No matter what style of trading you are looking to succeed in, reading a chart is one of the most important base skill sets to have. You are ultimately trying to determine where the price action of a security is going over a certain period of time. Calibrating a chart to be read properly will be a key component of your thesis. Put it all together and you have what we would call a good ‘setup’. In this handy guide, we’ll show you some of the fundamentals of how to read a candlestick chart and when you might use one. This way, when you get into more intense and specific technical training to grow your day trading career, you’ll be ready to apply this knowledge for financial independence.
Introduction to Chart Reading
When looking to determine what the chart of a security is telling us, it’s important to understand the absolute basic components first. Not all charts are candlestick charts, but we find them to have the most complete information using the fewest steps for day trading.
To begin with, as the candlesticks progress, the x and y-axis of the chart will always represent time vs. price respectively. However, the time frame you choose will dramatically influence what you are looking at, and how you might calibrate it changes depending on a trade type or even the personality of that day trader. Here are some common time frames and what they might be used for in day trading:
This shows a much longer-term trend of a security and how it has reacted over the course of several days to a week. This allows the swing trader to not focus on price action that might seem volatile in the course of a few minutes or hours, but is consistent when zoomed out to the daily candlesticks.
This chart allows us to hone in on the daily price action with more accuracy. We also use this timeframe to determine the current market value and direction. At StockAbility™, this timeframe is an integral part of our Location Analysis which is one of our patent-pending systems that we teach. 15-minute chart
We use 15-minute charts to refine our entries and reduce risk. It’s easily distracted by the movement on small time frames and this is where most amateur traders go wrong. . Mostly, you should consider each time frame as its own different tool and understand how and when to use them.
The Mechanics of a Candlestick Chart
Rather than using bar charts or line charts, people use candlestick charts because they provide more information at a glance. In each candlestick, a trader can determine four different price points – the open, close, high, and low throughout the time period on the chart.
It is often popular among day traders to shade their charts and candlesticks in ways that are more visually appealing or easy to read. While this might sound inconsequential, when you are making decisions to take trades at a rapid pace, your comfort in reading something over and over can add up to significant time if you make it easier.
The graphic above shows five of the most common and widely recognized candlestick formations from classic technical analysis. They each represent a certain change in price direction when they appear at specific points during a trend. The engulfing candle suggests a continuation of the trend. While the hammer or hanging man is usually found at the end of a trend and suggests a reversal. Another sign of a potential price reversal is the Doji, which implies signs of indecision and that a shift in momentum is looming in the market. While it is good to know these different names of these candlesticks, just by looking at their structure alone you can get a good idea of whether we are seeing strong buying and selling pressure, or simply a state of indecision.
A hammer candle really tells us that prices were pushed down significantly, only then to see strong buying stepping in to push the price back up. The hanging man is the exact opposite of this. It shows us that while prices did rise on the candlestick, intense selling pressure came in at the top of the candle’s range, resulting in the price being pushed back down and closing much lower in the overall range. We expect to see patterns and events like this forming around major market timing points where trends tend to end, and new ones likely begin.
As with most things in trading we also need to focus on price itself too. The typical methods that most traders use to incorporate candlestick patterns into their trading tend to lead to poor entries and weak risk to reward scenarios. One of the most common uses we see of candles, is when a trader or investor waits for a candle to close positive or negative before entering a position. This often leads to a late entry and greatly impacts the overall risk to reward profile of the setup. Here is such a scenario in more detail:
In the above example, we have marked off a Support Zone area, one of our ideal buying setups at StockAbility™. The zone suggested a key price transition area on UBER where new buyers jumped on board the mover after a nice pause and accumulation. The plan is to buy a retracement back to the zone with a tight entry and a stop-loss order set just below the lower of the 2 lines in the support zone. This is a protection order to get out of the trade if we are wrong, with just a small loss. We have planned and will set the trade accordingly. The results were as follows:
As we can see, the price dropped rapidly down to our support zone and triggered a buy opportunity immediately. We then saw a decent rally up to resistance around $55. This gave a move of around $3.50 with a risk of about $0.50. before buying. This risk to reward ratio was only achieved by buying when the price first came back to the support zone. If we had waited for the candle that triggered the support zone to have closed higher before buying, we would have entered around $53.00 and right now if still holding, would be sitting on a losing position. We personally prefer a situation where we are already in a position. The candle pattern just then confirms that it is a good trade.
Additionally, candlesticks charts and their wicks are considered by many to show the emotion of a security as it moves. This will let a trader determine a bullish or bearish pattern based on how it closes in their desired time period. Much like with any other form of trading tactics, we recommend that you find what works best for you via coaching, courses, and back-testing your personal results.
Get Proper Trading Education with StockAbility™
At StockAbility™, we have helped a community of inexperienced investors develop into successful day traders. We take pride in helping people learn the mechanics and basics of trading such as chart reading all the way to advanced concepts in options trading and other securities.
If you would like to take the next step towards controlling your financial future, we’re here to help. Reach out today to sign up for a free webinar or to connect with one of our coaches. We’re confident that it’s an investment you will see returns on for years to come.