Forget Candlestick Patterns – This is All You Need to Know

         

Understanding candlestick patterns goes far beyond remembering and recognizing certain formations. Many books have been written about candlestick patterns, featuring hundreds of different formations that supposedly provide secret information about what is going to happen next. Whereas it will make no difference to your trading performance whether you know what the Concealing Baby Swallow, Three Black Crows or Unique Three River Bottom are, once you understand what candlesticks really are, you can look further and read the story that price actually tells you.

Candles Tell You a Story

Candlesticks are just a different way of visualizing what is happening on your charts. But once you can read why and how candlesticks manifest on your charts, you can act and trade detached from pre-defined and arbitrary patterns, reading sentiment and momentum straight from your charts. In the following we take a look at the things that candlesticks tell you and how to read them.

How to Read Candlesticks: The 5 x 5 of Candles

One of the most important things candles tell you is whether Bulls or Bears are winning the game and, what might even be more important, by how much. But understanding the story of price goes further than checking whether a candle is black or white; to fully understand market sentiment you have to analyze the following five elements of candlesticks:

1. The length of wicks/candles

The length of wicks and candles can give you direct information about volatility. Longer candles imply greater volatility.

2. The ratio between bullish and bearish wicks

When price moves down and gets pushed back up, it leaves a long wick to the downside. That can signal that bearish strength is not enough to keep prices down.

3. The position of the body

In addition to the previous point, it is important to analyze the position of the body. Does the candle have a long wick to downside and is the body at the very top of the candle, it can signal greater strength than a body in the middle of the candle. In contrast, does the candle have long wicks to both sides and is the body positioned in the middle of the candle, it indicates indecision and equal power between Bulls and Bears.

4. The size of the body

A rule of thumb is that the larger the body, the stronger the signal it provides. A large body indicates that price moved a great distance between the open and the close of the candle.

5. The ratio between body and wicks

Is the body of the candle large, whereas the wicks are small, it shows that price moved from the open to the close without much volatility to either side. Small wicks and a large body are a sign of strength. In contrast, long wicks and a small body indicate indecision and equal power between Bulls and Bears.

If we combine the previous five points, we find that there are five possible scenarios what candles could tell us: (1) Strong bullish power, (2) Strong bearish power, (3) Bears tried to force price down, but Bulls managed to conquer, (4)  Bulls tried to force price up, but Bears managed to conquer (5) Bears and Bulls have equal power.

All candlesticks formations are made up of these five scenarios, combining the five previously described elements of candlestick information. By understanding the 5 x 5 of candle elements, you are well equipped and do not need to remember any candlestick pattern since they are all a combination of them.

Demystifying Candle Patterns

We showed you that it is not necessary to remember any candlestick formation if you understand the 5 x 5 candle elements previously discussed. To illustrate further how candlestick patterns are constructed, see the following graphic. As you see, an engulfing candlestick formation is therefore nothing but a pinbar/hammer when you add up the two engulfing candles.

More important, this is just one example of how candles are created and when you understand how to read price and candles, you will notice that there is no need to remember any more candlestick formation whatsoever.

Conclusion: No Need For Candlestick Patterns

With this article we want to show you that you do not have to learn any candlestick formation. When you understand the 5 x 5 of candlesticks, you know everything you need to know about candles. The 5 x 5 enables you to read every possible scenario that you can find on your charts.