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The Secret of Candlestick Charting — Louise Bedford

Chapter 11 — Seven Golden Candlestick Rules

It is time for you to be cast out amongst the other traders. The secret of the candlestick

has been revealed to you, and you are ready to convert your new-found knowledge into

money-making strategies.

Here are seven golden rules to assist you in your future candlestick trading endeavours.

1) Assess the Meaning Behind each Pattern

The candle graphically displays buyer and seller pressure. Candlesticks provide an insight

into the collective mind-set of other traders. Rather than committing every signal in this

book to memory, it would be far more effective to unravel the psychological principles

that contributed to that candle’s creation. Each pattern displays its secrets to the trained

eye. With experience, your ability to draw conclusions based on candlestick formations

will improve.

2) Analyse the Lead-up to the Trigger Candle

The lead-up to the trigger candle is equally as important as the pattern itself.

A share must be trending for a reversal formation to be effective. If the share is not

trending, the reversal pattern will not have a significant influence. The only way to

decipher the likely share price action after the reversal appears is to analyse the lead-up,

and then look for confirmation.

3) Watch for Appropriate Confirmation

After the appearance of a trigger candlestick, it is essential to await confirmation prior to

acting. To some extent, you will need to decide the amount of confirmation that you feel

is appropriate based on the duration of your view, and your level of conservatism.

Aggressive traders usually enforce a less stringent regime of confirmation prior to acting

based on a candlestick pattern. Players who are more conservative may wait two or three

periods. Confirmation is also suggested by using Western techniques, rather than relying

on the candlestick in isolation.

4) Know the Term of Your View

Usually you can expect a candlestick formation to affect the trading activity of between

one and ten subsequent periods. If you are a day-trader, you will need to be incredibly

proactive if you are acting based on a daily chart alone. It may be worth your while to

find a real-time candlestick supplier.

For traders with a medium-term view, candlesticks showing daily and weekly activity are

usually sufficient. For longer-term players, a weekly chart showing candlesticks may be

all that you require.

No indicator will provide correct signals 100% of the time. Even if someone had found

the perfect system, the market is based on so many variables that it is unlikely this

method will continue to be effective ad infinitum.

Numerous methods result in an incredible success rate when dealing with the left-hand

side of the chart. Unfortunately, we are not permitted to trade any trends that have

occurred in the past. We must content ourselves with estimating future share price

direction.

If we are relying on a system that is over-optimised, based on past data, clearly it will

show incredible clarity when we back-test. Yes, it will be completely capable of detecting

turning points in the past, but how will it perform in the future? This is called postdictive

error. It is an unfortunate consequence encountered by many rigid, inflexible systems.

Remain flexible, and allow your system for trading to evolve based on new market

information, but do not use this premise as an excuse for not following a system at all.

The best traders utilise systems in order to minimise the effects of emotion while

experiencing periods of pressure.

Find just a few methods that you are comfortable with. Stick with those methods and give

your system a chance to prove its worth before altering all of its inherent principles. If

candlesticks are now included in your repertoire, this is terrific news,

(I applaud your taste in indicators). However, if you do not relate to this method of

analysis, there is no shame in that. Just find something that you do relate to, and use it

consistently. If another method is more appropriate to your style, use it.

6) Apply Candle Addition to Multiple-Line Patterns

If you are unsure about the bullish or bearish nature of a new candlestick, apply the

process of candle addition. This will assist in showing whether a multiple-line pattern is

likely to have a positive or negative effect on share prices. By reducing several candles to

one line, the veil of confusion is often lifted.

When you become fluent in ‘candle-speak’, you will be able to perform candle addition

and candle development with speed and clarity. It is a skill that you will find very useful

to develop if you intend to become proficient in candlestick analysis.

7) Back-test, Back-test and Back-test

Each share has its own personality. The way a share responds to different candlesticks is

fascinating. Once you attune your eye to patterns within a share chart, many revelations

will become apparent. Some are very responsive to certain candlestick patterns. This

observation will assist in future trading scenarios, and may lead to a higher probability

trade based on a new appearance of the same pattern.

For each instrument, look for the frequency of pattern occurrence, the immediate

responsiveness to individual patterns, and the longer-term effectiveness of these

formations. This process will provide some guidelines regarding how that share is likely

to act in the future when a similar signal is exhibited.

It makes sense to focus on a few shares, and develop expertise in these instruments. This

will assist in your detection of appropriate patterns within these charts. If you spread your

resources too thinly by actively trading a multitude of shares in the market, it is possible

that you will miss valuable signals.

Sun Tzu was a military genius who wrote a classic treatise entitled The Art of War. The

principles in this ancient text are relevant whether you are planning a military coup,

aiming for success in the boardroom, or desire to excel as a trader. The fact that his ideas

were expressed approximately 2500 years ago shows that these concepts have stood the

test of time. One of his adages is: