THE JOY OF CANDLESTICK TRADING - a Learning Experience

[tymen1]

In our search for a correct risk/reward ratio for short term candlestick trading, I submit the following chart of surveys done on longer term time frames and with greater money >>>


By tymen1 at 2008-04-18

This chart needs explanation.

It is a chart of trades done on an evening star formation.

The trades were entered at "market" ie, at the bottom of the 3rd candle

The chart is dotted with red and green pyramids representing trades. The vertical scale is profit/loss - profit if a green trade and loss if a red trade.
The drawdown is the amount the trade retrace/pulled back to go -ve before it went +ve and produced a profit.

As you can see, most of the green trades were in the 0-2000 retrace section and most of the red ones were well above this.

Conclusion : A stop loss placed at 2000 would see the winning trades able to retrace and then produce profit. The trades that would ultimately lose anyway, would hit the stop loss.

The only sad thing here is that the patterns have a 36% success rate.

So for us too, there must be a cut off point where the stop loss is placed. Research on the Australian share market suggests that for an evening star pattern, price action should not retrace/pullback above the mid point of the 3rd candle in order for the trade to be profitable. Above this point, the trades do not fair well.

So can we reduce the stop loss position to the 3rd candle mid point instead of the top of the star?
A quick look shows that we would lose quite a few trades if we did this.

[tymen1]

Look at the following chart showing an evening star on a 40 minute chart >>>


By tymen1 at 2008-04-18

The 3rd candle did not meet out criterion of going past the 50% mark of the 1st candle. (shown with pink line).
It would, therefore, be classed as an unsatisfactory pattern.

The result was that the 4th candle (the first of the trade) was the only one to produce a profit and that only being about 5 pips total.

A stop loss set at the mid point of the 3rd pattern candle would have been a disaster. The price later went right up past any stop loss point - it was a total loss trade.

Quality candles are needed.

[tymen1]

Now I wish to go thro a short trade on an evening star pattern showing an improved entry technique.

Before we start, we divide our trading lots into two halves.

Now examine the following 5 minute Keltner chart :


By tymen1 at 2008-04-18

At first this chart looks absolutely daunting - so much detail!!

Lets go thro it :

The bottom half shows a fast MACD with settings - average 9, short 5, long 17.
The top half is the chart with the continuous blue lines being the Bolinger bands.
The Keltner channel is again shown shaded grey with the mid band in yellow.


The short entry at the 4th candle of an evening star pattern. This is shown by the black vertical dashed line at the left of the chart.
The standard Keltner vectors at the entry mark - MACD going down, BB level, resultant down, giving a below middle band entry, was acted on immediately and gave a short entry of 56.

This short entry was made with the first half of our allocated lots. You can see it on the chart with the black vertical line.



I will remain on this 5 min chart throughout the trade.


Then the price went down (profit) to a doji. After this 5 green candles brought the price right up and we hit -ve. At this point also, the price reached the top of the Keltner channel.
So at this point I added the 2nd half of the allocated lots going short. The price here was 66. This can be seen on the chart.

The computer now averages the two short entries and gives a total short entry of 61.
You can do this yourself...........(56+66)/2=122/2=61.

We now stand in a much better position with our trade. A short entry of 61 is better than a short entry of 56.

The trade then went down again to hit the lower BB with profit but not enough, then up again to hit the top BB with 2 candles, then down again to touch the bottom BB (again small profit), then up again to the top BB and ..............yep, down again.

Up, down, up, down, up ,down.................................roller coaster.

At this point I had enough and exited at 50 pips shown by the black vertical dashed line on the right of the screen.
A profit of 11 pips (61-50=11).

Note that I am giving only the last two figures of the price. I do this to keep things simple so that the principles here may be understood. I could easily give the full price, but I have found that from everyone else doing this, that it is confusing at times.

Conclusion ;

Careful adding to a position can give you a much better entry.

The best place to add to the position would be at the upper Bolinger band.
The price here reached 78. The average........(56+78)/2=134/2=67.

At exit 50, a profit of 17 pips would hve been gained. (67-50=17)

So where do we set the stop loss ??

[tymen1]

Now we look at the main chart of the trade just explained in the previous 5 minute chart >>>


By tymen1 at 2008-04-18

The evening star is shown in blue. It is actually constructed of 5 candles in this case, with the two previous green candles also making up the pattern.

If we look at it that way we see again that the red body of the last candle hardly reaches the mid point of our 1st candle of the 5 candle series.

This lower quality candle pattern combined with a powerful upward moving upper Bolinger band makes for a trade that does not really go anywhere. My exit point is shown by the black letter "E".

Had I stayed in this trade then the price would have gone right against me (yellow area) and broken thro the highest stop loss I could set (3 pips above top of star).

The yellow area shows a dark cloud (short trade) cover and after this the price went right down.

A two pattern principle can be seen here.

I will go into more detail about this tomorrow and we can arrive at a conclusion.

[mytwopips]

Hi Tymen,
Have you looked at all of your past winning trades to study if the tighter stop would have turned any of them into losers? Maybe the chart that you posted earlier gives a hint at the answer but not concrete. Sorry if I have missed something.

Also, if you have been consistently successful with your setups, why fix what is not broken? Or is that just the perfectionist coming out in you

[bernbeach]

Hi Tymen,
So I see you are in full action again I have a query: I am NOT a 5' or 15' scalper. I work with daily, 4hr & 30' charts. Could you give some practical ex. with screen pictures of your strategy? Thanks again in advance. Best Bern

[tymen1]

Originally Posted by bernbeach

Hi Tymen,
I have a query: I am NOT a 5' or 15' scalper. I work with daily, 4hr & 30' charts. Could you give some practical ex. with screen pictures of your strategy? Thanks again in advance. Best Bern

Coming up!

Just let me finish my comments here first regarding stop loss positions and risk/reward ratios for short term charting.
The relevant pictures for this have already been placed on Image Shack.

You request will need new pictures.

[tymen1]

Stop loss positions and risk/reward ratios.

Have a look at the following dynamic chart (20 minute) showing a wonderful long trade if you can get it.


By tymen1 at 2008-04-18

Wow, what a rise!

The Bolinger bands have really opened right up and the average (mid band) is going up like there is no tomorrow!

The price action is up there with it, walking the upper BB. Great is the smile of the long trader.

Now, what would happen if an evening star pattern were to appear??

[tymen1]

Well, wad-da-ya-know!

Here is one right now!! >>>


By tymen1 at 2008-04-18

So what happened? Did the price go down?

Nope.

Went sideways and after that.............who knows?

It looks like the evening star delivered the price a knockout blow. The price is now staggering around disoriented.

It could get up again - look at the gap between the price and the upper BB!
It may also fall over and crash to the ground (go down - short).

Lets look further.

[tymen1]

In this chart I have added a MACD >>>


By tymen1 at 2008-04-18

The MACD appears to have reached the top of a hill. This could give us some confidence that the price is not likely to rise further.

But, as we now know, indicators are lagging and they display what the price has done - not what the price will do next. The price action could go dramatically and the MACD will simply rise again.

At this point, a stop loss set at the top of the "star" body rather than the very top of the wick seems suitable. Two green candles followed the 3rd red evening star pattern candle. These two candles bring the price action very close (1 pip) to such a stop loss.

Now, if you used the staged entry method by adding to your position then your averaged entry would be quite close to your stop loss.

Lets look further :