How to Buy Low and Sell High (Candlesticks introduction)

Candlesticks charting technique has been used for many centuries in Japan and only made popular to the rest of the world a few decades ago. The technique has become more popular among traders as it provides easier identification of chart patterns as compared to the conventional OHLC bar chart.

The principles of the technique are simple. A candlestick chart uses the same as a conventional bar chart but provides more set ups and visually easier to identify. The broad 'body' of the candlestick is drawn between the market's opening and closing prices, like the line on a bar chart only thicker. “Shadows”, or lines, at either end extend to the session's highs and lows.

The body is then filled/coloured to show market direction – filled/black (or blue) blue if the close is below the open, hollow/white (or red) if prices close above the opening level. (See figure 1)



Steve Nison, the west's leading exponent of the method, says there has been an explosion of interest in North America and Europe in the past few years. "Candlestick trading techniques have become one of the most discussed forms of technical analysis in the trading community, both (in the U.S.) and abroad," he says.

The candlestick pattern formation can provide 3 major set ups – the price reversal, continuation and uncertainty. Price reversal is the most important and widely used set up. One of the reason why this technique is so interesting, apart from it being the value it provides in analyzing price actions, is because of the terminology used to describe the set up. A hammer candlestick pattern looks like a hammer on a candlesticks chart is a bullish reversal pattern and a Harami (bullish or bearish) is a two candle formation with a previous candle body much bigger than the current candle body, hence its name Harami, or pregnant lady. (See figure 2).

I have been using Japanese Candlesticks in my trading strategy and it’s far one of the best technique. The candlesticks technique can be applied on all trading instruments including stocks, index futures, commodities, warrants, options and so on. Let’s observe how it magically works on Malaysian stocks. First of all, let’s take a look at Tebrau's chart.



Upstart and Counter Attack on the Tebrau chart above (See figure 3) are bullish price reversal patterns while Engulfing Bear and Bearish Star are bearish reversal patterns. There are also other minor candlestick patterns on the chart like Doji, spinning tops etc. but they are not so significant. Doji patterns are uncertainty patterns and spinning tops are baby star patterns.

Observe that the bullish and bearish reversal patterns occur on most of the reversal points. These are one to two day candlestick patterns and therefore they provide quite fast signals. Most traders use these patterns as an early signal to detect price reversals and confirm with other technical indicators.

If you know about Candlesticks, you could buy Tebrau at about RM0.90 when there is an UpStart pattern, sell at about RM1.80 when there is an Engulfing Bear pattern and made a whopping 100% profits in just about 2 months. You could also make money buying at the Counter Attack pattern and sell it when a Bearish Star pattern shows up.

The candlestick patterns can also be applied on other time frames like the longer term weekly chart (See figure 4), or the short term minutes chart. This enables traders to use them to achieve short to long term objectives.

On the weekly chart below DIGI provides an opportunity for investors to buy when price went into a correction and then sent a Bullish Star Signal on 9 of September. Price then was about RM20.00 and five weeks later on the 24th October 2007, DIGI’s price stands at 24.00. It was a 20% move.



Candlesticks patterns are sometimes not detected on price reversals, but once the pattern is detected, the reversals turn to significant rallies. Therefore, traders can rely fully on candlesticks for entries but cannot rely fully on exits because they may not appear when the price starts to turn to the opposite direction. Other indicators are needed as back up for exiting a trade that was initiated by a candlesticks pattern.

It takes some creativity and research to combine candlesticks patterns and other technical indicators such as support and resistance, Fibonacci, Oscillators and trend studies to get good entry and exit signals. They can be used as a powerful trading strategy once combined with risk and money management.

Article prepared by Benny Lee