Step 3: Putting it all together

[brownsfan019 17]

In Step 1 and Step 2, we discussed some of the basics of using candlestick analysis in your trading. The next step is putting it all together.

 

Before we get into this, I should preface it by saying there are many, many schools of thought on this part of candlestick analysis. There are many schools of thought on how to trade individual patterns as well. I obviously can't go into detail on every single pattern out there, so we'll discuss them as there are questions.

 

In taking a trade, recognizing a possible trade is only a small part of the equation. You then need to know where your ENTRY, STOP LOSS AND PROFIT TARGET(S) will be.

 

PROFIT TARGET(S)

I will start with profit targets b/c it's easy - there's so many different ways to exit, I can't possibly list them here. In regards to candlestick analysis, Steve Nison has said many times that candlestick analysis does not provide possible profit target(s). Some other form of your trading plan will have to fill in here. This is of course an incredibly important part of your trading plan since it can make the difference between a profitable trade and a losing one. Just keep in mind that candlestick analysis will provide very clear possible entry points, but does not lay out an easy-to-use exit strategy. I personally will usually use a set profit target or stay in a trade until a reversal pattern appears.

 

CANDLESTICK ENTRY

Some might be thinking the entry is easy - see a hammer and go long at the market. And that's one option, but there are more. The options to enter on a candle pattern are:

 

1) Enter @ market at close of the candlestick pattern.

2) Enter somewhere on the next candle.

3) Enter after there is some bullish/bearish confirmation of the candle pattern.

 

CANDLESTICK STOP LOSS PLACEMENT

In the most traditional sense, placing a stop loss is rather simple - place at/near the high/low of the candlestick pattern. Will explain with some chart screenshots.

 

 

 

Let's look at an example...

 

Here's a nice looking hammer on the weekly DJIA chart. I borrowed this from James_gsx's thread.

 

So in this example, we have decisions to make.

 

ENTRY:

In this example you can enter in 3 ways:

 

1) As soon as the hammer closes, you go long @ the market to ensure a fill.

2) Since it's not uncommon for the low of a hammer to be tested, you can wait and go long after price drops.

3) You can wait for 'bullish confirmation' and go long once the HIGH of the hammer line is traded through.

 

There's good and bad of each setup...

1) As soon as the hammer closes, you go long @ the market to ensure a fill.

GOOD: You get in @ the market and there's no concern of 'missing' the trade.

BAD: Since we know hammers can be tested, you could see a quick stop out and/or take some heat on the trade immediately. Discipline would be key here.

 

2) Since it's not uncommon for the low of a hammer to be tested, you can wait and go long after price drops.

GOOD: If price comes down, you can get a 'better price'. Also, if you do take a stop loss, it will be much smaller than the other entry methods.

BAD: I have a real hard time wanting price to go DOWN for you to go LONG. To me, that's counterintuitive. Again, discipline is key to be able to say 'I want price to drop, get me long and then snap back up'.

 

3) You can wait for 'bullish confirmation' and go long once the HIGH of the hammer line is traded through.

GOOD: You want to see the bulls take the price and drive it up through the high of the hammer. If going long, it adds some additional confirmation to see price go UP.

BAD: Depending on stop loss placement, you could have a large stop on some trades and this hammer is a good example. If you place a buy stop above the candle high and then a stop loss below the bottom of the hammer, you can see there's some risk involved in the trade.

 

So as you can see, you have a very big decision to make on how you will enter the trade.

 

Note - if you find yourself thinking - I did not know that it's uncommon for a hammer's low to be retested, then you have quite a bit more studying to do before even thinking about Step 3. You just need to know this information about this pattern and any others you may trade. This comes from studying the patterns yourself, reading candlestick books and studying some more.

 

STOP LOSS PLACEMENT

Again, the most traditional candlestick analysis says to place your stop somewhere below the low of that hammer b/c you know that it can easily be retested. The last thing you want is to be long, get stopped out and then look back and think - if my stop was just placed better, I could have stayed in a winning trade vs. taking a loss.

 

Exactly where to place that stop is up to you. I suggest just a few tick(s) or price level(s) from that low. I mainly trade the ES, so most of my stops are near the low of that hammer as I know that area can be heavily defended. Again, it comes down to knowing how particular candle patterns work on your particular market(s). Make no mistake, this is not as easy as just going 'hammer hunting' w/o first knowing how hammers react on that particular market or stock. In other words, you have to KNOW how hammers react on your market/stock BEFORE considering a trade. If I see any charts of 'why didn't this hammer work', I am going to ask what your analysis has shown before we even discuss the chart.

 

PROFIT TARGETS

As I mentioned above, how/where/why you exit this trade is something that you need to develop on your own. There's plenty of resources on TL and other websites about possible exit scenarios. In this current volatility however, I would suggest considering staying in trades longer than you might during periods of low volatility.

 

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So there's an analysis on a hammer. What you have to decide is - what are my actions taken, if any on this? And why? What would cause you take this trade and what would cause you to not take this trade?

 

Let's see if we can get some discussion going here on this 'real' setup - take a look at a weekly DJIA chart and see what you see and what play you would make if trading off the weekly. Here's a link if you need a reference point - http://stockcharts.com/h-sc/ui

[Nick1984 10]

Awesome posts brown

Didn't know diddly about candles before. I really enjoy these posts!

[brownsfan019 17]

Glad you enjoy them Nick.

[Soultrader 12]

Yes, very much. Thank you brownsfan.

[Reaver 10]

Good info man.

[A2Z 10]

Thanks brownsfan

[walterw 10]

Brown, taking a look on your excellent threads ¡¡ as I am looking ES lately, what timeframe do you normally use for your candlestick trading on ES ?

 

thanks for great threads ¡¡ cheers Walter.

[brownsfan019 17]

Brown, taking a look on your excellent threads ¡¡ as I am looking ES lately, what timeframe do you normally use for your candlestick trading on ES ?

 

thanks for great threads ¡¡ cheers Walter.

 

Walter - the timeframe(s) I use on the ES are a function of the volatility, but normally looking at 1, 3 and 5 minute charts along with a couple VBC's as well. Now, I don't use all of those at once, I just monitor each to see where setups are looking good and try to adjust my timeframes accordingly.

 

If I had to pick one, I'd probably choose the 5 minute chart.

[walterw 10]

If I had to pick one, I'd probably choose the 5 minute chart.

 

Ok Brown, thats what I wanted to know... wich one would be the most classic one... thanks a lot and again congrats for this great section ¡¡

 

 

cheers Walter.

[OAC 10]

Scalpers should glance at the 15 min charts too. It tells you when to load up on your runners.

[angelaktariel 10]

WOW, this is so much great information, thank you so much for putting these threads together. Really teaching me a lot! I am a little familiar with the candlesticks, but since I am very new and not really trading yet, this last one showed me how to actually do a great setup. Love it!!! Thanks again,

 

Eva