THE JOY OF CANDLESTICK TRADING - a Learning Experience

Beginner Questions
366

[B]In our search for a correct risk/reward ratio for short term candlestick trading,[/B] 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.

[U]Conclusion [/U]: A stop loss placed at 2000 would see the winning trades able to retrace and then produce profit. The trades that would ultimately lose [U]anyway[/U], 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 [U]not retrace/pullback above the mid point of the 3rd candle[/U] 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.

367

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.

[B]Quality candles are needed.[/B]

368

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

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 [U]short entry [/U] 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 [U]going down[/U], BB [U]level[/U], resultant [U]down[/U], giving a [U]below middle band entry[/U], was acted on immediately and gave a short entry of 56.

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

[B]I will remain on this 5 min chart throughout the trade.[/B]

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 [U]two short[/U] entries and gives a total [U]short [/U]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. :frowning: :frowning:

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 [U]simple [/U]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.

[U]Conclusion[/U] ;

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)

[B]So where do we set the stop loss ??[/B]

369

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.

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

370

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:)

371

Hi Tymen,
So I see you are in full action again :slight_smile: I have a query: I am [I][B]NOT[/B][/I] 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

372

Coming up! :slight_smile:

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.

373

[B]Stop loss positions and risk/reward ratios.[/B]

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. :smiley: :smiley:

[B]Now, what would happen if an evening star pattern were to appear??[/B]

374

[B]Well, wad-da-ya-know![/B]

[B]Here is one right now!![/B] :smiley: :smiley: >>>


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).
[B]
Lets look further.[/B]

375

[B]In this chart I have added a MACD [/B] >>>


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.

[B]Lets look further :[/B]

376

This chart shows the final outcome. >>>


By tymen1 at 2008-04-22

Horay, the price went down by some 60 pips!! (pink arrow)

But, oh, woe! The orange arrow shows the price action going above our stop loss! (set 3 pips above the top of the star body)
In this trade we will have to revert to our original stop loss position (3 pips above the star wick) to make a profit.

But does this protect us?

Given that…

  1. We place our stop loss 3 pips above the star wick. (diagrams following next post)
    2)We use the 5 min KC entry method to get the best [U]short [/U]entry with [U]half [/U]of our allocated lots.
  2. We add the final lots to our position upon the maximum retrace/pullback so that the computer averages our position to get an even [U]better short entry[/U].

…we have an excellent risk/reward ratio.

A [U]risk [/U]of some 30/35 pips from [U]averaged best short entry[/U] to stop loss.
A [U]reward [/U]of some 60 pips from [U]averaged best short entry [/U]to exit.

But what about our win/lose ratio?

[B]Next chart ![/B]

377

[B]Below is a 40 minute chart of a similar situation but different currency pair [/B]>>>


By tymen1 at 2008-04-18

There are two evening stars here.

The price has been rising rapidly, walking the upper BB. The yellow evening star knocks it for a sixer and sends it staggering sideways.

With the highest stop loss and careful entry using the [U]KC method [/U]with an [U]added to position[/U] short entry, you can manage a profit on this candle pattern.

The maximum profit is about 20 pips and the stop loss distance is also about 20 pips giving a 1:1 risk/reward.

But it must be done quickly because down the track the price shoots straight tho our stop loss.

The blue evening star is much better. It takes the staggering price action and gives it the final knock down to the floor!
A stop loss here can be safely set at 50% of the length of the 3rd candle of the pattern.
Thus we get a stop loss of about 15 and a reward of about 50.

Much better! :smiley:

So what is the difference?

The next post will give final answers. (I have not forgotten Bernbeach and long term charts)

[B]Tomorrow !!! [/B] :smiley: :smiley:

378

So just to clarify that a evening star pattern can have a long upper wick as well? I am kinda confused of identifying. My image of that pattern is skewed. On the one pattern the upper wick is real long and the lower wick is short. In a few posts back it said that to get a ‘confirmation’ of a evening star pattern the lower wick needs to go close or past half of the first candle in the pattern. If it has a long upper wick and you can eyeball it, does the same apply?

I think I am getting a hang of these things… now if I can just get used to GFT… some of the stuff of it is kinda hard to figure out… like zooming OUT. I can zoom in no problem… lol

So much information to learn… candle sticks have my undivided attention!

379

OK, lets get this right. [U]Refer to the 2nd candle ie the “star” candle.[/U]

The upper wick can be as long or short as you want - even no wick!

The lower wick of this 2nd candle should, ideally, not go past the halfway point of the 1st candle of the pattern.

Now, this is a perfect situation. In reality great variations occur.

Refer again to this hyperlink to get that “skewed” image corrected once and for all.

