Welcome to The Stock Market Millionaire podcast, episode number 11 called “Using Candlestick Patterns to Your Advantage.” My name is Robert Roy. I am the CEO and founder of WealthBuildersHQ.com, and today we’re going to go into exactly how candlesticks work and what they are.
So the first question we have to tackle is what is candlestick charting? Because ,you’ve heard of charting a stock before, many of you have, but what does candlestick charting mean? Did we actually get a candle? Put it in like a little candelabra? Light it, not light it, what do we do? I mean, candlestick charting is a way that we look at a chart and use a certain type of a bar, hence the name candlestick, to determine where the stock is going. Now, this is one of many charting techniques there are such as bar charts, line charts, mountain charts, histograms… There’s even specialized candlestick charts like Heiken-Ashi, right?
The standard candlestick chart is one of two ways. Either you have a hollow, white candle, which is a bullish candle meaning the stock is going up, or you have a solid black candle, which means the stock is going down. That’s the first method. The second method is the candles would be green for bullish and red for bearish. There is no right or wrong, by the way, it’s just a comfort level. I personally like the hollow and the solid, the black and white coloring works best for me to see it. The red and green is a little bit too harsh on my eyes, but it really just comes down to a matter of comfort. There’s no right or wrong way to look at the chart.
And, when you look at the candlestick chart, it’s no different than looking at it at any other chart. It’s just a matter of what the candlestick tells you. You see, the way I look at it is this: the standard candle or a bar that was used in the past was a bar chart, and it had four pieces of data on it. Open, high, low, and close. Great. Tells me everything I need. Well, so does a candle stick, then why do I need to use a candlestick? Rob, if I use a bar, why a candlestick? Candle sticks are visual? I can very easily see by the color and shape of the bar because of the way it is created and crafted. I can very easily see from that what exactly is going on in the marketplace.
Candlesticks helped me to understand that it’s actually my preferred method. The way that I learned back in 1997 was on candlestick charts. Now we use other charting types, like a line chart. When I first got started, we had to draw all of our lines on line charts. What’s a line chart? Line chart is nothing more than the closing price of the stock.
So wait a second, what about all the other data? It’s not there!
So it’s a connect-the-dots of a week ago, let’s say Monday, it closed here at 10. On Tuesday at closed at 11. Well, connect the dots. Then on Wednesday closed the 12 connector, 11 to 12. Then on Thursday closed at 11, connect to 12 to 11. And on Friday, it closed at 15, connect the 11 to 15, and that gave us a line chart.
And that’s what we were told/taught is the only way you should ever draw your support and resistance lines. I don’t personally use that any longer. I think there’s a lot of value in using the bodies and or wicks, the two components of a candlestick, to help me determine supports and resistances as needed – as needed.
I don’t use it all the time, but when I’m trying to find an area of congestion, a place that we’ve been a lot of times, a candlestick chart really does go out of its way for me to help me. The line chart gives me very little data, and the bar chart, I can see it, but if you stare at a bar chart and then go look at the candlestick chart, it takes a half a second for me to read a bar chart and go that’s a bullish day or a bearish day, especially when the open and close if they’re close to each other. When I look at a candle, it’s clear as day. Very easy to understand, very easy to decipher boom, I’m right in. I’ve got my answer and we’re done now.
Why do some candlestick patterns work better than others? See, candlesticks are the bar, the type of bar the pattern would be just that ,the candle pattern that has been found. There are two major authors out there, that have written books on candlesticks – there are many authors, but two major ones, Greg Morris, and he wrote his latest version of his book with someone who is a coach for WealthBuildersHQ.com, and that’s Mr. Ryan Litchfield. Phenomenal candlestick trader, phenomenal trader, period, and exceptional chartist. He determined – no one else had – that the importance of a candle pattern, where it falls on a chart is going to be critical. In other words, did a certain pattern fall near a resistance line, or did it fall near a support line? Was the stock in a bearish pattern or a bullish pattern? You may have a bullish candle pattern and the stock is bearish. Is it really mean that the stock is turning bullish? Or, is it just a pattern that presented itself, but maybe it’s not as highly reliable based on location? And that’s what Ryan determined.
So Gregory Morris, along with Ryan Litchfield, and then you have Steve Nison. Steve Nison and Gregory Morris were the first two majors. Steve was a few months, I believe before Gregory Morris wrote his book, but outstanding both of the books on candlesticks, what they are and how they work.
