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Part 7: Candlestick Basics
Technical indicators come in many forms and provide insight into price behavior. Candlestick reversals are equally varied and consist of many signals that are reliable and that also appear often. There are literally dozens of different one-session, two-session, and three-session candlestick types, and this is an area deserving of in-depth study and mastery. Swing traders relying on candlesticks know that reliable reversal can appear in many forms. The focus here is on a short list of highly reliable indicators: the engulfing pattern, three white soldiers, and three black crows.
Like all signals, these are highly reliable reversal patterns, but in order to act as reversals, they have to show up at the top of an uptrend or at the bottom of a downtrend. When they do not, they may act as continuation signals, and in this way give you equally valuable insight into the trend.
These candlestick indicators are summarized on the chart. The engulfing pattern can be bullish or bearish and consists of two consecutive days. The three white soldiers pattern is a bullish three-day indicator. And the three black crows pattern has three consecutive sessions and is bearish.
An example of the bullish engulfing pattern was found on the three-month chart of General Mills shown in figure 2.13. In fact, two bullish engulfing indicators appeared in close proximity, the second one confirming the first. Following these, prices trended upward as expected.
The bearish variety showed up on the chart of Microsoft in figure 2.14. This was an interesting occurrence since it was immediately followed by a large downside gap. A chartist could have entered a trade during the second session once it became apparent that the bearish engulfing pattern was forming. The downtrend continued for four additional sessions and ended with an upside gap and reversal day.
In the chart shown in figure 2.15, the three white soldiers pattern appeared three times, and each had a different meaning. The first was a reversal signal. Soon after, a second three white soldiers pattern appears that served as a continuation pattern for the uptrend and also confirmed the first signal. The third three white soldiers pattern was also a continuation of the established uptrend.
The charts of Chevron shown in Figure 2.16 and Research in Motion (now Blackberry) in Figure 2.17 show reversal and continuation patterns based on three white soldiers and three black crows. These reversals and confirmation patterns were strong on both charts.
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