally by the bulls after the bears pushed the price down. This can be a bullish candle or a harbinger of change in market direction considering how much that price was fought over. Remember to review different time frames to see what was going on during the day.This doji shows a real tug of war and real market indecision. The only thing for sure is that people thought the opening and closing price were about right for the stock after pushing it all over the map. Remember the top of the wick is resistance and the bottom of the wick is support. Depending on how far apart those numbers are, you might see a lot of volatility in the market that pushed the price all over that range, only to close right where it opened. This doji has a long upper wick. It shows a strong push by the bears to drive the price down after the bulls pushed it all the way up to the top of the shadow. This can be the start of a part of a strong bearish rally. Remember to check other time frames.
CANDLE E: This is a slightly different version of C except here, the bears are stronger forcing the final closing price lower than the high of the day, but not succeeding in driving the closing price down below the opening price. This indicates a bit of caution to the bull trader and a bit of a wake up to the people with bearish inclinations to be on the lookout over the next periods for more bearish confirmations.
CANDLE F: This is much like candle B except that the bears seem to be more in control, but not so much in control that they could force a lower close. The bulls were in control in that the stock opened and then climbed during the day, but not so much in control that they could keep the price up near the high of the day.
CANDLE G: This is much like candle A (except inverse in meaning) This shadow could indicate the beginnings of a bearish sentiment because the bears could not drive the closing prices down as far as the open, yet they drove it down below the high of the day to close lower than the high of the day. That's it. The bear story is just the same for the equivalent black candles. Remember too that interpreting candles is much like interpreting your physical space in martial arts. It is an ar - they don't call it martial sciences do they now?
So, why is it an art? In part because you have to be able to be aware of all directions at all times in what is called a soft 360-degree "focus" IF you are omni-directionally aware you are obviously not laser focused in any western sense of the word "focused", but your attention is finely honed, and all your antennae are on high alert looking for anything to flash information at you.What this means is that if you are in any way unconscious when you spend time learning about candles, then more likely than not you will be susceptible to any and all hallucinations and superstitions and prejudices arising out of that unconscious inattention.
This could mean that simply listening to music while studying could set up unwanted and unhealthy association patterns which could affect your future choices. The same happens with strong emotions and strong smells. IF you did your best learning at 2 in the morning with bacon and coffee smells in the air, then you are more likely to recall the needed information at 2 in the morning with bacon and coffee smells in the air. IF you do not have those ?learning? triggers available when you are analyzing new data, then you may be more susceptible to distractions in looking at the data.
So the best plan is to set aside specific times during the day when you take on learning, other times for exploring that learning, and perhaps even more times to test your theories against reality. The more you create your space to take this on, the more your space will support you.If you remain omni-directionally focused, then having anything sneak up on you is less likely to derail you. In the next paper we start to look at 2 candles
Real Life Trader: Richard Karasik email email@example.com