Module 2   Technical AnalysisChapter 4

Getting Started with Candlesticks

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4.1 – History tends to repeat itself – The big assumption

As mentioned earlier one of the key assumptions in technical analysis is that, we rely on the fact that the history tends to repeats itself. This probably is one of the most important assumptions in Technical Analysis.

It would make sense to explore this assumption in greater detail at this juncture as candlestick patterns are heavily dependent on it.

Assume today, the 7th of July 2014 there are few things happening in a particular stock. Let us call this factor:

  1. Factor 1 – The stock has been falling for the last 4 consecutive trading sessions
  2. Factor 2 –Today (7th July 2014) is the 5th session and the stock is falling on relatively lower volumes
  3. Factor 3 – The range in which the stock trades today is quite small compared to the last four days.

With these factors are playing in the background, let us assume that on the next day (8th July 2014) the fall in stock gets arrested and in fact the stock rallies towards a positive close. So, as an outcome of the 3 factors the stock went up on the 6th day.

Time passes and let’s says after a few months, the same set of factors is observed for 5 consecutive trading sessions. What would you expect for the 6th day?

According to the assumption – History tends to repeat itself. However, we need to make an addendum to this assumption. When a set of factors that have panned out in the past tends to repeat itself in the future, we expect the same outcome to occur, as was observed in the past, provided the factors are the same.

Therefore, based on this assumption even this time around we can expect the stock price to go up on the 6th trading session.

4.2 – Candlestick patterns and what to expect

The candlesticks are used to identify trading patterns. Patterns, in turn, help the technical analyst to set up a trade. The patterns are formed by grouping two or more candles in a certain sequence. However, sometimes powerful trading signals can be identified by just a single candlestick pattern.

Hence, candlesticks can be broken down into single candlestick pattern and multiple candlestick patterns.

Under the single candlestick pattern, we will be learning the following…

  1. Marubozu
    1. Bullish Marubozu
    2. Bearish Marubozu
  2. Doji
  3. Spinning Tops
  4. Paper umbrella
    1. Hammer
    2. Hanging man
  5. Shooting star

Multiple candlestick patterns are a combination of multiple candles. Under the multiple candlestick patterns we will learn the following:

  1. Engulfing pattern
    1. Bullish Engulfing
    2. Bearish Engulfing
  2. Harami
    1. Bullish Harami
    2. Bearish Harami
  3. Piercing Pattern
  4. Dark cloud cover
  5. Morning Star
  6. Evening Star

Of course you must be wondering what these names mean. As I had mentioned in the previous chapter, some of the patterns retain the original Japanese name.

Candlestick patterns help the trader develop a complete point of view. Each pattern comes with an in-built risk mechanism. Candlesticks give an insight into both entry and stop loss price.

4.3 – Few assumptions specific to candlesticks

Before we jump in and start learning about the patterns, there are few more assumptions that we need to keep in mind. These assumptions are specific to candlesticks. Do pay a lot of attention to these assumptions as we will keep referring back to these assumptions quite often later.

At this stage, these assumptions may not be very clear to you. I will explain them in greater detail as and when we proceed. However, do keep these assumptions in the back of your mind:

  • Buy strength and sell weakness – Strength is represented by a bullish (blue) candle and weakness by a bearish (red) candle. Hence whenever you are buying ensure it is a blue candle day and whenever you are selling, ensure it’s a red candle day.
  • Be flexible with patterns (quantify and verify) – While the textbook definition of a pattern could state certain criteria, there could be minor variations to the pattern owing to market conditions. So one needs to be a bit flexible. However one needs to be flexible within limits, and hence it is required to always quantify the flexibility.
  • Look for a prior trend – If you are looking at a bullish pattern, the prior trend should be bearish and likewise if you are looking for a bearish pattern, the prior trend should be bullish.

In the next chapter, we will begin by learning about single candlestick patterns.


Key takeaways from this chapter

  1. History tends to repeat itself – we modified this assumption by adding the factor angle
  2. Candlestick patterns can be broken down into single and multiple candlestick patterns
  3. There are three important assumptions specific to candlestick patterns
    1. Buy strength and sell weakness
    2. Be flexible – quantify and verify
    3. Look for a prior trend.

