Study of Trading Psychology behind Candles

[Soultrader]

I am taking a look back since the beginning of 2007 to better understand psychology behind candles. These charts do not show actual trades taken, but examples of possible trades based on the psychology behind candles. (yes it is hindsight analysis but the point here is to learn the pscy behind candles) I will be following up with various charts from the beginning of the year.

Setup Parameters: 20pt stop maximum
Strategy: Pivots, Previous Day High/Low, and Candles
Chart: 1500v

Chart #1: Jan. 4, 2007



Green Line: Resistance 1
Yellow Line: Daily Pivot or PP
White Dotted Line: Previous Day Low

Step by step candle analysis:

Taking a look at the first opening bar. The green bar shows optimism for new established longs as it stretches above resistance 1. The second bar shows a long wick (longer than the real body of the candle) indicating selling. The early longs booked in profits while the late longs (those bought near the end of the first candle) are definitely feeling uncomfortable at this point. The next two bars are red candles closing below the first green buying bar. This is extremely important to understand. The longs from the first bar are now facing a loss. Paper profits have now turned into paper loss.

The market chops for a few and then retests the R1 pivot line. The fact that it reaches about half way of the first opening bar (Bar 1) gives the longs false hope. They have seen price advance, price decline below their entry point, and now price coming back to their entry point. Notice the blue arrow that says "Bearish Engulfing". The red bar crushes all hope as sellers come right back in. The longs who are willing to take a loss will start selling as they are seeing downside pressure. Those who are still praying will leave their stops in and wait for the market to take them out.

An good entry would be on the next bar after the bearish engulfing pattern. The white dotted line represents the entry point at 12623 with a stop above the high of the previous bar at 12635. (right above r1 also)

The second bearish englufing patterns occurs on the next red bar. (yellow arrow) That bar takes all the stops out from the earlier longs (Bar 1). This drives a downward momentum with stops and shorts.

Exit signals:

I find exit signals with candles a little too late. Therefore I personally find it good to have an exit target before the entry based on significant price levels. The white dotted line shows the previous days low. A very good target level. For shorts who are expecting more, narrow range bar gives off the first warning signal. Notice the rising three methods also. Three red bars followed by a green bar that takes out the real body of the first red bar. This should be an immediate warning signal for shorts as well. Traders who shorted any of the three red bars are now seeing price move against them. You also get the first higher low confirmation.

The chart shows a simple setup using candles, pivots, and the psychology behind the candles. More charts to come...