Japanese Candlestick Charting Explained

Yes, there is much to learn - but it will pay you big dividends if you can live with it!! :slight_smile: :slight_smile: :slight_smile:

Good trading to you! :slight_smile:

380

The following diagram shows what has been happening in the last few charts I have posted. Notes below the chart >>>


By tymen1 at 2008-04-22

In this diagram an extreme rising upper Bolinger band is shown in blue. The price action walks the band, is shown in pink. An evening star appears.

[U]This is surely the most extreme case you will ever encounter[/U] in trading an evening star. The upper and lower Bolinger bands together look like the open end of a trumpet.
The price is going long extremely strongly and we are expecting the evening star to turn this around promptly into a short trade.

No way!

From extreme optimism to sudden extreme pessimism. I don’t think so! :wink:

In this totally extreme case the evening star knocks the price sideways for a time. But then 3 tracks become possible. They are shown.

Only one of these three will safely go on to produce a good profit - the other two going long past the stop loss.

There is then, the possibility of sniper trading while the price action is still level. However, this is very risky - we do not know when the price action will change track, and which track it will follow.

So if we forget about the sniper trade, are we effectively gambling to go onto this trade to get that good profit?
Do you like casinos?

1 chance in 3? Although the green track may be the least likely of them. Still, you have to contend with the possibility of the orange track.

The [U]best [/U]chance here is to wait until another evening star or similar short producing pattern appears. This was shown in the previous chart labelled “price drops immediately”.

Note here 2 things :

  1. The blue highlighted pattern was superior to the yellow highlighted one. The 3rd red candle was much longer in this pattern and went past the 1st green one. Not so in the yellow highlighted pattern.
    The 2nd evening star, is, therfore, a superior evening star pattern.

  2. The Bolinger band in the blue highlighted pattern is [U]level[/U]. This is [U]VERY IMPORTANT![/U]. You look at the Bolinger band at the [U]close [/U]of the [U]3rd candle[/U] to discern this correctly.
    Clearly the 1st pattern BB is at an extreme extension (together with the lower BB it looks like the opening end of a trumpet).
    The 2nd pattern BB is much more sedate and, indicates that a short trade has a great probability of success here.

[B]Next post >[/B]

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[B]We are now in a position to make some conclusions [/B]:

Using the above extreme case as a parameter, we are able to develop some guide lines for setting our risk/reward ratio.

We must get better trades. What is a better trade?

[B]In better trades :

  1. We allow the trade to run its full length to get maximum pips.

  2. We set the stop loss as short as possible.[/B]

Now looking at the extreme case above…

  1. We look for [U]quality evening star candle patterns[/U] - ones where the 3rd red candle is as long as possible.
  2. We [U]examine the BB[/U] to see what the spread of both the upper and lower are like.

In extreme cases, we can dare a sniper trade but risk the health of our stop loss. The stop loss in this case should be place about 3 pips above the star wick.

In these extreme cases, it is better to await another candlestick pattern.
If not, then avoiding this trade is a safe move.

If the BB is level after the 3rd candle, [U]and [/U]we have a quality pattern, then the stop loss could be set at the halfway mark of the 3rd candle. This would make a great improvement in the stop loss distance.
The price action here is likely to go straight down or, at worst retrace only slightly.
Good profit potential exists.

In between senarios can have a stop loss set at the [U]top of the body of the 3rd red candle.[/U]
Such senarios are cases where the pattern is not the best but the BB is relatively level or even going down.

In all cases, the staged entry is used to get the maximum best short entry.

I hope all this helps.

[B]I invite all comments and suggestions.[/B]

382

Tymen ; Most enlightening , I see why you have been sucessfull with this srategy… I can only hope my mind can absorb enough of this great information. :stuck_out_tongue:

383

3 suggested stop loss positions are given below >>>


By tymen1 at 2008-04-24

  1. The [U]high risk[/U] position is 3 pips above the [U]wick [/U]of the star candle.

  2. The [U]medium risk[/U] position is 1/2 pips above the 3rd candle [U]body [/U]as shown.

  3. The [U]low risk[/U] position is 1/2 pips above the [U]mid point[/U] of the 3rd candle.

384

Hi Tymen,

I think you just answered one of my questions I haven’t asked yet; when to choose which stop - depending on quality of pattern.

I guess it takes experience to discern which patterns are quality and which aren’t (I would have taken the yellow pattern, seeing how I don’t know that the blue pattern is coming). That BB tip should help though.

Could you elaborate a little futher on the Macd action you mentioned?

Would you target 10 pips no matter the timeframe?

Have a good one.

385

I would not worry too much about that MACD on that “trumpet” chart. It is of no help to us at all really. Remember, it is lagging. But I put it on to show that the price was temporarily at a level point.

I take it this is the MACD you are talking about.

The second question was answered with my statement previously :

In better trades :

  1. We allow the trade to run its full length to get maximum pips.

The next post should be of particular interest to you.