Buyers And Sellers
There are only two groups of people
in the stock market. There are buyers
and sellers. We want to find out which
group is in control of the price action
now. We use candles to figure that out.
The picture above shows how
candlesticks are constructed. The highs
and lows of the time period are called
the "wicks" and the open and close form
the "body". The candle itself is the
"range". When stocks close at the bottom
of the range we conclude that the
sellers are in control. When stocks
close at the top of the range we
conclude that buyers are in control.
Note: In the stock
market, for every buyer there has to be
a seller and for every seller there has
to be a buyer.
If a stock closes at the top of the
range, this means that buyers were more
aggressive and were willing to get in at
any price. The sellers were only willing
to sell at higher prices. This causes
the stock to move up.
If a stock closes at the bottom of
the range, this means that sellers were
more aggressive and were willing to get
out at any price. The buyers were only
willing to buy at lower prices. This
causes the stock to move down.
Where a stock closes in relation to
the range tells us who is winning the
war between buyers and sellers. This is
the most important thing to know when
reading candlestick charts.
We can classify candles in two
categories: wide range candles (WRC) and
narrow range candles (NRC). Wide range
candles state that there is high
volatility (interest in the stock) and
narrow range candles state that there is
low volatility (little interest in the
stock).
Note that stocks tend to move in
the direction of wide range candles.
The arrows on the chart below show
how stocks move in relation to the range
and closing prices:
Wide Range Candles
If we know that stocks tend to move
in the direction of wide range candles,
we can look to the left of any chart to
gauge the interest of either the buyers
or sellers and trade in the direction of
the trend and the candles.
The importance of this cannot be
overstated! You want to know if there is
interest in the stock and if it is being
accumulated or distributed by
institutional traders.
Narrow Range Candles
Narrow range candles imply low
volatility. This is a period of time
when there is very little interest in
the stock. Looking at the chart above
you can see that these narrow range
candles often lead to reversals (up or
down) because:
Low volatility leads to high
volatility and high volatility leads to
low volatility. So, knowing this,
doesn't it make sense to enter a stock
in periods of low volatility and exit a
stock in periods of high volatility?
Yes.
Hammers, Doji's and Shooting Stars?
The number one rule when reading
candlestick charts is this: You want to
buy stocks when nobody wants it and sell
stocks when everybody wants it! This is
the only way to consistently make money
swing trading!
I know what you’re thinking. You
thought this page was going to be about
hammers, doji’s, and shooting stars.
Sorry to disappoint you, but knowing all
of the different types of candlestick
patterns is really not at all necessary
once you understand why a candle
represents the struggle between buyers
and sellers.
Consider this:
In this picture we see a classic
candlestick pattern called a hammer.
What happened to cause this? The stock
opened, then at some point the sellers
took control of the stock and pushed it
lower. Many traders were shorting this
stock thinking it was headed lower.
But by the end of the day, the buyers
took control, forced those short sellers
to cover their positions, and the stock
had enough strength to close the stock
at the top of the range.
When we are reading candlestick
charts, why would we need to know the
name of the pattern? What we do need to
know is why the candle looks the way
that it does rather than spending our
time memorizing candlestick patterns!