When you look at why some patterns work better than others though, now you go into, we a doji, which is a one day candle. Doji means indecision. Open-close equal the same. Right? So in other words, we opened at 40, we closed at 40. Doesn’t matter, the high and the low though, those are the wicks of the body, of the wicks of the candle, rather. So it really doesn’t matter the price that they moved to; the important thing is open and close to the same. Well, if open and close prices are the same, that means nothing happened. It was flat today. Correct. Well, some will look at that and say, “Ooh, that’s a very important candle.” And, to some extent it could be, but here’s how and where it’s important. It’s not important today. It’s important that I find that yesterday. In other words, the market is closed today and I go back and I find a doji yesterday, because now, did I find that doji near resistance, which is your ceiling right up at the top that I find the doji up at the top, and now the stock has banged its head into that with a doji and the next day failed? See that’s a powerful candle pattern – doji one day ago – compared to a doji that just falls in the middle of nowhere, or has no confirmation of another day to say, “Ooh, this just happened.” Right. So why does some candle patterns work better than others? That’s because there is more reliability of certain patterns than others. As I said, with the doji, just a doji is okay. A doji one day go is so much more powerful if it falls in the right place, the right location on the chart.
So another question is, is there any kind of specific software that I need for candlestick charting? And the answer is no, you just need a broker. Almost every broker out there is going to have candlestick charts. And I say “almost” every broker, I’m pretty sure that every broker does, but just in case, there’s the one, the off one that you happen to choose, we’ll say “almost” every broker. Are there specific software programs that are better than others? Well, you know, a candle pattern is a candle pattern. If you find a doji pattern, if you find a hangman, a Heikan-Ashi, it doesn’t matter. Whatever the pattern is, it’s no different whether it’s TradeStation, ToS, Omega Chartz or any other program that’s out there is fine. You just need to have the software from your broker.
Now, what market conditions work best for trading candles? So what market conditions are the best conditions for candlestick trading? First, you need to consider the direction of the chart, right? So what does that mean? Is the chart bullish, going up? Is it bearish, going down, or is it, I-don’t-know- ish, going sideways? Maybe choppy even? You’ve got to determine the direction of the chart first. And for me, the direction of the chart even starts off before I look at an individual stock like an Apple or a Google or whomever, it might be, you want to do this with the overall market, which is the S & P 500. You want to look there first.
So let’s say that you have an overall chart that’s going up, and you have a bearish candle pattern. Well, you may get a short-term pullback, but is that what you’re trying to trade? For me, if I see the market is bullish and I find a stock that’s bullish, I want to wait until the stock gets back to a support and bounces and take that bullish trade from there. Because, you have bullish candlestick patterns and you have bearish candlestick patterns. You’ve got to determine that direction of where the market’s going, of where your stock is going before you could trade one. Now there are sister or related patterns to each other. So, you have a “rising three” pattern, which is a bullish candlestick pattern. Well, there’s also a “falling three” pattern, which is a bearish pattern. You have a doji, which if it happens at support in a bullish trend, is a reversal pattern looking for a move to the downside. If you have a doji in a bearish or downward move that happens near a support level, it is a bullish move. So, bearish move if it hits resistance and rolls over, bullish move if it bounces off of support and starts to turn to the upside. So you have that sister or related pattern to each other. They are found in different locations.
Today is a Monday. I did a Power Hour training, which you do a free training each and every Monday online, live 12 noon Eastern time. You can find us on YouTube, Facebook, and we do it in our own Zoom room as well. And, the question was asked about a chart and they said, “oh, is that a hammer pattern?” And it’s okay, it’s not, but I understand why you think it is. The candle pattern is the shape of a hammer pattern because a candle and a hang man, I’m sorry. Let me rephrase that. A hammer and a hang man are the exact same looking candle pattern. Rob, how do you tell the difference? Location, location, location. If it happened at a resistance, it’s a hanging man. If it happened that support, it’s a hammer where you’re hammering out a base.
So now I started to say some phrases in here such as reversal and so forth. There are reversal candlestick patterns, such as an “abandoned baby” pattern or an “engulfing pattern,” which I like engulfing patterns, there are two-day candle pattern because they’re setting me up for my favorite candle patterns, which we’d call “three outside” patterns. It could be three outside, down, or three outside up bullish and bearish is all that means. It’s a three-day pattern, which requires an, an engulfing pattern first. And then, and only then do we get confirmation on that third day.
And then there are continuation patterns like a hanging man or a rising three. You’ve got these various continuation patterns that take place, right? So we want to make sure that we know that there are some differences between the various candle patterns, between the various candlesticks, and how they relate to what we do in trading.
Alright, there, you have it. Ladies and gentlemen, stay focused on the quest of becoming a great trader, keep crushing it. And remember, you’re just one trade away. This is Robert Roy signing off saying, I will see you all at our next event. Take care now. Bye.