325 comments

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  1. HAWWA says:

    Team Zerodha……keep rocking. Special thanks to Mr. Karthik Rangappa for his way of teaching!!!

    • Karthik Rangappa says:

      Please do stay tuned for further updates.

      • Vedant says:

        Don’t you think the advice to buy on a bullish trade and sell on bearish trade is wrong?
        In fact, one should do the reverse of that. What do you say?

        • Karthik Rangappa says:

          The other way to look at this is – you are buying strength and selling weakness.

          • l_earn_err says:

            This isn’t clear.
            It is just an assumption but analysing logically, when we are buying during blue candle day, it means we are paying more for a stock and the high price we paid for the stock may go down after sometime.
            Then how come we buy strength and sell weakness here?

          • Karthik Rangappa says:

            Consider this, a stock moves from 100 to 160 in 3 months, this is a 60% move. Buying this at 100 and selling this at 160 is easier said than done. You cannot time is unless you have luck favoring you. So instead of trying to time and aspiring to catch the entire 60% move, I’m happy buying at 120 (after ensuring the trend has established) and selling around 145-50. So in a sesnse, you catch a portion of the big move, which is completely fair enough.

        • Dharmesh Yadav says:

          but on bearish day a person can also do short trading for making profit

          • gautam singla says:

            Like u said before TA/ candlsticks is for short term or intraday trading.What if a person is trying to trade for long term period given that its fundamental is strong than he has to do the opposite ,right?

            I AM SPECIFICALLY ASKING IN REGARD TO ENTRY POINT PRICE FOR LONG TERM TRADING

          • Karthik Rangappa says:

            If you are trading long term, I’d suggest you don’t really look at TA. How would it matter if you bought a stock at 100 or 103 in the longer run?

          • Prabhsimran says:

            Can these candlestick patterns be used for short span like 5 minutes?

          • Karthik Rangappa says:

            Yup, can be used across any time frame, any asset.

      • gautam singla says:

        SIR,
        Like u said before TA/ candlsticks is for short term or intraday trading.What if a person is trying to trade for long term period given that its fundamental is strong than he has to do the opposite ,right?

        I AM SPECIFICALLY ASKING IN REGARD TO ENTRY POINT PRICE FOR LONG TERM TRADING

  2. rimpo says:

    Great Tutorial !!………Thanks Mr. Karthik Rangappa

  3. trendchaser says:

    waiting for programming for traders book in this manner

  4. Charles says:

    Sir, Is it necessary that a candlestick pattern has to have a high/ low price of a trend ? Referring to the image, does the last candle indicate Bearish Engulfing pattern. Thanks.

    • Charles says:

      Sorry. Forgot to upload the image before.

    • Karthik Rangappa says:

      Yes, infact I can see 2 bearish engulfing patters here.

      • SaikiranGarapati says:

        2 Bearish Engulfing Patterns means, In the last of the Graph only you can able to see it right?
        Please confirm that.

        • Karthik Rangappa says:

          Unable to get the context Saikiran, can you please elaborate. Thanks.

          • SaikiranGarapati says:

            Can you tell me or Draw a circle Where you are seeing 2 Bearish Engulfing Patterns..So that i can co relate with what i have studied in your Article..

          • Karthik Rangappa says:

            Are you sure this is in context of this chapter? I’m unable to spot the line where I’ve mentioned ‘2 bearish engulfing pattern’. Can you kindly help me place it? Thanks.

      • Jayatheerth malagi says:

        Sir thanks for this information which u provided but wat timing of candle stick we have to consider . Bcz there r sever period candle stick such that 1 minute , 5 minute n 15 minute n 30 minute candle sticks r there so which time candle stick is better to predict the market .

  5. DC0334 says:

    Sir,
    Firstly, What the third candlestick (from left) suggest as there is no body part?

    secondly ,Why some candlestick have dark green and some have light green?

    lastly, You mention somewhere that if BODY part is LONG then it may be good signal. Is it true? Or I understood wrong?

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